Angels & Demons (&Zavy)

It's Friday afternoon, never a great time to write a blog, but this is about me trying to help people and to respond to something that irritated me: its here if you want to read it.  It's not too long and its in three parts, so it should be pretty digestible.

Angels and Demons, by Dan Brown is a rollicking adventure tale set against a backdrop of a powerful institution the Catholic Church.  In the Da Vinci Code, Professor Langdon wanted to reveal a great secret held by that institution: in Angels and Demons he needs to solve a puzzle to free the pope elect from danger. Strangely enough, Private Equity (PE) investing is a bit like being a protagonist in these works; especially if you're trying to democratise PE. You need to rescue small retail investors from themselves, and to do it, you need to reveal a secret.

11 years ago Armillary Private Capital set out to try to help more people better understand: portfolio theory; risk, and private capital.

Three years ago we took this beyond wholesale investors, with our joint venture with Crowd Cube, and now with a new shareholder base and a new tech platform Crowdsphere, we are taking it to small retail investors.

Crowdsphere's goal is simple: to democratise PE.  To recyle that awful phrase used, if not coined, by Thomas Piketty in Capital in the 21st Century, this process is about improving the lot of those who are not in the top 1%. Don't get me wrong, we are not about feeding the poor, or housing the homeless, its an opportunity for those that can and do save, that have surplus earnings, to do a bit better. Then, to quote, John Wesley they can: "Earn all they can, save all they can, and give all they can." After all the difference between 10% compound returns and 15% compound returns is that at 10% you double your money in eight years: at 15% its five years. 

As an asset class PE does this due to the pricing of its securities reflecting the illiquidity of its assets, and the use of non-standard investment products. The problem is how do small retail investors access PE funds, if they can't commit $200k plus? The answer is crowd's and angel investing.

Angel's, Ministers and Regulations

Yesterday, David Wallace and I had a fantastic meeting with Bill Murphy of Enterprise Angels.

It turns out that we share about 90% of a worldview, like us he is more focused on getting businesses to cash flow breakeven and key valuation inflection points, rather than the capitalise and pray 'moon- shot' approach to investment, but we were not in agreement in regards to Crowd Funding.  David and I think we can trust people once they know what to do, Bill is not so sure. He thinks that the Minister of Commerce has exposed retail investors to, too much risk, by leaving the Crowd less regulated.

Bill's concern is that non-wholesale investors may not understand, or apply the portfolio disciplines that more sophisticated angel investors and wholesale investors do.  So rather than simply demonise the Crowd as being uninformed, I thought I would share exactly how early stage investors, either Angels or Crowds should invest.

The Secret: Portfolio Theory 

Firstly, as Ben Graham would say, do your homework.  With a crowd structure, look for platforms that deal with later stage businesses, or businesses with their own crowds, or businesses that have good boards.  If you're an Angel check out the DD report for yourself.

Ask your Crowd provider how they filter transactions and how many they turn down? Then look at each opportunity, there must be at least two or three features of the product, service, team or investment narrative that you get.  If not, don't invest, its just not for you.

If you're happy about the platform's or your angel groups DD, excited about the security, then ask yourself about relative price and get some sense of what Ben Graham talked about as a 'margin of safety'.  Whilst early stage companies just won't have: Size; Strong Balance sheets (but they probably shouldn't have debt either!!); Earnings Stability, and a dividend record. BUT what they should have is Earnings growth; Price/Earnings or in the SAAS world Price/ARR.  I will use Zavy to give you an example of this later.

Finally, you need to understand that liquidity risk, even company survival risk, is potentially a real issue for some of these early stage companies. So you overcome these risks by portfolio construction and diversification. PE's and VC's implicitly understand that when they give small amounts of money to an enterprise to achieve key milestones they minimise their risk. They also identify and allocate capital to about 10 investments, sometime more if they are larger and better resourced. 

This has to with diversification of risk: nothing is certain in investing, except death and taxes, individual stock performances will vary markedly, diversification allows the portfolio to suffer some reversals in fortune without destroying all the capital.  One of the other problems is having the portfolio spread too thinly, or over diversification. As Warren Buffet said: "if you have a harem of forty women, you never get to know any of them very well." You can't reinforce success, and you can't get out of problems if you don't know your investments very well.  Too many is as big a problem as too few.

Zavy

 Let's look at Zavy for the moment, and its peer on Crowdsphere: Noted.

Zavy is currently a 100% subsidiary of one of NZ's leading insight businesses TRA (formerly The Research Agency). If the Crowd raise is successful, Zavy will be a 89% - 75% subsidiary of TRA.  The three founder executive shareholders of TRA: Andrew, Amber and Connon have grown this business phenomenally over the last nine years, it is # 3 in terms of market share and the # 1 independent insights firm. It has had a CAGR of 43% since inception and featured twice on Deloittes Fast50 List.

Zavy's balance sheet reflects a very significant real investment by TRA in Zavy.  Zavy's board comprises three executive directors: Andrew, Connon and Antony, it has had a full time executive employee since March/April 2016.

Zavy is twice as expensive as Noted.  It's pre-money valuation is $2m, versus Noted's $1m, so let's look at the relative price and value issues. Noted has an exciting beta product, users, two directors and a commercialisation strategy. Zavy has customers, revenues, three directors and a full time staff member, actual revenues, and very real revenue growth.  Both represent fair value in regards to the individual development of each business.

Let's compare Zavy to another early stage social media related technology company that raised capital earlier this year. It had a cracking board, a big executive team (and overhead), a unique application of a technology, three years of corporate existence and revenues of about $1m - $1.5m, and forecast ARR next year of $2m. Its capital round was priced at 5 x one year forecast ARR.

I liked that business, a lot, I wanted to invest, but I new I had to invest in a follow on round on another entity, and I just couldn't get my head around using such a high multiple of future year ARR revenues.

Now I come to Zavy. When it launched its IM in October, the ARR was $270k, now with the 4 month trial from a global Australian based consumer goods business, and one of the power companies upping their use ARR is now $340k p.a.

So in the other case, l didn't like the use of only forecast numbers and no anchor on actuals, so in Zavy's case lets use the average: $340k + $1m = $1.34m/2 = $652k x 5 = $3.35m. This suggests to me that Zavy's offer of securities has a "margin of safety", albeit, not in a full traditional sense, and its already 34% on its way to complete its forecast $1M in sales, and breakeven 13 months before balance date! 

If your interested check out Zavy on Crowdsphere.  https://crowdsphere.co.nz/

Please note Leon Grandy is a director and shareholder of Armillary, a director and beneficial shareholder of Crowdsphere, and an investor in Zavy, if this Crowdsphere round is successful.  Armillary has also provided advisory services to TRA.

 https://crowdsphere.co.nz/