Integrated Investing
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When will I get my money back?
What are the potential outcomes from this investment opportunity that will please me?
Can I trust the entrepreneur and their team with my money?
The first question is about return of capital. The second question is about return on capital. Often, the third question is the most important. How the entrepreneur answers the first two questions can provide insight into whether they can be trusted. If the investor can trust the entrepreneur, they will be in a better position to get their money back and get a return on investment. The integrated investing toolkit is designed to help you, the investor, gather the information needed to answer these three major questions.
The toolkit is a combination of traditional investment evaluation tools that are useful and applicable to impact investing; venture development and evaluation tools; and impact identification and evaluation tools.
The traditional investment evaluation tools are a selection of analysis-based approaches that have been used for decades to evaluate investment opportunities. They focus on financial outcomes and commercial impact, so even though they are useful in an impact investing context, they need to be complemented by other tools particular to impact and early-stage venture opportunities. Useful traditional investment evaluation tools include due diligence checklists, scenario analysis, SWOT analysis, and financial analysis.
Venture development and evaluation tools are tools that have been in development since the year 2000. The business model canvas and seven domains model, conceived originally for entrepreneurs starting new ventures to help them design new business models and to evaluate their team, market, and industry as they were just starting out, are just as useful from an investor’s perspective.
Impact identification and evaluation tools are new tools that I developed to help impact investors assess the impact of an opportunity. One of the tools is based on the impact concept of access to essential resources that was introduced in Chapter 1. Another tool is a variation of the business model canvas, but with a focus on the impact in each component of a business model. The third impact evaluation tool is a form of cost/benefit analysis that takes into consideration the cost and benefit to a number of different stakeholder groups within and around a venture.
It is the integration of traditional investment evaluation tools, venture development and evaluation tools, and impact identification and evaluation tools that gives you, the integrated investor, a complete set of processes and methods for ascertaining investment opportunities that are a good fit for you and have a good chance of achieving the blended financial and social returns you’re looking for. This is the first investment methodology that combines elements from traditional, venture, and impact investment; to date, they have all operated differently. Combining useful tools from each of these investment worlds is a radical new concept that is powerful for you as an integrated investor seeking financial and social returns.
Traditional Evaluation Tools
Traditional investment evaluation tools have been used by people evaluating a wide variety of investment opportunities of all sizes, from opportunities oriented only toward profit to impact investing. Traditional evaluation tools help you gather current and historical information about the entrepreneur, the venture, and the investment opportunity. Some traditional tools, such as analyzing financial projections and scenario analysis, help you evaluate assumptions and to make guesses about what the future might look like for the investment opportunity in front of you.
Traditional evaluation tools rely heavily on analysis and require you to have a benchmark to compare against. Comparing to and contrasting against a benchmark helps you use the information you gather to decide whether the investment opportunity is a good or bad fit for you.
To truly decide if the opportunity is the right fit for you, however, you still need to apply integrated decision making.
DUE DILIGENCE CHECKLISTS
A due diligence checklist is a useful memory aid. It can remind you exactly what information you need to gather from an entrepreneur about them, their team, their venture, and the opportunity they are addressing.
An example due diligence checklist is referenced in the Further Reading section at the end of this book. You may want to add items that you feel would help you in your decision making and tailor a due diligence checklist to meet your specific needs. Bear in mind, though, that it is unlikely you will be able to collect everything on the list. For one, not all the information will be available at such an early stage for a venture. In some cases, not all of it will even be relevant.
Prioritize the information from the due diligence checklist depending upon the opportunity and circumstance to help you answer your major questions.
SCENARIO ANALYSIS
Whereas a due diligence checklist helps you gather current and historical information about an investment opportunity, scenario analysis helps you imagine and evaluate the future of a venture. I think of it as future-oriented research.
While it is impossible to completely predict the future, scenario analysis helps you anticipate possible twists and turns with your venture. It helps you imagine how things might turn out in the short to medium term. The scenarios may or may not happen, but analyzing their potential can help you be prepared.
At the heart of scenario analysis lies the question, “If this happens, then what?” Scenario analysis involves a number of future-oriented questions:
What if the management team’s assumptions come true?
What if the assumptions you are making about the business come true?
What if the business exceeds expectations or outperforms the assumptions?
What if the assumptions do not prove to be true?
What if you made a different assumption or the management team chose a different route forward?
