Speaker 1: Hello, and welcome to today's episode of The Money Puzzle.
Speaker 1: I'm your host James Gerard, standing in for James Kirby
Speaker 1: this week as he enjoys a well deserved break. Today
Speaker 1: we've got a special episode plan which is all about
Speaker 1: private equity investments and venture capital investments. It may sound
Speaker 1: very mysterious, at the end of the day, private equity
Speaker 1: is just basically investing in a company that's not listed
Speaker 1: on the share market. So imagine investing in your local bakery.
Speaker 1: That could be considered private equity. And for those who
Speaker 1: have watched the TV show Billions, if you don't have
Speaker 1: billions of dollars like Bobby Axelrod does to invest there
Speaker 1: are still some pathways for the everyday mum and dad
Speaker 1: investor to invest into private equity. But this particular asset class,
Speaker 1: it requires a lot of research into it because it's
Speaker 1: a big case of buyer, where with private equity there's
Speaker 1: a lot less information there, there's a lot more risks,
Speaker 1: so it's generally a lot more less transparent than the
Speaker 1: share on the share market. So investors need to be
Speaker 1: a lot more careful before they invest into private equity.
Speaker 1: So today we'll break down the basics, we'll share some
Speaker 1: tips and tricks, we'll discuss the ins and outs of
Speaker 1: private equity. And to help us do this, we've got
Speaker 1: a very special guest. Rudy Engelbreck is a close friend
Speaker 1: of mine and also a private investor, and he's kindly
Speaker 1: agreed to open the books and share his experience on
Speaker 1: private equity investing in Australia. Have he migrated from South
Speaker 1: Africa around ten years ago. But to be very clear,
Speaker 1: Rudy's not providing advice. All his views are his own
Speaker 1: personal views. He's not acting in any other capacity. So always,
Speaker 1: as is the case on the Money Puzzle, everything we
Speaker 1: discuss is general advice. It's not personal advice, and you
Speaker 1: should seek your own advice from a professional before making
Speaker 1: any decisions. So, without any further ado, Rudy, welcome to
Speaker 1: the Money Puzzle.
Speaker 2: Thank you, Jane, thank you for inviting me to go
Speaker 2: to the show.
Speaker 1: My pleasure. Let's get right into it. So firstly, I'd
Speaker 1: liked for you to tell our listeners a little bit
Speaker 1: about yourself. So you're your background and what's your history
Speaker 1: of private equity? What he attracted you to this type
Speaker 1: of asset class?
Speaker 2: Sure to be a quick overview. My journey started in
Speaker 2: two thousand when I was still in South Africa and
Speaker 2: I had an opportunity to join a young fintech startup
Speaker 2: and they were going to build a new wealth management platform.
Speaker 2: I had experience in that industry and then as a
Speaker 2: key person in the venture, I wanted to lever reach
Speaker 2: my knowledge, use my experience of wealth platforms and technology,
Speaker 2: and to do that I ask them to invest in
Speaker 2: the holding company who actually owned a fintech startup at
Speaker 2: that time. That was quite nice and two years later,
Speaker 2: when I left the fintech to pursue my next venture,
Speaker 2: I then realized, hang on, these shares are now locked
Speaker 2: up somewhere and I need to find a buyer for
Speaker 2: my shares or leave it beyond and wait for a
Speaker 2: future exit. So that was my first introduction. It's into
Speaker 2: liquidity and also the premium on buyer and selling the
Speaker 2: shares and the differences in the prices. So it was
Speaker 2: a good introduction into this unlisted private equew market. It
Speaker 2: was a good lesson and I managed to sell my
Speaker 2: shares for a slight loss, but I went on and
Speaker 2: I learned from that.
Speaker 1: Great So to start, you fell into it by default
Speaker 1: you joined a company that was a private company that
Speaker 1: was growing. So it wasn't so much you were actively
Speaker 1: seeking a private equity investment. You were a staff member
Speaker 1: that had equity in this company.
Speaker 2: That's right. Yes, I wanted to just being a normal
Speaker 2: STOLF member and also be part of the key team.
Speaker 2: I wanted to leverach that knowledge and so look, I
Speaker 2: want to take my investment and grow it in a
Speaker 2: higher capacity.
Speaker 1: Perfect you started there, and then what happened from that point?
Speaker 1: What more did you do in private equity?
Speaker 2: Then? Was the normal business world. I started a business
Speaker 2: as well, and when I moved to Australia, I started
Speaker 2: another business year and through starting that business, I got
Speaker 2: involved in another fintech startup, also in the wealth platform industry.
