Management – An Intrinsic View

This is a follow up on the post ‘The ABC of Investing in a young business. I gave a brief outline of various pieces that contribute to the puzzle of a successful business. Whereas the end game is making money in investment in a company, management plays a great role to achieve this. Last year we saw CMC motors suspended from the NSE as management/ directors had gotten greedy and neglected their fiduciary duties to the investors. Uchumi is a company that was almost brought to its knees and only the intervention of the government to aid the company from collapse could it be able to provide the turn around. The above cases are extreme, but there are times where passive management contributes in a market leader being overtaken by technology and competitors. In 1990s, Kodak was the largest manufacturer of camera and film, so huge was it in this market that they coined a name off its product-The Kodak moment. Management led the company to its collapse, they did not only ignore the digital camera they invented but also neglected the rise of technology in photography. Recent companies like Blackberry, Sony among others, market leaders in their own right have lost their place on the board to aggressive and innovative companies; a direct result of effective management.

So what are the characteristics needed in management of a company you want to invest in, or as a business owner what characteristics are expected from me when I am raising capital? These attributes traverse across the companies regardless of the stage on growth, and whether they are multinationals or simple local startups.

Honesty and integrity- A simple lie, overstatement of figures, miscommunication can result in lack of trust between an Investor and the business owner. Huge deals have been abandoned at the last moment as trust was broken between the two parties. A story is told of two investors who went to tour a milling company that was seeking investment. As they were doing the rounds checking the physical assets, they met a worker busy packaging the flour. One of them stopped to ask her how many packets she packed per day, she replied- I don’t know, I was hired the other day and was told to look busy as some Big shots were coming over and she was instructed to look busy. That company lost credibility in an instant.

Experience- This still remains a very vital aspect. An investor gains comfort from the fact that the person running the business has vast experience in the industry. For an exporting company, the person will need to know his way round packaging, transport, payment arrangements with the buyers etc. That been said a substitute to this is when the person has extensive knowledge in a particular field that it supersedes experience if they are no experienced competitors in that industry.

Achievement-This is not necessarily tied to the business though it is an advantage. What the entrepreneur has accomplished at a personal level show the kind of drive he possesses. They have the spark that lights a dark room, high achievers and an investor is comfortable betting big on them

High energy Level-The making of a great company requires a lot of hard work input, the ability to go the extra mile. Entrepreneurs with high energy level are able to consistently operate at high capacity. It is a case of 1% inspiration and 99% perspiration

Motivation- Ask any great runner what pushes him/her past to run faster after clocking 38km, the prize awaiting them at mark 42km. Every business owner should identify what he/she wants to accomplish, why he chooses to do. Making money is a great motivator but focusing only on that opens the door for greed. Every professional is driven by a cause; a doctor to treat people, a farmer to feed people. To maximize the cause with profits is a perfect blend. You should be able to answer the questions- Why do you want to do all of this, knowing it is going to take time out of your life? Why is it you want to get involved in this difficult situation?

Young Yet Profound

Every large company that exists starts somewhere. Most are ideas in peoples head driven by demand and innovation to become industry leaders. While there are those that benefit from government involvement- regulation, subsidies, quota systems etc.; all in one way or another have the following characteristics that shall be listed below. A case for Safaricom stemming off from Kenya post & telecommunication or Equity bank from a farmers Sacco, they identify niches in the market that they exploited and the resultant growth inevitable.

Life Cycle of a young company

Various Stages of funding for a company

To properly understand young companies, we must internalize their growth. The figure above shows a company through its early stages of the cycle. At the ideas stage, most investors shun away from investments, as they companies look very good on paper and referring to the earlier post- The ABC of investing in a young business, numbers are key. Investors want to see steady revenue; they want to see how a company values and prices its product or service and how the industry receives the product.  This company is young and depending on the actual position in the life cycle, it might be spending money and not having revenues. They are different investment strategies among investors and few opt for this segment in their portfolio due to the high risk of failure. In the example of restaurants, 75% close down or change ownership in the first one year, yet the ones that make it become great. Twitter and LinkedIn have gone through several rounds of funding to be where they are. This industry sees the highest expected return in any investment short of a Ponzi scheme; 50%-60% aren’t unreasonable targets for IRR, though they may be on the higher side.

So what defines these young companies?

Innovation

The ability to integrate and incorporate new approaches and methodologies in solving problems make these companies stand out. Radical innovation- that which disrupts traditional economic mechanisms as the established firms find it costly to implement change. You will get the tee shirts not from a large scale manufacturer but from your neighbor who can customize your ideal print on the tee shirts.

Employment

The don’t usually offer the most paying jobs in the market but young companies provide  the largest supply of new jobs to an industry. Any government that seeks to reduce unemployment should facilitate creation of business as they have a larger ripple effect in the economy than say EABL adding more staff to its payroll

Economic Growth

Since most young companies are high growth companies, they tend to outperform the economy in growth, contributing to the GDP of the economy. A case in Kenya the banks performance has been boosted by the lending to SME, a case of Equity for example.

One thing that its clear to grow a company one needs money, period

The ABC of Investing in a Young Business

As an investor, you are presented with many opportunities to invest in various business ventures. If you are an Investment analyst in the P.E world, these request are a dime a dozen. Angel investors listen to people pitch their ideas for funding. At ilab, at Strathmore, they have a pitch Friday where various techies get to discuss their ideas in front of a panel composed of their peers, investors and mentors.

The real question remains. What constitutes a great investment? How do you identify a business that if you put your money it shall grow tenfold? That is the question every investor seeks to be answered. That been said you can be able to differentiate the grey from the white, key signs that usually determine whether the business is worth a second look. Kindly note that only angel investor will listen to an idea that is not running yet; they are few in number and in Kenya, even fewer.

I shall focus on the venture capitalist investing in a business. The most important aspect that he looks at is the numbers. The business is lucrative at first look, but what a VC asks is how will the investment grow the business? The financials must be accurate or near accurate. The beauty about this stage of investment is that the business usually has no complex structure either in operation or ownership and through valuation one is able to get an enterprise value pre-investment. The story on valuation is a blog-post on its own but for explanation basis; we need to determine the value of the company before the investment.

Second aspect is that the investment must make a lot of money, or be a high growth company for exit either to a P.E company or through an IPO. An exit is the point at which the investor sells his stake either to a P.E company, sell his holdings through a securities exchange or sell back to the business owner. As stated above this target business can be making a lot of money but it needs that money to grow such that a proper investor should rather have his investment worth a lot than require a certain cash payment each year.

The most vital part though usually ranked third is management. The owner of the business is the key feature to the success of the business. The must be knowledgeable in the field they are operating in. It might be a lucrative business model but the owner does not understand the industry. A good example is having an IT specialist start a transport company; it clearly needs someone with experience in the industry. This is the rule and not the exception, as we clearly know of people with a Midas touch, people who are successful in any endeavor they pursue.