I’ve recently had an epiphany. For a decade and a half, I’ve been assessing investment opportunities in just about every industry and at every step of the corporate life-cycle (from seed investments to buy-outs). Along the way, I’ve repeatedly educated multiple stakeholders on the different disciplines involved in developing fact-based and informed opinions on these opportunities (business valuation, commercial due diligence, financial due diligence, quality or earnings, management team assessment, market forecasts, digital competencies assessment, etc).
I always felt there ought to be a “catch all”, simple and direct formula to capture and explain the entire diligence process in a few words. Such a formula would be helpful to orient new recruits and colleagues, as well as to brief target companies ahead of the process. I find that the term “fundamental analysis” is a decent proxy borrowed from the public markets’ value-investing folks. However, the term does not seem to resonate with the private market crowd.
Well inspiration finally struck. Here’s my three-word formula to capture the process:
Assets and Assumptions.
Yep, when investing, you buy assets and your buy assumptions. If it’s not an asset, it’s an assumption. Simple as that.
The asset is arguably the easy part. Tangible assets can be touched, seen, visited. They are quantified through financial statements. Intangible assets (such as brands and IP) are trickier, but can still be dealt with through the proper valuation methodologies. For the sake of this post, I will also include the target company’s key personnel as an asset. Accounting standards obviously don’t agree with me on this, but I definitely feel justified in classyfying humans as intangible, verifiable assets during the due diligence process. You can see folks, you can interview them, you can purchase key-person insurance for them…so, you know what, I say they’re assets!
Enough with the assets. What about the assumptions ? Well they pretty much cover the rest of your investment decision variables. Everything related to your perceived outlook of the target company is an assumption. Your PESTL analysis and outlook (political, environmental, social, technological and legal components) ? A set of assumptions. Your assessment of your key competitors and suppliers’ next strategic move ? An assumption. Your assessment of potential new entrants disrupting your industry ? An assumption. And on and on.
As i’ve written about in the past, a major challenge is that some assumptions are made consciously while others are not. The investor might strive to make the best assumptions regarding his « known unknowns » without realizing the key assumptions he’s unconciously making in the « unknown unknowns » category. This can be lethal because an unidentified, unconscious assumption will go unscrutinized. Business graveyards are filled with those kinds of unscrutinized, unconscious yet very real assumptions. That’s what’s called a blind spot.
That’s it for now. Now go work on solidifying your assumptions. Because no strong thesis can rest on weak assumptions!