Looking for a 10-Fold Return
June 21, 2021
Admittedly, I’m a startup person. The lab I joined in grad school was a startup. All the companies I’ve worked for were startups. I even started my own businesses. I went to business school to focus on entrepreneurship and new ventures because I wanted to work in venture capital and help investors understand the complexities of the life sciences and health care industries. While I never got a job in venture capital, I am thrilled that I get to do that work for 7investing members today.
Startups are obviously different from most established and public companies (the biotech industry may be an exception), with an important difference being revenue generation. Venture capitalists therefore have to use different pieces of information to determine a company’s value – team, product-market fit, total addressable market, and business model. Although my area of focus is different now, I still use the same general principles in evaluating companies.
VC’s invest in companies with the goal to get a 10-fold return on their investment, knowing that not every company in their portfolio will make it. Similarly, I look for companies that can also provide a 10-fold return and add them to my long-term investment portfolio. This is my approach for evaluating public companies with the goal of delivering a 10-fold return:
Team – I look for a team that can not only create the vision, but also has the leadership, knowledge, and skills to bring that vision to fruition. In a startup that team is typically fewer than a dozen people compared to a publicly traded company that might employ tens of thousands. Within the team, however big or small, needs to be the skills to carry out all tasks and a culture that aligns with the goals of the business and empowers each employee to reach those goals.
Product-Market Fit – It is easy for a company to fall in love with their technology. But if the market doesn’t love it (or worse yet doesn’t have a need for it), there is little chance for success. For public companies, I look to understand how the market appreciates the product through sales (product price and value), net promoter scores, and brand allegiance. Companies that make products that people love tend to be successful.
Total Addressable Market (TAM) – This is the growth potential of a company. Simply put, it is how large the market is that has a need for the company’s product(s). For a public company that is generating revenue, it is possible to compare revenue to the TAM to see where the company is on its growth trajectory. As a long-term investor, I look for companies that have only reached a small fraction of their TAM or that have adjacent markets to grow into.
Business Model – This is how the business makes money. For startups, the business model may be somewhat fluid as the company is still figuring out their product-market fit. For public companies, this should be firmly established. The company needs to have a model that generates revenue with a good operating margin, meaning that the cost of creating and selling the product should be substantially less than revenue.
Although I am new to the 7investing team and have only made a couple of recommendations, I consistently look at these key factors when evaluating and recommending a company. Once I have narrowed my options, I look more closely at a company’s SEC filings to review their information more carefully to make sure that the numbers align with my understanding of the business. As in venture capital, investing in a company, especially one in which you have no control, can be risky (see my article on dealing with risk and an emotional market) so you need to understand your risk, trust yourself, and do your homework. You’re not always going to be right to find that unicorn or 10-bagger, but you should get a decent return in the long term.