[I’ve been pestering an associate for some time to guest author a post on hitting the wire as I believe he has a lot of wisdom to share. He’s a busy guy and I’ve nagged and bullied him for a good 6 months for this. Zuko, many thanks for graciously agreeing and not blacklisting my email address!
After a few sessions of analyzing the financial projections provided by entities his private equity firm were considering as investments I suggested he compile some advice for those hopeful souls who embark on that challenge.]
Here they are:
Keep it simple:- we have to be able to explain to others what you do and how you make money; real money – that stuff called “cash” – we’re primarily interested in the cash generation of your endeavour. Who pays you? When? Why is your service important to your clients? And yes, who are your targeted potential clients?
Build from a foundation:- what is unique about your business? why is no one else doing it? or why do you think you are different from everyone doing what you do?
Show your logic/workings:- we have to see the IP, and then believe it really is worth something, we might not believe it is the silver bullet you think it is, get over it. Prove it by stepping us through your assumptions and calculations.
Show your research:- why does client x need your particular service or product?
Be clear about your assumptions:- unless your business is going to show 25%+ returns over a 3-5 year period, you are not going to attract investors, however you shouldn’t try modeling with that as the input; be honest and realistic because we will hold you to those numbers. Granulation is key. Lots of spreadsheets that allow us to interrogate your logic are good; it shows you have worked on this project, a 1-pager ain’t going to get you money, but 400 pages of irrelevant data won’t either, so just be honest.
Use comments in the Excel workbook:- typically you will just have to explain your assumptions in detail, conservative is better than super bullish… call it honestly.
Be prepared to defend your model:- it’s your business: you have to have conviction, if you cant defend it you’re not going to get funded, period.
Admit your unknowns and know your limitations; its OK to admit these - you can’t be everything to everyone. In fact, we’re often looking for a niche player, but a player who is really good at what they do and whose clients must really want their product or service. Ideally there should be long term contracts of 2-3 years. Ideally.
Don’t jump!:- Avoid projecting large jumps in growth in this year or next. Steps in revenue or profit are OK, even drops - just explain them! We like surprises on the upside, not the down. We like to know quickly when things are not going to work out. We want alignment in terms of what bad results or lost contracts means, if it hurts us it must hurt you too and similarly on the upside. We don’t want your pain to be our advantage and visa versa. Good alignment is vital.
Track record:- Show what track record you have that lends credence to the future trends you’re showing, be careful to be honest here, we will do reference checks!
Industry norms:- Know them: growth potential, margins, etc. and state where your projections are bullish and why. Remember though that you don’t have to track the industry if your service/product is not going to do that, no substitute for telling it how it is.
Give us what we want to know:
- That you know your business.
- That you know your market.
- That you have done your homework.
- That you know yourself (your strengths & weaknesses).
- That your business has a good chance of growing to the degree where we can see a healthy return on our investment.
Substantiate:- We just have to uncover one area where you’ve used unfounded, unreasonable, unsubstantiated figures and we’ll begin to doubt the whole model. Then we wonder what else is misstated. We want to do this for the same reasons you did many moons ago, we like a good story, but we invest in things we understand and trust. It doesn’t have the change the world or mean something to anybody, but it must be a necessity to somebody and make us money.
Your skin in the game:- How much of your money/wealth are you risking? So what you have invested (by invested I mean hard cash) and how does this number relate to the number you want from us. If you are putting in 50% of the cash, great, the more even better! If less than that, then we’ll want more upside as we’ll be risking more. Then we also want to know or understand your balance sheet capability. Why aren’t you putting more in if you have money, especially if you expect us to put in 60%+ of the money?
No sweat?:- We are ok with sweat equity but that can’t be all your business is premised on in terms of goodwill unless you’re a Bill Gates (i.e. have a properly proven track record). So if 30% of your contribution is sweat to get the business to the level it is at, that’s OK, but the balance ideally should be cash (just like you want from us). It must hurt you too if this investment doesn’t work. We’re not big on personal sureties, but you must be on the hook and the best hook is cash.
We’re looking for a partner:- the chemistry must be there, you must be able to take us home - literally, if this business is important for you and your family then you should be telling your wife or confidant about us and you should be happy to have us as your partner. Look for things that we have in common, that’s what builds relationships.
What end?:- Think big - how big can this investment be? Build your business with the end in mind, how does this all end? For us, “heaps of cash when we cash out is pretty much our standard answer”. If you think Microsoft is going to buy this business you better have a silver bullet. Silver bullets are extremely rare in our view. For the rest we just want to know your business is sustainable and someone or some company will want to own it in the future, so you should be telling us who those companies are and why they would want it.
Numbers that makes us happy:- (and here I’m talking about PAPE) Typically in terms of return profiles, we want to invest R30-100m today on a roughly 3-5 PE multiple, meaning in 3-5 years we get all our money back. So that means at least at least 50% of the money we invest comes back in dividends or distributions in 3-5 years. In cash, ideally. It all comes back – that’s what a PE multiple tells us. Betting on the future beyond 5 years is not our strength unless you are a miner and have 20 years of reserves of a mineral that very few people have and clients who need it. In that instance we might even pay a 10x multiple as long as there is 15-20 year track record. So a dividend paying track record speaks volumes about cash generation, speaks volumes about alignment, we want you to want to pay out dividends, reinvesting free cash is important for longevity and sustainability but cash back in our account is also important and we hope it is important for you too. We love investing alongside a guy, he pays himself and us a dividend every year or twice a year and then goes skiing or upgrades his car and house...that’s beautiful! Then he starts buying back our shares... music! Then every two to three years he’s spotting the next best thing for this business.... brilliant!
On salaries, budgets, KPIs, etc. – salaries should be market related with 50%+ performance relate. Don’t sandbag the budget! - we expect double digit growth on decent margins, this is a growth company right? KPI’s:- let’s keep it simple; we don’t really want to monitor staff turnover or how much revenue grew, we’re only interested in value creation (long term) and growth in profitability (short term). What you do with the staff, where you have your strategy sessions, where you take your clients, how fancy your reports are, etc. is your baby. You do what you have to do...keep it clean, keep it honest. We don’t want to be sued and we don’t want to be embarrassed!
Sustaining the love:- If we sell the business and we’ve loved each other and typically the love is directly correlated to how much money we made together, and we find some other business, we will call you to partner and run the business and invest alongside us. Remember, we’re not managers of businesses, that’s what you do well. The less we meddle when you doing your thing the better, if the company is growing and paying dividends we will do as you tell us, literally.
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Dr Zuko Kubukeli is a quiet, unassuming, bloke with a PhD in Human Biology behind his name (although he’s more likely to be dissecting balance sheets than anything biological these days), a sharp mind and a nose for a good investments. My interactions with Zuko have been as a technical consultant on due diligences commissioned by Pan-African Private Equity Fund of which he is a principal. He can be reached on zkubukeli(at)pan-african.co.za
