|#535 MWAVC| — PE or VC Money?
Hi,
Welcome (back) to MWAVC, a newsletter about finance, investing, venture capital and all that jazz. My name is Ato (more about me here and here) and I try to write every single day. Most of it is stuff I find interesting that I’d like to share and hear your thoughts on. If you’d like to sign up, you can do so here. Or just read on.
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After a long hiatus, I’m back. First 75% of the year went by pretty quickly but I got a chance to focus on what I should be working on — really helping out with my portfolio companies and digging deeper into the venture capital and private equity world to figure out my space and where I can make the most impact. Seeing how most (if not all) the companies I’ve made angel investments in are rapidly growing, I began conversations about their subsequent fundraises. A couple will be raising towards the end of the year and as I’m all about helping the people around me make money, I pitched them on putting together syndicates to invest towards their fundraise. So I’d like to invite whoever is a reader of the newsletter and would like to be part of these syndicates to register here. I’ll send out memos as and when I find interesting deals, and book a large enough allocation for me to invest, and bring some of my good friends along too. I’m looking to close out 5 transactions before the end of the year. One already closed, so 4 more for Ato. Looking forward to having you as part of the team!
Big sense from my chairwoman Dr. Ola. She broke down what kind of money you can raise based on the type of company you have. Also, her videos are crazy informational. Please watch them and Enjoy.
A friend is raising money for his textile factory which does about $50m in revenue
Flutterwave was making this amount in revenue when it was valued over $1bn & making losses (NB: FW wasn’t making losses at that time but it is now). He was confused when I told him that his valuation would be less than $100m even though he is profitable.
This #thread will address two key issues:
1.The difference between the valuation of technology companies & traditional companies.
2. How a private equity company will value your company vs a venture capital firm vs a strategic
Microsoft is an example of a pure software company. The product they are selling is the software. You pay for the software and it’s the same software they sell to companies across the world with no additional production cost.
In fact the cost of adding an additional customer is zero. The customers are sticky with high switching costs (what are the alternatives ) and strong network effects; more & more people buy the software because others are using it.
Microsoft is an investors dream. They keep selling the same thing over and over again to millions of businesses, every single year, on a subscription basis. Customers are sticky as there are no alternatives. Margins are high because marginal production cost is zero.
The second category of tech businesses are companies like Uber/Airbnb etc. The software facilitates a transaction & they make a commission.
These often, but not always have lower valuations multiples than pure software companies simply because they have lower margins and less predictable recurring revenues as well as less powerful network effects.
For example, not many people pay Uber or Airbnb a subscription every month for their services. Furthermore, margins are lower as its not the actual Uber software being sold like in the case of Microsoft. The software facilitates a transaction.
There are also more alternatives to companies like Uber and Airbnb so the network effects aren't as strong as a Microsoft.
Companies like Netflix however, do receive steady subscription income. However, the cost of producing content/buying content plus lack of strong network effects/low switching costs typically provide lower margins compared to "pure software".
Tech & tech enabled businesses whether pure software or marketplaces attract higher valuations than traditional businesses because of their ability to scale without significant additional cost.
If you are interested in taking a deep dive into venture capital and how tech company valuations are calculated watch my lecture here.
Now back to the textile factory. There is a cost to each piece of clothing that the factory produces, there can be economies of scale, but the cost of fixed cost production for each garment cannot fall to zero like in a software business.
To enter another country he will have to build another factory or pay for logistics to physically move his product there.
This is why companies like Dangote Cement, Flour Mills, my friends textile factory etc cannot attract venture capital & have much lower valuations despite the fact that on the face of it they are financially healthier (more profit, more sustainable)
So how are valuations for more traditional companies calculated? Usually an EBITDA multiple which is typical in that particular industry. To get a rough idea multiply your profit before tax by 4. Some industries have higher or lower EBITDA multiples.
Also a DCF can be used to calculate the value. This goes into corporate finance so I would advice you watch my lecture here to understand NPV, IRR, WACC & DCF calculations here.
So if traditional companies can't raise from venture capital firms who do they raise from?
When they are smaller, non tech business angels can take an equity stake.
Larger traditional businesses raise from Private equity firms!! Many people confuse the terms venture capital & private equity. Learn the difference in my lecture here.
Traditional companies also have steady cashflows and assets which means they are well suited for traditional debt financing.
For both traditional companies & tech companies, but especially for tech, investors look at GROWTH. If your company's revenues are flat year on year, then you will have a harder time raising external capital than a fast growing company.
Both venture capitalists and private equity investors like fast growth. But VC's are obsessed with it and rather than profitability which is a concern in most PE transactions, VC's are more concerned about growth.
When you are looking to raise money it's VERY important to understand what your potential investors are thinking.
A typical PE fund will want to exit a company at 4-6x. Whereas a VC would need a 10x exit or more to return their fund.
To learn more abt exits watch my video. I talk about a hypothetical scenario where Mike Adenuga invests in my VC fund here.
So last but not least the Nigeria/Africa factor.
Both PE & VC investors are expecting a dollar return on their investments. Many African countries have currencies that are devaluing rapidly.
Of course there are exceptions like Cape Verde and the Francophone countries whose currencies are pegged to the Euro.
There is also the issue of total addressable market which tends to be smaller. I analyse TAM and give pointers on achieving massive scale despite the "African factor" in this video here.
Sign up to my cousin Yasbo’s newsletter, ChopLife Express btw AND listen to her podcast, Savings or Current. She’s already been dropping some serious gems, including this one on time management and this one on how the economy works.
Also, Afrobility Podcast is exactly what you need to be listening to for the deep-dives into Africa’s most note-worthy companies.
Recommended Substacks: Afridigest by Emeka; African Entrepreneurship Series by Jeph; Getthebrief by Loye and Fola.
📱📱Quote of the day
“The only way out is through.”
Remember: “Until the lion learns to write, every story will glorify the hunter.”
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