Speaker 2: This was a wealth platform that offered their products and
Speaker 2: services to Australian financial advisors. So it sounds a bit
Speaker 2: like a case of deja vu, and it is. So
Speaker 2: I ended up investing in the startup and I educated
Speaker 2: myself on shelled agreements, company constitutions, got introduced more to
Speaker 2: subscription notices, company valuations and your financial statements. And in
Speaker 2: this case, I also engaged with legal advice and legal
Speaker 2: counsel to review shelters, agreements and the terms and conditions
Speaker 2: and term sheets. It was a bit expensive because I
Speaker 2: had to pay the market rates for legal advice, but
Speaker 2: it was a good lesson again because I learned a
Speaker 2: lot from reading pages and pages of documentation got it.
Speaker 1: So it sounds like that this is another case of
Speaker 1: using your professional experience be in a company, but also
Speaker 1: invest in that company as well. Apart from that, have
Speaker 1: you invested in other companies that you haven't worked in
Speaker 1: or you don't work in.
Speaker 2: Definitely, As you can see, at first, I started with
Speaker 2: companies where I had a deep understanding of the industry
Speaker 2: and I had a passion in that world, and over
Speaker 2: time I started to look for other opportunities out there.
Speaker 2: I branched out into other industries not connected to world platforms,
Speaker 2: but still were the heavy focus on technology because of
Speaker 2: my background in technology. So one was a evaluation platform
Speaker 2: for property, another one was a financial advisor platform providing
Speaker 2: financial advice technology. Another platform was purely building out fund
Speaker 2: management type solutions. And then over time I even ventured
Speaker 2: into more nuts and bolts type of businesses, VISA businesses
Speaker 2: that would say invest in it's a fund management company
Speaker 2: that they would then acquire a company that builds patios
Speaker 2: and roofs, for instance, and they have then a different profile.
Speaker 2: It's a lower risk profile, and there's a dividend income
Speaker 2: coming out of that investment. Yeah, so it actually brought
Speaker 2: it out to anything.
Speaker 1: Else excellent, But it still sounds like that the type
Speaker 1: of companies you invest in, you understand them because they're
Speaker 1: either in the finance sector or the IT sector, or
Speaker 1: maybe a crossover of both. So is it fair to
Speaker 1: say that you have a preference to invest into private
Speaker 1: companies that you have a finger on the pulse using
Speaker 1: that saying rather than something that might be totally foreign
Speaker 1: to you. So investing into a home tools company, for example.
Speaker 2: At first, I obviously wanted to be engaged and wanted
Speaker 2: to understand a lot about the businesses. And then over
Speaker 2: time the last few investments I've made were more about
Speaker 2: show me your track record, show me your history with
Speaker 2: a company, show me the returns, look at the balanced statement,
Speaker 2: financial statements, and look at the risk profile. I've actually
Speaker 2: I've entered into other more I would say, as I
Speaker 2: said before, the nuts and bolts. The other one is
Speaker 2: also a building trust company, so they actually provide construction services.
Speaker 2: I don't know anything really about that industry, but I
Speaker 2: like the fact that there's a sound financial model and
Speaker 2: it's literally about products and services they sell and then
Speaker 2: they have estimated earnings and then they either deliver on
Speaker 2: that or not.
Speaker 1: I'd like to know more about how these opportunities come
Speaker 1: across your plate, but also how you do the due diligence.
Speaker 1: We might do that a little bit more detail later,
Speaker 1: but for now, I'd like to move on to getting
Speaker 1: started in private equity. So what type of investor is
Speaker 1: suited to private equity in your opinion?
Speaker 2: Yeah, this really depends on each individual. A probaect with
Speaker 2: is quite different from list that shares and some of
Speaker 2: the factors you need to consider for yourself as an
Speaker 2: individual as your financial capacity, how much savings you have
Speaker 2: that you want to allocate to this. As at last,
Speaker 2: what kind of risk do you what kind of risks
Speaker 2: are you prepared to take, because many of these investments
Speaker 2: are quite risky and and some you could actually lose
Speaker 2: your whole investment. And then also the other one is
Speaker 2: how long would you are you prepared to keep your
Speaker 2: capital locked up in this investment because they're typically are
Speaker 2: quite lengthy type of investments that could be five plus years,
Speaker 2: ten years, sometimes even love it.
Speaker 1: I think it'd be good to explain a little bit
Speaker 1: more about what is the whole life cycle of a
Speaker 1: private equity or a venture capital investment, And maybe we'll
Speaker 1: start with just clarifying the difference between venture capital and
Speaker 1: private equity, and then we'll talk through what the life
Speaker 1: cycle is, and we're going to have a brief chat
Speaker 1: about the different rounds of funding as well that companies
Speaker 1: would typically seek. So my understanding is that a venture
Speaker 1: capital company is more at the incubator early stage, where
Speaker 1: they're at their infancy. They're either just an idea or
Speaker 1: they're a company that's relatively recently formed that's running at
Speaker 1: a loss because they have wages, but they're not selling
Speaker 1: any products or services yet, whereas private equity is a
Speaker 1: little bit further down the track. They're not there as
Speaker 1: a share market listed company, but they're probably developed with
Speaker 1: regards to their offering, and they still maybe running out
Speaker 1: of a loss and they may need some capital to
Speaker 1: kicker off marketing further or to develop further, but it's
Speaker 1: later on. So is that your understanding as well, Really
Speaker 1: how private equity and venture capital are different.