What future actions might you have to take to help the business achieve its greatest potential and be successful? What if the management team followed your advice and took those actions?
Scenario analysis is not meant to be exhaustive. It is an opportunity to imagine the future for the business and not take the management team’s assumptions, or your own, at face value. Go deeper into the scenario analysis by asking “Then what?” at least three times as you imagine a future path.
ANALYZING FINANCIAL PROJECTIONS
Recall the three main questions on your mind as an investor mentioned earlier in this chapter. Analyzing financial projections prepared by a business’s management team can help you answer these questions because projections give an indication of the path the team and the venture are on, including the potential profit, revenues, and other financial measures of progress. With this information, you can make a guess about the current and future valuation of the venture. Financial projections can give you an idea about whether there will be growth in the valuation, and if there is a potential exit. This sheds some light on two of your central questions: When will you get your money back and what outcomes will please me?
For financial projections to be meaningful to you, you need a benchmark or expectation that you can use as a comparison. Potential outcomes that are better than your benchmark or expectation will please you.
When I see that a management team has done their homework and gone through the trouble of preparing intelligent, robust financial projections, I feel that they have thought about the assumptions and factors affecting their business, tested some of them, and are being open about the variables that remain guesses and estimates. This is an early indication of the management team’s ability to plan for, manage, and direct the business. It gives me a glimpse into how they make decisions, and gives me greater confidence in the team. It makes me feel I can trust them with my investment.
The assumptions underlying financial projections are just as important as the projections themselves. Look at whether the assumptions are both realistic and ambitious. Are the assumptions and projections exciting? Does the entrepreneur know what has been tested a
nd what is a guess?
Some of the things related to financial projections that you might ask for include the following:
Past financial performance to date, if it exists
Two- to three-year projections
Here are questions you can ask about the financial projections:
What assumptions did the entrepreneur make?
Have they tested as many assumptions as they could?
Are they transparent about the unknowns?
Is there a balance between big vision and realism?
Do you want to take a leap of faith with the entrepreneur based on the information you have gathered or analyzed?
SWOT ANALYSIS
SWOT stands for strengths, weaknesses, opportunities, and threats. It is a risk evaluation tool that helps investors capture the positive and negative aspects of an investment opportunity on a matrix.
Strengths : Think about the positive features of the venture you’re evaluating that are internal to the business. Examples could be the experience and track record of the management team, the attractiveness of the venture’s product or service, the team’s ability to attract customers, the list of customers the business has already attracted, or the impressive group of advisors that surround the venture.
Weaknesses : These are the negative internal features of the venture. Examples of weaknesses to look out for in a venture include gaps in skills and experience within the management team, shortcomings in the product or service, and a lack of basic systems and processes that will allow the business to deliver its products and services.
Opportunities : These are positive factors that are external to the venture—for example, trends amongst significant groups of potential customers. Changes in technology, the economy, society, and political environment that favor the venture’s business could also be opportunities.
Threats : External factors with a negative effect on the venture are threats. These include fierce competition, potential downturns in the market the venture is operating in, and economic, societal and political variables that could negatively affect the venture’s ability to operate and succeed.
RISK ANALYSIS
Risk analysis entails identifying events or factors that could cause loss of resources, cause delays to desired time frames, jeopardize the success of a project, or circumvent desired outcomes. Risk analysis also includes evaluating the degree of potential risk and identifying ways to mitigate or manage it. Risk analysis is the process of considering the downside of situations and gathering information to make decisions in the event of something undesirable happening.
Below is an example of how information about potential risks can be gathered. When identifying risk, providing some information about its potential impact is helpful for decision making. More importantly, it is best not to leave a risk unaddressed. Thinking ahead about how to mitigate or manage risk, including further information required or next steps to take, helps you be more prepared and enter into an investment relationship with eyes open.
EXAMPLE OF A RISK TABLE
Risk Identified How to Mitigate or Manage the Risk
Example: highly competitive, crowded industry Example: patented intellectual property, first mover and leader in the industry, rapid customer adoption
Example: first-time founders, risk of lack of experience Example: in operation for more than two years, demonstrated ability to attract customers and deliver value and impact
Venture Development and Evaluation Tools
In the 2000s, a methodology and set of tools emerged to help entrepreneurs develop their ventures in a more efficient, lean way. It was called lean startup methodology, and it was created as an attempt to test hypotheses quickly, develop quick prototypes called minimum viable products, and build a startup venture in an agile, responsive, and flexible way, rather than wasting a lot of resources on going down an uncertain path and subsequent failing.
