What forms negotiations? One’s views of the possibilities vs one’s view of the limitations….. Khubiyan ya Khamiyan (Possibilities or Limitations)?
We can go back to 2018 when the drone laws turned the face of the drone industry, they were the major headwind for the sector. Limitations of the sector were all to highlight. Until today when investors of recent drone listings on the stock exchange made ~ 2x — 100x on their drone sector investments, ask now, the drone industry is all about possibilities.
What about limitations when you hunt for possibilities and what about possibilities when you discover limitations?
The question makes its way to form the basis of all the arguments, including a Venture Capitalists approach in selecting companies for investments. Let me pull my analyst notes and delve deeper.
Any common month, I get more than 50 businesses to analyze. Let’s pick 2 of the better of them.
- Business A: A growth stage venture, posting exceptional growth year-on-year in a large market, thus naturally commanding an expensive valuation.
- Business B: A growth stage venture, posting stagnant growth year-on-year in a small yet emerging market, thus commanding a decent valuation.
What’s your pick?
(Ps: We can argue with the fact of finding businesses with good qualities of both Business A & B, but we can’t deny the fact that no business is perfect! There lie numerous other factors such as regulatory landscape, competition, team pedigree & others which have to be chosen to pick one business over other for investment, bringing our argument to ground zero)
I must’ve created a divide based on how our preconceived notions would have influenced us to choose amongst the two.
Lets address both the choices:
- Preference of Business A over Business B: Business A is expanding in a large market, and with the track record, this growth is expected to continue. As a result, the valuation of Business A is likely to increase, leading to a high chance of earning good returns from our investment. On the other hand, Business B is expected to consolidate its valuation due to its comparatively slower growth in a smaller market, resulting in weaker returns from our investment.
- Preference of Business B over Business A: Business B operates in a yet to emerge market, its growth is likely to get throttled as its market emerges. This could create an opportunity to generate good returns while investing at a reasonable valuation and exit later when the company’s growth leads to a higher value. In contrast, Business A’s value has already increased significantly, leaving less room for further growth.
What makes more sense to you?
Any of the above two are answers of biases conveniently highlighting the possibilities of one and limitations of another.
What do we do?
To eliminate biases, you must follow a systematic approach that yields clear outcomes. This approach evolves and betters itself as the team learns, experts contribute insights, and parts of the method are put to the test. Our procedure at Auxano underscores both the potentials and limitations by assigning them scores. We term it the ‘Invincible Matrix,’ where an investment needs to exceed a specific threshold to be deemed viable. This framework prioritizes the significant aspects over the trivial ones, always keeping in mind the risk tolerance and fund’s underlying thesis.
For instance, Auxano, is a fund that invests in early stage companies that are next generation, technology led, consumer focussed and operate in the subscription economy. The aim is to look at businesses that will ride emerging mega trends, making it easier to choose between alternatives Business A & Business B.
Auxano invested in the drone sector for the first time in 2018, 2021 & 2022. Despite sector turmoils, our early investors got an exit at ~ 8.5 times their initial investment in 2022.
Lastly, most investors, us included, don’t simply categorize businesses as good or bad. Our pursuit revolves around identifying businesses that align with our method’s criteria to be considered investable. At Auxano, we have a preference for technology-driven enterprises led by robust and resilient teams capable of capitalizing on emerging megatrends. Additionally, we opt to support those that are Category Creators, Market Creators and Market Leaders. Our preferred investment stages include Seed, Pre-Series A, and Series A.
This is a journey, and as India leap forwards in this decade, interesting times ahead.
Author:
Kanuj Jadwani