Speaker 2: Yeah, that's right. So usually most people will start up
Speaker 2: in the first phase will be I've got an idea
Speaker 2: and I think I've got a great business that I'm
Speaker 2: going to know bold and typically you could access there
Speaker 2: are different ways you could access capital. You could go
Speaker 2: to friends and family, if you get your own funds,
Speaker 2: et cetera, and you kick that off over time. What's
Speaker 2: what you could do is then go to an early
Speaker 2: stage and again you would talk to angel investors. You'll
Speaker 2: have your pitchtick ready, which will explain later exactly what
Speaker 2: goes into that. You'll have areas that you highlight and
Speaker 2: that which is your valuation, how much capital that you require,
Speaker 2: and how you're going to sell that to the to
Speaker 2: the angel investors. And then over time you get into
Speaker 2: a growth phase where you will then do subsequent rounds
Speaker 2: and this is how you can get more private equity
Speaker 2: companies and also venture capital companies to then invest bigger
Speaker 2: chunks of capital into your business. And now you're in
Speaker 2: the final stages and if you're lucky, then you could
Speaker 2: actually have a positive return where you actually have dividence
Speaker 2: coming out or not, or if it's a growth based company.
Speaker 2: You could focus on growing the business through revenue, and
Speaker 2: even if you're making a loss, as long as there's
Speaker 2: enough growth to back it. You could then get uses
Speaker 2: to come in as well or other institutions, and an
Speaker 2: exit can be prepared where you could sell the company
Speaker 2: as well and work through the phases, or we could
Speaker 2: ipo it even So, yeah, that was a quick summary
Speaker 2: of that, and you can dive into more detail into
Speaker 2: each of the phases again now.
Speaker 1: I think that as good as a high level summary.
Speaker 1: So basically a company starts up. The first one is
Speaker 1: the angel round, so that's right at the beginning to
Speaker 1: help kick things off. And then you have the seed round,
Speaker 1: which is at the early stage of development, and then
Speaker 1: you might have a Bridge round and Series ABC and
Speaker 1: so forth, and then you might have a pre IPO
Speaker 1: raise or there there might be other raisers beyond that,
Speaker 1: but the general cycle there with raises, and what generally
Speaker 1: happens is that new investors brought in, new shares are issued.
Speaker 1: Existing shareholders can be diluted because there's more shares now,
Speaker 1: but generally the company valuations go up every time a
Speaker 1: company raises capital. That is the hope. It doesn't always happen. Now.
Speaker 1: One thing which I find interesting because I look at
Speaker 1: private equity investments as well and have invested in some,
Speaker 1: is how they come to me and or how they
Speaker 1: come to you? How do they get in front of us?
Speaker 1: And the first thing that I always think is why
Speaker 1: is this company come in to me? Because in my
Speaker 1: head I have this thing called the sucker money, and
Speaker 1: so I think, is this company trying to find the
Speaker 1: easier source of money? They're showing a fancy pitch deck,
Speaker 1: a nice PowerPoint presentation with all these charts around the opportunity,
Speaker 1: the billions of dollars of market there, and how they're
Speaker 1: going to penetrate that market and do great. And they're
Speaker 1: hoping to to dazzle the mom and dad investor and
Speaker 1: get them to invest into it. But a more seasoned
Speaker 1: private equity investor or a private equity firm would probably
Speaker 1: be able to see through that. What are your thoughts
Speaker 1: around the funding side of things? And also how do
Speaker 1: they come across your desk these opportunities.
Speaker 2: Yeah, so that is certainly true, James. There's, as you said,
Speaker 2: the term the sucker money, or sometimes the triple F
Speaker 2: which is the friends, family and fools. So yeah, you've
Speaker 2: got to watch out and if you have any they're
Speaker 2: going after the easy money, then you're probably ninety percent
Speaker 2: of the time, right, there is a lot of that.