When I encountered this methodology, I thought, If this is how ventures are now being built, we investors need to make sure our tools for evaluating ventures catch up to the tools the entrepreneurs are using to build them . I looked at the lean startup methodology and I took two tools I thought would be useful in evaluating ventures as investment opportunities: the business model canvas and the seven domains model.
Getting Started, Starting Lean
In January 2012, I was fortunate to attend a small conference for startup entrepreneurs in London called Leancamp. It convened expert speakers and local entrepreneurs to share knowledge and techniques for developing new ventures using the lean startup methodology and related tools. I was in the early stages of developing Pique Ventures, my impact investment management and consulting business. At that time, I was exploring different investment models and was still in my own customer discovery phase. I hadn’t yet decided to build and launch Pique Fund. Not only were the tools I learned at Leancamp useful for me in the development of my own business, they gave me a more in-depth understanding of the venture development challenges and opportunities that entrepreneurs (people that I could be investing in) face, and it gave me insight into tools that would later become useful for the integrated investing toolkit.
The lean startup methodology first started getting attention in 2011 after Eric Ries, an entrepreneur and former chief technology officer for a startup called IMVU , published a book under that name. Lean startup’s origins come from the Japanese concept of lean manufacturing, an approach to making products in a customer-focused way. The approach seeks to eliminate any steps from the manufacturing process that are wasteful and do not create value for the end customer. Ries applied and modified the lean approach of manufacturing to starting and growing a business.
At Leancamp, I heard Eric Ries speak, and I also attended talks by Alexander Osterwalder, the co-creator of the business model canvas, and by John Mullins, a professor at the London Business School who developed the seven domains model, author of The New Business Road Test , and coauthor of Getting to Plan B. I adopted and applied these tools to help investors evaluate businesses as potential investment opportunities.
BUSINESS MODEL CANVAS
The business model canvas1 was a crowdsourced innovation. To create it, Alexander Osterwalder and Yves Pigneur sought out the perspectives and contributions of 470 business practitioners from forty-five countries. The outcome was a visual representation of nine key components of a company or organization’s business model that describes its value proposition, customers, infrastructure, and finances.
The nine key components are described in further detail below:
VALUE:
Value proposition: The products and services a business offers to meet the needs of its customers. A venture’s value proposition is what distinguishes it from its competitors.
CUSTOMERS:
Customer segment(s): The set or sets of customers that the company is trying to serve. This could be mass market or niche, a specific demographic, or profile of customer. If the venture is trying to serve too many customer segments (or everyone), that’s a red flag that it has not figured out who they are actually serving.
Customer relationships: How the venture interacts with its customers. For example, a customer relationship could be spoken, online, automated, through a community, or co-created.
Channels: How the venture’s products and services reach its customers—that is, the company’s distribution channels.
INFRASTRUCTURE:
Key partners: The other people, businesses, and organizations that the venture needs to deliver its products and services. Key partners can include suppliers, staff and contractors, and other production or delivery partners.
Key activities: The actions and processes required by the venture and its partners to deliver the products and services. This includes, but is not limited to, production, processing, sales and marketing, and communications.
Key resources: The materials, inputs, and people power required to deliver the products and services. These resource
s can be human, financial, physical, and intellectual.
FINANCES:
Revenue streams: The way a venture generates income from each customer segment—for example, directly selling a product or service, subscription fees, licensing fees, or advertising.
Cost structure: The expenses and costs of operating the venture, including fixed and variable costs, salaries and wages, and economies of scale or scope.
I like using the business model canvas in my evaluation toolkit because it enables an entrepreneur to quickly communicate their business model to me. For investors, it does require that you have an understanding of different models to compare to (the book Business Model Generation provides a number of examples of different types of business models, if you want to learn more). By comparing a venture’s business model canvas to other business models you know, you can begin to evaluate whether the business model of the venture you are considering makes sense, whether there are any specific strengths or weaknesses in it, and which components require further investigation.
SEVEN DOMAINS MODEL
The seven domains model was developed by John Mullins, a professor at the London School of Business. It reminds you to look at seven key factors in a venture—factors that Mullins categorizes into three groups: market, industry, and team. There are two market domains (macro and micro), two industry domains (again, macro and micro), and three team domains.