Sowing the Right Seeds in a Portfolio Company

A reprioritization of strategic initiatives at a company can become a tussle between entrepreneurs and investors. In general, investors will look for a focus on a narrow, well-defined and tested set of opportunities; whereas entrepreneurs, while pursuing those initiatives, will also seek new avenues for additional growth.

Part of the reason for this dichotomy is different time horizons. PE Investors typically have a 4-6-year timeframe for exit and want the business to maximize value-creation over that period, while entrepreneurs seek to sow seeds that grow the business over a much longer time frame, possibly extending over decades.

Clearly, not all seeds will yield favorable results and hence there may be a natural inclination to sow multiple seeds. It is easier, on a very fundamental level, to pursue a few different ideas in nascency. From an entrepreneur’s perspective, it balances out the opportunity for future growth without having to risk putting all the eggs in one basket.

At SeaLink Capital Partners (SCP), our mission is to partner with entrepreneurs to accelerate their growth through a collaborative approach. Of course, we want to enhance value-creation and maximize the return on our investment, but we also recognize that the best partnerships are ones in which everyone emerges stronger. Our aim is to enable companies that we invest in to grow from strength to strength during and even post our financial investment.

When we evaluate companies, we spend a lot of time with management to understand its vision and plans for the business for the next 5-10 years. It’s crucially important at that stage to make sure that we are aligned with the management’s belief on where growth is expected to come – what initiatives should be pursued and which seeds for growth should be sown.

Having said that, business environments change and some of the key features of strong management teams are agility and adaptability. There may be instances where post investment, management identifies additional areas of opportunity based on evolving market conditions. How should an engaged investor ensure that the business is focusing on the right set of well-thought-out priorities for future growth? And how can investors make sure that entrepreneurs and management teams do not spread themselves too thinly across priorities?

As part of our engagement model, we work closely with management on strategy development. We ask them the difficult but important questions in progress reviews and work together to develop the right set of priorities for both the short and long-term.

Here are some of the areas that we probe into for any new priorities:

What will be the company’s differentiation in this new area? Entering a growing market segment as a “me-too” player without tangible differentiation is not a sustainable long-term strategy. There have been instances of entrepreneurs focusing on revenue growth (at the expense of profitability) in order to drive up valuations for their businesses. Buying revenue growth is not really a challenge, and it can be a slippery slope for entrepreneurs if they don’t exert strong discipline. A short-term spike in sales can come at a high cost, not just in terms of the financial investment, but also in terms of the opportunity cost of missed priorities.

On the other hand, if there is an attractive market adjacency and the business has a natural competitive advantage that can be exploited, as investors and partners for long-term value creation we would want to explore that with the management team further.

What is your level of conviction on this new initiative? This is an extremely important question to ask the management. A bet was placed on the future potential of the company based on ongoing and planned strategic initiatives. New ideas that take management attention and bandwidth away from them will have to clear a high bar of conviction. The onus here is on the management team to prove their attractiveness. Getting that proof of conviction may require staged investment, pilot projects, and further diligence into the sector before jumping in with both feet.

How will incentives be aligned? There has to be skin in the game on both sides. There can’t be a situation wherein if a new initiative fails, the investor bears the complete burden. Financial incentives have to be aligned to share the reward as well as the risk of pursuing new opportunities.

What are the interim milestones and how will success/failure be measured? Separating emotions from outcomes is crucial. Too often, entrepreneurs and resultantly investors remain hopeful of a turnaround even when all signs suggest otherwise. For the sake of transparency and the removal of subjectivity, it is important that at the beginning of a new initiative, intermediate measurable milestones are established. Critically, the discussion should also include metrics at which the company will pull the plug on an initiative that is not delivering, thereby removing all subjectivity or ego-related issues later.

How do you plan to sustain the trajectory of planned initiatives? In other words, how do you make sure that the “new thing” does not divert too much management bandwidth or capital away from the initiatives on which the investment thesis was based, thereby putting its success at risk? While we understand and even appreciate the need for entrepreneurs to plant seeds for the future of the company, as custodians of capital, protecting the investment and managing risk appropriately is very important for us.

Showing agility and adaptability in evolving market conditions is a great attribute to have in management teams, and one that investors will support. However, a change in strategic focus has to be done for the right reasons.