Speaker 2: What I do is I try to see who else
Speaker 2: is also part of this investing round. I look at
Speaker 2: their track record in terms of you are they If
Speaker 2: they're they're like a Macquarie Bank is also investing then
Speaker 2: or another listed company or even a companies who are
Speaker 2: specializing in this industry with big funds or they've done
Speaker 2: this before, then you know that their due diligence are
Speaker 2: going to be quite thorough because they're not going to
Speaker 2: invest their millions of dollars alongside your few hundred thousand
Speaker 2: or ten thousand or whatever it is. They're going to
Speaker 2: make sure that they look after themselves at first. So
Speaker 2: you can be rest assured that most of the times
Speaker 2: they've got armies of consultants and auditors, etc. For the
Speaker 2: due diligence. So that's a good one. If you're in
Speaker 2: a scenario we don't have other investors or what co
Speaker 2: investing that you can lean on, then you've got to
Speaker 2: do a lot of your undue diligence. And this literally
Speaker 2: means working through the sessions with the founders, the current
Speaker 2: executive team, the man, the key management, we're working into
Speaker 2: the next level down in the company, the senior leadership
Speaker 2: team in the company. And in my case, because I
Speaker 2: had some of the knowledge in the industry, I worked
Speaker 2: in also quite a lot of details into technology as
Speaker 2: well as the financial models, and I had some experience
Speaker 2: in an area where you don't have that experience. You
Speaker 2: can also then engage with other people who've got similar
Speaker 2: experience and bring them in. And this is how this
Speaker 2: market works. As people talk to other people, there's a
Speaker 2: network of people. You start to build up a I
Speaker 2: like a trusted network. If I trust this person, then
Speaker 2: they trust that person. Then I can probably lean on
Speaker 2: the trust relationship between these parties, and then I can
Speaker 2: also start to do some more due diligence there. Unfortunately,
Speaker 2: it's ninety percent of the cases. You do tend up
Speaker 2: to tend to do a lot of the due diligence
Speaker 2: for yourself because this is your money that you're going
Speaker 2: to invest. And yeah, if you don't do that, it's
Speaker 2: a buyableware situation.
Speaker 1: Yeah, and you've told me before with some of the
Speaker 1: you diligence that you do you mentioned doing due diligence
Speaker 1: on the management team, and that can include things like
Speaker 1: looking at their LinkedIn history, where were they at before,
Speaker 1: were there's companies successful, what was the exit for that company,
Speaker 1: and you can get a census to whether they're being
Speaker 1: successful or whether they're serial entrepreneurs where they're jumping from
Speaker 1: one startup to another startup. They're raising capital, so ie
Speaker 1: using other people's money to try and get a business
Speaker 1: off the ground. If it does great, If it doesn't,
Speaker 1: they sink it and they start something again. So they're
Speaker 1: the type of entrepreneurs we probably don't want to invest into,
Speaker 1: whereas we have others that have been management in companies.
Speaker 1: They've grown it it's e the iPod or they've trade
Speaker 1: so out it and then they go for a holiday
Speaker 1: for a while, they come back they do something else,
Speaker 1: so they've got pedigree, they've got runs on the board. Well,
Speaker 1: what we'll do is Rudy will take a quick break
Speaker 1: and then we'll come back and have a chat more
Speaker 1: and we'll jump into private equity jargon. Listeners will be
Speaker 1: back in a moment. Hello and welcome back to the
Speaker 1: Money Puzzle. I'm James Gerard, writer a contributor to the
Speaker 1: Wealth section of The Australian and also Financial Advisor with
Speaker 1: Financial Advisor dot com dot Au. And on this week's show,
Speaker 1: I have Rudy angle Breck. So we're going to dig
Speaker 1: deeper into private equity. But before I do that, I
Speaker 1: just want to remind everybody again that this is general advice,
Speaker 1: not personal advice, so please seek out a qualified advisor
Speaker 1: before making any decisions. Now, Rudy, let's have a chat
Speaker 1: about some jargon in private equity. There's all these words
Speaker 1: that sort of flow around burn rates and runways and
Speaker 1: pitch decks. So what don't we go through some of
Speaker 1: those top ones and you can just break it down
Speaker 1: in simple English? What are these things? So let's start
Speaker 1: with a pitch deck p t ch deck.
Speaker 2: What is that? So a pitch deck is very detailed.
Speaker 2: Usually it's a presentation that could from literally five pages
Speaker 2: to fifty pages, and the whole key is to get
Speaker 2: the message across in thirty minutes or less to invest.
Speaker 2: As you can imagine that a founder and their team
Speaker 2: I have to pitch this deck to probably ten two
Speaker 2: hundred people to raise money, and they want to make
Speaker 2: it as streamline as possible. The details that will usually
Speaker 2: be and that pitch check will be a quick over
Speaker 2: with the company, the market opportunity and the company's unique
Speaker 2: selling proposition, the competitive advantage. They have a bit about
Speaker 2: the management team. If they've got a good management team
Speaker 2: with a good track record and runs on the board,
Speaker 2: then they're obviously going to put that in there. The
Speaker 2: business model with their revenue streams and cost structures. And
Speaker 2: I usually look at those numbers and I multiply all
Speaker 2: costs by three on our revisal revenues and divide by three,
Speaker 2: and then I also look get up and down cases
Speaker 2: and that so I always look at those numbers. Never
Speaker 2: trust the numbers. Ask these questions on those numbers when
Speaker 2: you see them, the product offering or the service offering
Speaker 2: that they will have in the pipeline. And then they
Speaker 2: even should have financial performance a sorry performance as well
Speaker 2: as future projections and forecasts. And then also a little
Speaker 2: bit more about the capital structure in terms of how
Speaker 2: much money they've got in the bank, how much money
Speaker 2: they're inter raise, how much money they have raised, and
Speaker 2: what evaluations they've used in the past. And then basically
Speaker 2: some of the risk factors that they see or companies
Speaker 2: carry risk and issues that they can try and look
Speaker 2: at and prevent, and then some reasonable excess strategy or
Speaker 2: sometimes they don't have one, but if they have one,
Speaker 2: then usually some clear numbers or in three years they
Speaker 2: want to do this or sell to someone or list,
Speaker 2: et cetera.
