Paul Kedrosky’s research had pointed out, it takes a VC to invest $50 million and be in the industry for seven years to make a good VC. Since the last 4 years, I have been working in a real estate private equity fund. I have been involved in deals worth more than USD 100 millions and although I have not completed 7 years in the investments business, I would like to believe that I am nearly there in becoming a good investor.
Here are my key learnings of the last few years:
Understanding the business: This sounds so obvious and simple and yet is the most difficult part to achieve. Often it does not require very sharp intellect but rigour, perseverance and patience of a good learner. The best guide in understanding the business is not research reports but by actually experiencing the business. The best real estate fund managers have been developers, some of the finest VC investors have been technology entrepreneurs themselves. The rationale is obvious; people who have been there and done that know the nuances of the business better than others and hence can evaluate a deal much more easily. If you do not have the business experience it is a good idea to actually ‘work’ in such a company before hand. So you can work at a developer’s office, a solar power generating company, a bio gas plant etc for 10-15 days to get a first hand knowledge of the challenges faced in such businesses (before evaluating real estate or a clean energy deal). This is difficult to achieve, but if possible, is one of the best ways to evaluate a deal.
Understanding the business model of the customers of the business in which you are investing: Following are some of the basic questions that should be asked:
- Can they afford the product that your company is making?
- What choices do they have?
- How easy/difficult is it for them to substitute your company?
- What is the dependency on your company and the overall industry?
Conversations with industry experts are often an easy and quick way to have insights. This also gives an idea about the competitive scenario prevailing in the market and the kind of challenges your investee company could face. For example, if investors had the patience of studying the financial statements of retailers in 2005, 2006, 2007, it would have clearly shown the huge losses and the big problems that the retailers were facing. One need not wait for a Lehman crisis to understand the troubles of investing in shopping malls.
Entrepreneur: It is a well accepted fact that the biggest factor in an investment decision is the entrepreneur himself. Everything else becomes secondary. I wont dwell too much on this; just 2 points:
- Spending time with the entrepreneur. It is very important to spend atleast 50-60 hours with the entrepreneur before putting money on him. This need not be in serious meetings in the office but could be for a drinking session or a lunch/dinner meeting with friends. The idea is to know him personally. It is surprising how much information one can get in casual settings rather than a Q & A session in the Board Room.
- Another important factor is to also know about the circle of influence of the entrepreneur. Who are the key people that he/she listens to? It is very important to touch base and connect with such people.
All said and done, at the end of the day, there is some amount of crystal ball gazing that takes place and there is no substitute for great insight. Happy Investing !