Value and Valuation — Seeking and Finding

A White Paper

Firstly, I want to acknowledge Dr. Janmejaya Sinha for inspiring me to explore this topic in a structured way and bringing his unique brand of wisdom to this critical issue. Ashish Karan for being my thought partner and bringing a practitioner’s perspective. Vivek Mandhata for ensuring that the final output was of good quality. As usual, brickbats are mine, bouquets are attributable to all of us.

The topic is very deep. So a blog and 5–6 slides cant do justice to it fully in a scientific way. But in this document, i attempt to make some salient points. This content will be slightly long form. If you are short of time, please scroll through the images.

I have made cross links to some of my earlier blogs that are relevant to the themes mentioned here. Through this year, i will write more on the topics of this article and deepen the thinking.

When I had started my career almost a couple of decades ago, it was very hard to have a meaningful discussion with senior Indian clients about valuation and shareholder returns. On most occasions the topic was dismissed by some version of the following argument “Indian stock market is not reliable anyway. So what happens to my valuation is not my focus.”

How the world has changed. Our personal and professional spaces over last few years are filled with questions on valuation. Today, as investors / founders / operators / employees — not having a preliminary understanding of valuation is an impediment.

1. Laying the foundation

1.1. It is imperative to seek healthy valuation. Not high / not low. Healthy. Healthy valuation is that valuation which does not force the company to undertake initiatives that are completely misaligned with its:
(a) model, (b) capabilities and (c) risk tolerance (or risk appetite)

1.2. Healthy valuation provides companies with three superpowers:

· Ability to raise resources without excessive dilution

· Right to remain sovereign

· Currency to acquire assets

1.3. For getting healthy valuation you need to be at the intersection of a Good Company AND a Good Stock.

· Good company = Predictable and strong fundamental metrics

· Good stock = Strong potential upside, adjusted for the risks

2. Know what type of investment archetype are you? Know yourself.

There are broadly speaking five investment archetypes. It is important to know which one you represent.

2.1. Very early stage — interesting idea + strong team. But no proof of concept or viability

2.2. Start-up stage — some prototypes / MVPs rolled out. But no business model established

2.3. Growth stage — business model established. But scale and maturity missing

2.4. Late stage — mature business operating at scale. But next phase of value unlock comes from transformation and/or diversification

2.5. Portfolio of bets — a mix of ideas at different stages. Typically seen with hold-co / conglomerate type structures

3. How does the investor assess your asset? Know your investor.

Qualified investors and analysts typically care about five aspects.

3.1. What is the upside to downside ratio? Read more here (Dreams to Nightmare ratio).

3.2. What is the time horizon of this investment? When is the liquidity event possible?

3.3. What are the key metrics and what are they sensitive to? Valuation metrics come in here.

3.4. Are there capital and return protection structures embedded?

3.5. What is the role and stature of this specific investment in the investor’s portfolio?

4. What it takes to create a great stock — always on process.

A lot of time is spent thinking and working on becoming a great company. By not spending adequate time in thinking about being a good stock we do major disservice to the first point of this blog. It is imperative to seek ‘healthy valuation’. You don’t give your company the three superpowers mentioned in the first section.

There are 10 moves. But they need to be made consistently and over long(ish) periods of time.

4.1. Align / position your opportunity towards a large macro trend; build the right narrative

· High multiples are inherent to large high growth macro trends. Industry matters a lot — its rare to outperform an entire industry consistently

4.2. Place multiple bets towards a large goal; avoid single points of failure

· Investors love focus in very early-stage companies, but as companies mature, they like management teams that have multiple bets placed towards a large opportunity. Creates optionality and pivots

4.3. Build high talent density with high performance culture

· Attracting and retaining high quality talent in a high-performance culture increases the chances of success manifolds

4.4. Explicitly reduce exposure to structural risks in your idea; be known as a strong risk manager

· Isolate the specific biggest risks to your idea — capital, talent, macros etc; Hedge those risks explicitly and all the time

4.5. Over invest (relative to competition) in assets that are critical for building unique IP or in other words ‘moat’

· Isolate the specific assets that will make you win — e.g. data, algorithms, channels, UX design, partnerships etc — and over invest in them

4.6. Build a reputation of a good-actor in the ecosystem with strong governance

· Be known for taking hard decisions because they are right

4.7. Be available for stakeholders (analysts, key media, regulators, influencers) and give them the right level of disclosure for them to do their job properly

· Always ensure that your chosen important stakeholders don’t look bad because of your errors of omission or commission

4.8. Align your incentives with the investors’ incentives — but also remember to align on the downside

· Everyone makes money or loses money together — this needs to be symmetric for all parties otherwise one side takes the upside and other downside

4.9. Know what to expect from your cap table

· Will the investors be supportive or exit at the first sign of risk? Depends on the role of your investment in their portfolio and who they are

4.10. Have high pain threshold but be clear about your and your investors’ max risk appetite and if you need an off-ramp; always be solvent with salvage value

· Despite best intentions and efforts, things can go south. Know when the risk appetite is breached and what off-ramps are feasible

Evaluating our investor narrative and company’s strategy against these 10 points on a regular basis can keep us on the right track towards unlocking healthy valuation while managing downside risks.

5. Patterns of investment that have worked and hurdles seen in Indian context.

In conversations with some very senior clients and investors the following patterns emerged. Patterns which have justified good investments. Patterns that have hindered investments.

Happy Seeking and Finding!