By Sridhar Sankararaman, Managing Director, Multiple Alternative Asset Management.
If one were to ask a contingent of investment professionals, ‘Is investing an art or a science?’, the popular answer may be quite predictable. There are codified frameworks on financial modelling, triangulation of valuation, technical/fundamental analysis of listed companies and so on – all of which make investing sound like a fully rational, technical activity; a science, if you will.
But if investing is a science, why do some investors generate a substantially different alpha in the same vintage?
Let us take a step back. Investing is about crystal ball gazing into the future 5-10 years to predict the potential of a business. Aim to build a detailed financial model and identify the top 3 assumptions that move the needle for the business. So, while modelling is a science, isolating the key assumptions is an art. Sometimes the key assumption may be an unknown risk factor and thereby may not even find a place in the financial model.
The reality though is that no amount of diligence will be able to give definitive comfort as to how each of these key assumptions may play out. In many cases, especially involving business transformation, there may be no past track record to due diligence on. Ultimately, it is a leap of faith that one takes – some call this conviction, intuition or maybe art.
So, what allows one to take the ‘right’ leaps more often than not and make that superior judgment in a consistent predictable manner? Is it even possible to codify this? If you pick the macro segment well and within that invest behind the management team that has the best DNA to win, you will more likely than not get the investment right.
Our belief is that investing is a lot more art than science. The science is about sector expertise that allows you to pick the macro segments well. The art is a nuanced judgement on the founder and management team. There is enough evidence that management teams which have the right DNA to win in an industry are best placed to capture the macro-opportunities in that industry. So how does one identify this DNA? In India, it is neither possible nor practical to ask founders to undergo a psychometric test.
The closest we can get to understanding the founder psyche is to actively look for traits based on the founder’s past choices and behavior. We use a proprietary 20 factor model called Leadership Energy Level (LEL) to analyse the founder’s DNA. These factors are then grouped to give us a picture on several leadership traits, such as how disruptive is the mindset, ability to influence, strategic agility, winning instinct and institution building capability.
We believe that these traits are important to assess irrespective of the stage and sector of the business. Obviously, the relative importance of each trait will be different depending on the choice of sector. For instance, in an early-stage consumer facing business, having a disruptive mindset may be more relevant than institution building.
This assessment brings to fore the natural leadership profile/style of the founder; their strengths and weaknesses. The question we often ask ourselves is how aware is the founder of their blind spots; how self-aware are they. Founders who have surrounded themselves with capable team members to cover for their blind spots certainly are in another league, a cut above – they are aware, humble, accepting and will not allow themselves to limit the potential of the business. Ultimately, it is the people behind the business that create value.
As PE investors, we get ringside seats to a founder’s journey and an opportunity to influence the outcome. This ability to influence the founder in minority investments is an earned right – it is effective only if it is commanded and not demanded. An investor earns the right to influence if he has the empathy to understand the founder, comes with the mindset to listen and not just tell; and more importantly gives the founder confidence to unleash his full potential. An investor who is constantly second guessing the founder makes for a very nervous boardroom conversation.
To summarize, successful investing is all about
• Careful selection of the sub-segment to invest in basis the macros (meaning? Based on the macros?)
• Picking founders who have the DNA to win in that segment
• Enabling the founders to succeed by realizing their full potential
If you enjoyed this article, be sure to read CAIA Association’s new report, The Rise of India’s Private Equity Market.
About the Author:
Sridhar Sankararaman has 2 decades of experience in financial services (including 15 years in private equity). He joined Multiples (US 1 .5 bn PE fund manager) close to its inception in 2009. He currently leads investments in digital, B2C and consumer technology sectors. Previously, he led investments across healthcare, pharma and manufacturing sectors. He has actively contributed to building investment and founder evaluation frameworks for the firm.
During his investing career, he has been able to connect well with Founders and influence them on strategy and people decisions. He thinks of his ability to influence as his key strength and uses it to bring about positive change. He enjoys brainstorming ideas with Founders and derives immense satisfaction when they derive value from these interactions as well.
Sridhar received his MBA from Indian School of Business and is a Chartered Accountant by training.