Speaker 1: Excellent thanks Reddie. What I find is a red flag
Speaker 1: when I review pitch decks is if there is no
Speaker 1: financial forecast, if there are no financial numbers in there
Speaker 1: around income and expense or even projected because in a
Speaker 1: pitch deck that the company is trying to show you
Speaker 1: things that they want you to see. If they don't
Speaker 1: want you to see something that they don't put it
Speaker 1: in the pitch deck. So I get a bit concerned
Speaker 1: when they're light on the financial and the forecasts and
Speaker 1: they're more about the big picture. This is the market
Speaker 1: opportunity because they then have this valuation which could be
Speaker 1: anywhere from a few hundred thousand to tens of millions
Speaker 1: of dollars, and there may not be as much science
Speaker 1: behind it as the investor would want, particularly if they're
Speaker 1: not showing that the financials in the pitch deck. So
Speaker 1: it's always prudent that if you're interested in the company
Speaker 1: and you see the pitch deck, but it has even
Speaker 1: if it has financials, it's generally a good idea to
Speaker 1: ask for what's called the data room, which is generally
Speaker 1: a cloud based location where the company will store more information.
Speaker 1: So they might have an Excel spreadsheet with financial forecasts,
Speaker 1: and it's interesting to drill down into that because although
Speaker 1: they may be projecting certain things around the growth of
Speaker 1: the company, you need to check that and be critical.
Speaker 1: As you were saying, rudy of those assumptions. So is
Speaker 1: the growth rate they're using of say forty percent, is
Speaker 1: that in line with the market growth rate for that
Speaker 1: particular company. Is it achievable to increase customers from x
Speaker 1: to y over a twelve month period? Is it reasonable
Speaker 1: that they're going to only spend this amount of marketing
Speaker 1: to acquire customers. So all these sort of things need
Speaker 1: to be sense checked to get a good understanding of
Speaker 1: is this a realistic picture of where the company might
Speaker 1: be into the future. What do you reckon really.
Speaker 2: One hundred percent agree a good check is exactly the
Speaker 2: historic numbers. Look at the historic numbers, and if there
Speaker 2: was a forty growth rate over the last two years
Speaker 2: and they're projecting a two hundred percent growth rate over
Speaker 2: the next two years. You want to know what events
Speaker 2: are actually going to trigger those and you can ask
Speaker 2: questions around that, and you can see on a growth visually,
Speaker 2: why is this thing spiking up the revenue whatever your
Speaker 2: costs and was the cost not going to go up,
Speaker 2: et cetera. So there's a lot of promit there can
Speaker 2: be a lot of promises made without the real backing,
Speaker 2: and that you want to see historic numbers because that
Speaker 2: gives you good indication.
Speaker 1: Yeah, no, it does. And what would be a rule
Speaker 1: of thumb or is there one for valuations? How do
Speaker 1: you value a private equity company? Is there is it
Speaker 1: a multiple of revenue? Is it a multiple of profit?
Speaker 1: What about in the early stage, whether there is no
Speaker 1: revenue or profit, there's just an idea or maybe just losses.
Speaker 1: That makes it more difficult to value that type of
Speaker 1: company as well.
Speaker 2: Yeah, so, first of before we jump into the manue,
Speaker 2: the rule of fun could be if you don't have
Speaker 2: any earnings or profits, then you could use revenue or
Speaker 2: sales and you could use multiples there. You could you
Speaker 2: literally look at other companies in the market who are
Speaker 2: either listed, so you can then get good ratios in
Speaker 2: terms of their revenue is x and their evaluation is
Speaker 2: a multiple of X. What is that multiple? You can
Speaker 2: start to apply that, but remember listed company is different
Speaker 2: from an unlisted company because they are liquid and they
Speaker 2: have nice financials that you can look at. In this case,
Speaker 2: you can then enough to reduce the multiple by a
Speaker 2: factor to so it's unlisted, it's not proven yet, it's
Speaker 2: still in the growth page as well. That's one way.
Speaker 2: If there are earnings you can use that. And again
Speaker 2: you can relate it to other companies in the market,
Speaker 2: if they are listed or if they are unlisted. You
Speaker 2: might get information. You might have had a company that
Speaker 2: you raised, that you were involved and then they raise
Speaker 2: money and you can use similar multiples. And you can
Speaker 2: also then look at the unique areas that they claim
Speaker 2: that's going to be better, and then you could adjust
Speaker 2: the multiples. But those are typically the rules of umbers.
