Scaling Success
At Fulcrum, investing is driven by a philosophy that hinges on eight critical tenets. These tenets are:
We analyze business, not markets
The idea must be differentiated and scalable
Starting with a differentiated business offering and working to sustain it builds favourable business economics. This gets reflected in different metrics – a higher price or higher volumes or better metrics like lower cost of sales, lower lead time to sales, higher repeat purchases, lower cost of maintenance/service etc. Consistently building and nurturing the offering also leads to a high entry barrier and makes it difficult for competition to replicate the offering.
This also reflects in a higher ROE and the ability to scale business without constant need for additional capital or in a superior ROE, if additional capital is invested. Conversely, Fulcrum avoids businesses that exhibit commodity market like features that force management to defend the business through price cuts, higher promotion, free offerings etc. If not managed well, all ventures degenerate into commodity businesses with poor economics.
The market must be strongly favourable
A unique position in the market generally creates favourable business economics. However, we pass a potential investment through another set of filters to look for favourable market characteristics.
- Is the larger market (as opposed to the target market) growing and likely to grow at an acceptable rate for a long time?
- What are the strengths of the market leader? How will they respond to our offering?
- What is the competitive landscape like? Does it have many leaders, many aspirants, fragmented market share and the like?
At Fulcrum, we want strong business economics to be augmented by favourable market economics.
The team must be highly capable
Quality of the management team is the single biggest factor in an investment’s success. We place great emphasis on partnering with entrepreneurs with great mettle and support them to excel. Integrity, intelligence and energy matter most to us. We also look for:
- A well rounded management team (at least 4) than a management with one or two individuals and encourage the team to recognize one member as the CEO.
- We like to see people with complementary skill sets and experiences reflecting the critical dimensions of the business plan, rather than a team of engineers or accountants or sales men.
We are hands on investors
We believe a highly involved and demanding board is not incongruous with a highly independent Management/CEO. On the contrary, the two reinforce each other when the relationship is structured well.
As a board member, significant investor and equity holder of a portfolio company, we believe the best intentions of management should be periodically measured against performance. Giving an honest score card to the management adds value and also squarely flags the risk ahead.
Most management teams, including the most self-aware, have a tendency to slip into an ‘all is well’ pattern and may periodically draw a bulls eye around the darts already thrown. Unchecked, this tendency turns a management from being effective and efficient into one removed from market realities. A great business stops being great.
The best antidote to this universal tendency of management is to have a highly active and interested board that anchors the management to reality, using board meetings as the right forum, consistent accounting methods, accurate accounts, numbers thrown up by the MIS and well-tested business plans. Furthermore, we add our experience to bolster a young management team’s enthusiasm.
Our valuation is fair
We look to invest in great companies at a fair value and not ordinary businesses at bargain prices. We realize such bargains might eventually turn out to be very expensive indeed.
However, a great business may not translate into a great investment. To become a great investment, it has to be purchased at a fair price.
In valuing a start-up company, we rely on the discounted cash flow of the business plan and use a conservative terminal value for the same. This, we believe, is the only method consistent with our philosophy of being a business analyst rather than a market analyst.
Understanding precedes investing
“Problems do not arise from what we know or don’t know, problems arise from what we know, that ain’t so”.
Any investor (good and bad) will have a check list that includes criteria like good team, great market, fair valuation etc. However, the key to successful investing lies not in these criteria but being in a position to pass better judgments than the rest of the market in these areas.
The first question we ask ourselves is “Are we even in a position to reach a reasonable probability of passing superior judgments on these questions?” If we aren’t, we are quite happy to pass the opportunity. Our probability of success is significantly enhanced if we invest in the areas we understand well.
