Choosing Your Investors Wisely
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The trouble with being principled is that people often see this as a sign of weakness that they can exploit.
I invested in a Cape-based start-up a few years ago. The problem with the investment from the outset was that it was a syndicated deal, with more than one investor involved. In syndicated deals, each investor may take a different approach and have a specific philosophy when making their investment decisions. Unfortunately, what reigns supreme for one investor may not be the same as for another.
Most entrepreneurs never consider this. In the highly regulated and often rigid capital markets of South Africa, most entrepreneurs are so overwhelmed to get a meeting that they never ask these questions of the investor:
- What is your investment philosophy?
- What is your investment approach?
- Can you show me your tombstones?
- What is your mosaic theory?
The truth about investors
Here’s the unvarnished truth: In South Africa the investment committee (in particular venture capital as an asset class) is full of people who have not thought through these questions. Drafting a PPM (private placement memorandum), raising capital or managing GPs (gross profits) is only one part of the value chain and only answers two of the above questions.
Since establishing our fund in the UK, we as a firm — and I as an individual and leader — have had to go through a steep learning curve to understand this asset class.
Over the course of the Cape-based investment we have had to make several recapitalisations. This is common in highly risky asset classes like venture capital. I assumed that the other investors simply wanted the same things that I did: Growth in organic revenues that would lead to a rise in the equity of the business and healthy exit multiples.
Therein lies the problem, because while this seems simple enough, how you get there is a vitally important part of the equation. Even if your end goal is the same, if the approaches vary, there will be friction between investors.
Different values and methods
What we have realised along this journey is that the way we invest (approach), why we invest (philosophy) and when we invest and divest (tombstones) differs radically from some of our co-investors. They want quick metric growth. Metric growth leads to valuation growth. Priced correctly, this will deliver a healthy exit multiple.
We are more Warren Buffet than Marc Andreessen. We want long-term, controlled growth supported by a real focus on the development of the entrepreneurs themselves.
We spend a long time understanding the business of the entrepreneur and diagnosing risks and inefficiencies, not only so we can price them, but so that we can deploy assets to fix areas that need attention.
We handhold our entrepreneurs as they build their businesses. You’d be surprised by how many black equity investors, who, understanding the past and how it denied them the knowledge of how to build a business, talk about developing black entrepreneurs on their marketing platforms but when pressed, don’t have a tested process to build entrepreneurs.
There is a prevalent (and lazy) assumption that investment is the development the entrepreneur needs.
Making a match
Entrepreneurs in South Africa need to learn that building a business is tough. It doesn’t happen overnight and the results and gratification are often delayed. The most important decision you will ever have to make in building your business is what kind of capital you will use and what kind of investors you will seek.
Don’t simply accept any investor that promises you the world. Make sure their philosophies align with your own, and that you can share a vision for your business and growth path.
Some of the most common promises that investors make include:
1. My big profile can help you build your business and brand
Test: Ask them what process they will follow in supporting your business, and can you meet another entrepreneur for whom they have done this.
2. We empower vulnerable groups like women, youth and those with disabilities
Test: Ask them how they price and factor the cost of including these vulnerable groups and how this focus helps you the entrepreneur build the business.
3. I will not invest capital but I will take equity in exchange for mentoring you
This is rubbish. Mentorship is mentorship and investments are investments. Nobody trusts an investment where there is no skin in the game.