Speaker 2: Look at other companies and multiples and try to find
Speaker 2: something that works.
Speaker 1: Got it in the companies that you've invested into. What
Speaker 1: would be a broad range of multiples of revenue that
Speaker 1: have been attached to valuations of those companies that are
Speaker 1: we talking in five times revenue, ten twenty times.
Speaker 2: Yeah, it's a if it's a non if it's non tech,
Speaker 2: you could have three times to five times sale sales,
Speaker 2: so the revenue so free times. It depends on the industry. Again,
Speaker 2: look at the industry. Tech companies could sometimes go five
Speaker 2: times or more. And obviously if they have a unique
Speaker 2: product of no one else as then the scars the limit.
Speaker 2: Someone could literally see the idea and value that differently
Speaker 2: and you could get ten times or twenty times. And
Speaker 2: if you look at in the past, you could have
Speaker 2: seen typically crazy types of multiple supply to certain industries
Speaker 2: and certain companies. But look at the average and work
Speaker 2: with that. But yeah, five to ten times is high,
Speaker 2: but it can be happened.
Speaker 1: Well, let's do one more jargon and then we'll move on. Really,
Speaker 1: tell me what is the burn rate? What does that mean?
Speaker 2: Okay, a company obviously, every day that it operates, it
Speaker 2: has expenses and it also has revenue coming in. And
Speaker 2: if you measure that on a monkey basis, then this
Speaker 2: is how much money is either being burned because they're
Speaker 2: running at a loss or if they're lucky, they actually
Speaker 2: show profit. But usually because you're investing in a growth
Speaker 2: oriented company, they'll be burning at a loss, and you
Speaker 2: measure this on a monkey basis. And then the other
Speaker 2: piece of jargon that we can add on is the runway.
Speaker 2: So often you've calculated the burn rate, you can then
Speaker 2: figure out based on these numbers and your future cash flows,
Speaker 2: you're going to have, say twenty four months of runway left.
Speaker 2: And it's typically used in the context of an aeroplane
Speaker 2: when they want to take off. There's a piece of
Speaker 2: runway left and the aeroplane needs to be up in
Speaker 2: the air before it runs out of runway. And obviously
Speaker 2: if the runway is going to be too short, then
Speaker 2: we need to raise more money again and that's when
Speaker 2: the next round happens, hopefully at a higher evaluation.
Speaker 1: I like it. I like the financial engineering there with
Speaker 1: the wording of it. Rather than saying I'm losing heaps
Speaker 1: of money every month and I'm going to run out
Speaker 1: of money in X number of months, I've got a
Speaker 1: burn rate of this and a runwate of that. Sounds
Speaker 1: a lot better.
Speaker 2: Yeah, all right.
Speaker 1: Let's have a chat about risks. So what would you
Speaker 1: say the top couple of risks that you would say
Speaker 1: to investors to think about before they jump into a
Speaker 1: private equity or adventure capital type investment.
Speaker 2: We've touched briefly on this before and when we discuss
Speaker 2: what top investor would like to invest, but and what
Speaker 2: factors you need to consider. So the risk or the
Speaker 2: one is liquidit to your risks. So pe or private
Speaker 2: equity investments are not traded on public markets, and your
Speaker 2: capital could be locked up for five to ten years.
Speaker 2: Sometimes you like in less than five, but it's a
Speaker 2: long time. So are you prepared to have it locked
Speaker 2: up and you can't sell it? If you sell it,
Speaker 2: usually sell it at a discount to other investors, and
Speaker 2: you don't want to do that market risk. If there's
Speaker 2: a market downturn, then the cost of capital and debt
Speaker 2: becomes quite expensive. So if you raising capital and investing
Speaker 2: through a downturn, obviously you could invest at a time
Speaker 2: when the company is valued at x, and then two
Speaker 2: years later they valued at a lower evaluation, and then,
Speaker 2: like anything in any investment that could be lower, they
Speaker 2: now need to raise new money. They ran out of
Speaker 2: run way. They raise new money and the shares that
Speaker 2: the issue will be at a lower evaluation. This is
Speaker 2: known as a downrounde and typically it's not favorable and
Speaker 2: it will leave the current shelds even further. And then
Speaker 2: there's the other one, which is the operational and execution risk.
Speaker 2: So the company and management team simply they just could
Speaker 2: simply struggle to execute operationally, or there's no sales or
Speaker 2: something change in the market, some regulation came through and
Speaker 2: closed down the market opportunities for them. So that's a
Speaker 2: few of the risks.
