9 Reasons We Passed on This Deal

Ideas…like grains of sand on the beach. I’ve mentioned this before in my post “8 Reasons Not to Sign an NDA” and it bears repeating.

Unless you have a proprietary product involving intellectual property, a scientific process or something which is entirely unique and therefore valuable, you are immediately devaluing your proposition from the get-go by asking investors to sign an NDA.

Most investors aren’t out there trying to steal your idea, and in the process of doing thorough due diligence, speaking to customers, vendors, suppliers, etc. certain things will need to be asked. Handcuffing potential investors out of the gate can be counter-productive.

I recently met with a company which made such an error. We signed the NDA since we felt that there was value to digging deeper before dismissing the opportunity altogether. I’m completely OK with founders making little errors, especially when operating in an environment unfamiliar to them. It’s certainly not an automatic deal killer.

I merely make reference to it since this could be valuable information for start-ups who are preparing to raise capital and pitch their business to Angels or VCs.

Without divulging the name of the company and thus compromising the NDA, something I would never do, regardless of signing such a document, I thought it useful to review very briefly why we passed on this particular deal.

I don’t pretend to know whether this company will be successful or not, I can only opine based on my experience of doing this day-in-day-out for quite a few years now. Early-stage private equity is sufficiently risky that success comes from being very, very critical and eliminating risks as much as is humanly possible. Once you are on board as an investor you then do everything in your power to help that business succeed.

So, on to the details. The company we took a pass on wants to offer a consumer goods product in a country they do not yet operate in…specifically Thailand. The product exists elsewhere in Singapore, Korea, Japan and Malaysia and has proved somewhat successful. They are not reinventing the wheel or launching a completely new product, so there is a precedent.

The concept therefore has been validated albeit in different countries with different rules, regulations and bureaucracy. Not an insurmountable problem, and in fact this is a logical strategy. Take a validated business in one country and roll it out in another. Perfectly sensible and potentially profitable. Yet we still passed.

Here’s why:

  1. The company has not proven their own capability in producing, marketing and selling the product in question. This is a complete start-up. We’re not looking at a company with existing management, existing infrastructure and product who are now moving into a new market. There are countless examples of large companies with substantial resources in terms of capital, skills and resources who have failed to successfully breach new markets. In Australia for example, where I’ve been for the last couple days, Krispy Kreme, not an insignificant company has tried and failed to penetrate this market and have been closing down their stores.
  2. The founder has invested an inconsequential amount of capital, less than 2% of the capital raise, into the business, while retaining what we perceive to be an unjustifiably large slice of equity. I’ll admit to being a little aggressive on this side of things, but that is simply a matter of having seen hundreds of businesses and knowing that the numbers don’t lie. Founders always think their business is worth more than it usually is. Often much more. It’s a catch 22. By nature they are optimistic people and without such optimism they wouldn’t stand a chance.
  3. The actual management and day-to-day operations and implementation of the business model will be handled by a management team who have nothing to lose. They have not invested a single cent into the business and are being gifted equity ON TOP of being paid a competitive salary.  In short my capital will be used to pay what are premium salaries, hoping that they will execute on the business plan. I know that the company would argue this point with, saying that the salaries are below market. They are below market for a large corporate, but you cannot compare apples and carburetors.A start-up company will never pay what a large multinational will pay. Furthermore you cannot have you cake and eat it to. If you are paid salaries as well as equity then your equity needs to be minimal, and if you are taking equity your salary should be minimal. We in fact look for any business that is pre-revenue to pay its founders nothing. Yes, nothing. I’m not getting paid anything and I’m risking my capital. In the event they fail I lose 100% of my investment, yet they collect a nice wage and walk away. In the event that they are successful they collect a nice wage, a healthy slice of equity and make a lot of money. All reward no risk. We’re taking all the risk and receive very little (in comparison) reward…not happening!
  4. Questionable etiquette that will likely show up elsewhere later. Management pitched my colleagues and I at a local restaurant. I had a glass of water, my colleagues had fruit juice, management drank a couple beers. At the conclusion of the meeting management got up and left without going over and paying the bill, or even offering. Let me be clear, this is not about the bill. This is simply a matter of courtesy and in our opinion demonstrates the manner in which they will do business. Mark wrote a pretty funny and relevant story about exactly this topic, “How Fronting a $600 Dinner Saved Me $250,000”. It left an uneasy feeling with all of us at the table.
  5. Management have a long track record in Southeast Asia…but. Many would be impressed with credentials. I’m not and here is why. Their experience is ALL as being employees for someone else. They likely have not learned what every founder and entrepreneur learns the hard way. Those who are business owners know what I’m talking about. It’s like having a child. Until you have your own child, raise it, feed it, care for it you will not know what it takes. They may be awesome employees, but in our opinion they need an entrepreneur on the ground in Asia. The risks are way to high otherwise.
  6. The company will roll out their product in stores in Thailand. This will require roughly $3mm in working capital. I think it’s complete folly to spend such an amount of money determining if there is a market for your product in the country. I can test this market with a wheelie cart in a Bangkok shopping mall for roughly $220. I did the math.
  7. Their presentation mentioned that an agreement had been reached for the employ of the marketing executive in Thailand. Upon discussions with this individual in Thailand it was apparent that this was still under negotiation and it was not a “done deal” so to speak. Further discussions revealed that both gents were working full time and would continue to do so only unless they could transition (once all capital had been raised). This was the logical conclusion for them. They were essentially getting another job since their salaries would be paid from the capital raise. Again…no skin, no risk!
  8. This was a brokered deal. The deal was brought to us by a broker. Very, very, very rarely these days will we look at a deal brought to us by a broker unknown to us. Obviously we knew it was brokered and still looked at the deal, so we’re open to a good deal even if it’s brokered. This is not a jibe at brokers, as some are great and I have no issue with them. It does however create additional friction costs for us as investors, and given the large amount of deal flow we have right now, and our limited resources it’s just a matter of picking only the very best. Read my article on unseen friction costs for more on this.
  9. Estimates where inconsistent with similar businesses I’ve looked at operating in Thailand. The actual costs of doing business in emerging markets are NEVER EVER what they look like on paper. Anyone who has done even the smallest amount of business in Thailand, or in fact any of the emerging and frontier countries we often focus on will know this.

Now, I’ve obviously highlighted a lot of issues I had with this particular deal, and this therefore is a one-sided story. I was not all bad. There were many other reasons that we took more than 5 minutest to look at the deal, including a strong corporate structure, a good dividend policy for shareholders and a first money out proposal. Also, the founder was very smart, well-educated and experienced within the broad industry in the US.

I obviously have no idea if this business will work or not, and if shareholders will subsequently make a lot of money. I sincerely hope that they succeed. It wouldn’t be the first time I’ve missed out on a great opportunity. As they say, you can’t kiss all the girls.

– Chris

“Make every detail perfect and limit the number of details to perfect.” – Jack Dorsey, Twitter co-founder


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