Speaker 1: Got it all right, So we've got liquidity. Money is
Speaker 1: trapped until there's an exit event. In most cases, there's
Speaker 1: this market whereso conditions can change and evaluation of the
Speaker 1: company can be affected. And then we've got operational resk
Speaker 1: so things may not go to plan and that might
Speaker 1: be due to the company itself broader market conditions. That's
Speaker 1: really good, Rudy. I want to get your tips and
Speaker 1: tricks for success in private equity. But before we do that,
Speaker 1: let's just take another short break. Hello and welcome back
Speaker 1: to the Money Puzzle. I'm James Gerard, writer contributor to
Speaker 1: the Wealth section of The Australian and also financial advisor
Speaker 1: with Financial Advisor dot com dot Au and on this
Speaker 1: week show, I have Rudy Engel break. So Rudy, let's
Speaker 1: have a chat about tips and tricks for private equity investors.
Speaker 1: So what are some of the things that you've learned
Speaker 1: over the years that you think would be useful for
Speaker 1: a new investor in this area to know about.
Speaker 2: I would start off with looking at the people, the
Speaker 2: management team, the key executives, their track record, much of
Speaker 2: that I'm comfortable with them, then I can actually relate
Speaker 2: to them. Is my own personal way of doing a
Speaker 2: bit of due diligence on the people. First. Ultimately, companies
Speaker 2: are built by people selling products built by people again
Speaker 2: and selling it to other people, so it is ultimately
Speaker 2: driven by that. The second thing I would do is
Speaker 2: work through the numbers due diligence questions, try to break
Speaker 2: their assumptions and models and ideas. And sometimes it could
Speaker 2: be that you just don't know enough and they do
Speaker 2: know quite a lot more than you do. But keep
Speaker 2: on asking the questions that would seem obvious even in
Speaker 2: that way. Also, don't be too scared by too much
Speaker 2: technology talk or other questions. If they cannot explain it clearly,
Speaker 2: then they're going to have to sell these products and
Speaker 2: explain it to other people. So it must be simple
Speaker 2: to understand for you. If you don't understand it, then
Speaker 2: maybe it's also not for you and you can pass.
Speaker 2: Another area that I look at as the industry, I'll
Speaker 2: look at similar companies or compare it. I compare to
Speaker 2: aaliations like we mentioned before, look at similar multiples. I'll
Speaker 2: look at how they raise capital, how much capital that
Speaker 2: they raise, just to get another data point and guideline
Speaker 2: on that. And in general, I avoid companies with debt.
Speaker 2: I don't understand why you would want to raise capital
Speaker 2: and then use that to service your current debt, even
Speaker 2: if they promise not to pay back debt and they
Speaker 2: use it working capital as I just don't understand while
Speaker 2: they can't just issue more shares. Again, there could be
Speaker 2: other reasons for that. That's me. I just don't want
Speaker 2: more debt. And then be patient, ensure that you're comfortable
Speaker 2: that the money that you invest it can be locked
Speaker 2: up for many years, don't expected to have a return
Speaker 2: next year, and then also accept it not all investments
Speaker 2: will yield the five x or ten x or twenty
Speaker 2: x type of returns and multiples that everyone else talks about. Remember,
Speaker 2: people talk about the winner, not the ten losers out
Speaker 2: there or the average return spere that in.
Speaker 1: Mind excellent and in terms of the way that people
Speaker 1: can get access to private equity investments, we've been talking
Speaker 1: mainly about the direct pathway where we're investing, we become
Speaker 1: shareholders on the share register of a private company. But
Speaker 1: there's also other pathways available to the everyday investor. There's ETFs.
Speaker 1: There's a ping Ghana or maybe that's not an ETF,
Speaker 1: but it's a maybe it's a listed investment company or
Speaker 1: it's a listed trust. Ping Ghana have one and they
Speaker 1: invest into private equity investments, so that's brought through the ASX.
Speaker 1: There's a managed fund by Schroeder as well. They've got
Speaker 1: a private equity fund. So you can take a hands
Speaker 1: off approach and let a professional fund manager invest into
Speaker 1: a portfolio of private equity investments for you if you
Speaker 1: don't want to go through the trenches and the hard
Speaker 1: work of doing the du diligence yourself, and also if
Speaker 1: you want to diversify more and have a whole portfolio
Speaker 1: of investments rather than a smaller amount, because generally private
Speaker 1: equity investments, if you go direct, they will usually want
Speaker 1: you to be what's called a whole sale investor, which
Speaker 1: means that they will want you to have an accountant's
Speaker 1: letter clearance as signed off on, which means that the
Speaker 1: accountant needs to certify that you earn either more than
Speaker 1: two hundred and fifty thousand dollars per it a past
Speaker 1: two financial years or your net worth is more than
Speaker 1: two point five million dollars. And then the minimum investment
Speaker 1: it's generally one hundred thousand, sometimes two hundred thousand. Some
Speaker 1: companies will drop it to fifty thousand, but they're larger
Speaker 1: amounts that they're not like five hundred dollars, which is
Speaker 1: the case when you buy shares on the share market.
Speaker 1: Even for quite wealthy investors. It's quite difficult to invest
Speaker 1: in a whole heap of private equity investments just due
Speaker 1: to the minimum investment restrictions. Funds are another way to
Speaker 1: do it, and really there's a few websites around, aren't
Speaker 1: there that they like they crowdfund into private equity investments.
Speaker 1: So they put up a campaign about a chili sauce
Speaker 1: or something like that, or a new gin distillery, and
Speaker 1: they try and get people into that. That's another way
Speaker 1: that people can get into private equity investments. But I
Speaker 1: would caution that pathway because my perception is that pathway
Speaker 1: appeals to more I have to use that term, but
Speaker 1: the sucker money because they're throwing more around the images
Speaker 1: and the market opportunity more than the numbers. In those
Speaker 1: type of things. It's more of a psychological thing that, oh, yes,
Speaker 1: I use this product. I can actually go buy some
Speaker 1: shares and be a shareholder. But when you have a
Speaker 1: look at what you own of the company, it might
Speaker 1: be like zero point zero one percent, whereas you thought
Speaker 1: it might have been a bit more than that. But
Speaker 1: it's a little bit opaque with regards to the financials
Speaker 1: and evaluations. It's more on the idea, that's right.
Speaker 2: Yeah. To add on to your comments about investing in
Speaker 2: the listed trusts or on the ASX, there are companies
Speaker 2: and funds that will offer you a product where you invest,
Speaker 2: say fifty or ten thousand dollars into the fund, and
Speaker 2: then the fund manager will perform all the due diligence
Speaker 2: for you because that's their job, and they will then
Speaker 2: obviously tides an annual fee to manage the fund. There
Speaker 2: will be performance fees that they'll sar. It's based on
Speaker 2: the performance of the assets in the fund and the
Speaker 2: companies invest in and you're just one of the investors
Speaker 2: in this pe fund. However, it can be worth it,
Speaker 2: especially when the fund investing in multiple companies over the
Speaker 2: timeline of the fund. They diversify the risk for you,
Speaker 2: and they will also offer you some liquidity where you
Speaker 2: might not have to wait five to seven years. You
Speaker 2: could once a year or twice a year be able
Speaker 2: to retraw a percentage of your funds in them. So
Speaker 2: that is one way instead of going crowdfunding, where James
Speaker 2: totally right. The crowdfunding feels like a hailgun approach. We
Speaker 2: just spray money and hope to get something back, where
Speaker 2: at least with a fund manager with a good track record,
Speaker 2: they will do a lot of the work for you.
Speaker 1: That's right. Really, we're almost out of time. If you
Speaker 1: could give me one final thought with regards to private
Speaker 1: equity and venture capital to take our listeners away with,
Speaker 1: what would you say?
Speaker 2: I would definitely take the advice of a financial advisor
Speaker 2: to walk with me this through the detail and assess
Speaker 2: my risks and my profile and goals before I just
Speaker 2: go and invest. Because the last thing you need is
Speaker 2: to invest a big chunk of your life savings into
Speaker 2: something and then wait for that. We might not get
Speaker 2: a reach out, so make sure your ascid adication and
Speaker 2: your goals are aligned.
Speaker 1: Fantastic. Thank you for that, Rudy, and thank you so
Speaker 1: much for joining us today. It's been really insightful and
Speaker 1: I've enjoyed our chat and I'm sure our listeners will
Speaker 1: as well. So thank you again, Rudy Engelbrek for joining
Speaker 1: us on The Money Puzzle.
Speaker 2: Thank you, James really enjoyed it. Thanks for the time.
Speaker 1: Excellent, And to our listeners, thank you for tuning into
Speaker 1: today's episode of The Money Puzzle. Send in a question
Speaker 1: and James Kirby will answer it in a couple of
Speaker 1: weeks time. I'll be with you for the next two weeks,
Speaker 1: and coming up on next week's episode, we're going to
Speaker 1: have a return of an accountant named Timothy Ricardo. He
Speaker 1: was on a few months ago when I last guest hosted,
Speaker 1: and he copped a bit of flak from his clients
Speaker 1: and friends because we were talking about what are some
Speaker 1: of the things that you can claim as a tax
Speaker 1: deductions and we had a lot of weird scenarios, but
Speaker 1: Tim seemed to say no to everything, so Tim's been
Speaker 1: given the task of saying yes to something, so he's
Speaker 1: going to come prepared next week with some tax deductions
Speaker 1: that you didn't think that you could get that you
Speaker 1: could actually get, as well as talking about other contemporary
Speaker 1: tax issues. So we look forward to that. You can
Speaker 1: tweet us your thoughts, just use a hashtag the Money
Speaker 1: Puzzle or one word or email us on the Money
Speaker 1: Puzzle at the Australian dot com dot au. Until next time,
Speaker 1: I'm James Gerard. Talk to you soon.