6. How much do you keep, how much does your investor?

What’s new, reader?! How are you doing? I’ve been driving through memory lane and, in this column, I won’t be able to finish our story on how we raised the “dough” to launch Resuelve, haha. Hopefully, I’ll make it in the next two. This time, I’ll tell you some basic things about valuation, and I’ll go on introducing some of our original investors.

Last time we read each other, I told you about the ideal investors or “Fs,” and we had just me Alan Smithers. One of the questions Zorro and I frequently hear is: How do you know how much of the company you own, and how much do the investors for your company get? In other words: how do you decide the value of something that could just be a simple PowerPoint or a business plan?

What’s an idea worth, or something that only generates loss? In practical terms, things are worth as much as people are willing to pay for them. In other words: offer and demand.

Regardless of whatever a theory says, or what any valuation methodology points out, if you have a bag of poop, and someone is willing to pay one million pesos for it, then that bag of poop is worth one million pesos.

Lots of highly sophisticated and stuck up people can disagree with such valuation, all of those “Princes” (as my good friend Juan Pablo Pina would call them) who work in Funds and Investment Banks, like to think they’re hyper-sophisticated, and the holy grail of valuation. However, often (not always) the “investment hunger,” or FOMO (Fear of Missing Out), ends up by dismissing the best Excel, DCF, or Valuation by Multiples.

Having said that, and assuming I’m speaking with disciplined investors, any project’s value must be related with its return potential, and the risk it entails. For example, if I invest today in CETES, in other words, lending money to the Mexican government, I can only expect to receive a yearly return of 7.5% with a minuscule possibility of losing my money. I am aware that I’ll be getting 7.5% in return, at most, but it’s almost impossible that I’ll have any losses.

Therefore, if I’ll invest in something with a lot of risk of not working (such as an idea in PowerPoint), I should expect that, if things happen as planned, my return will be fucking remarkable. Notice I used the word: PLANNED! Here’s where a business plan, and a sound financial model, are useful.

The business plan, together with the financial model, are the guidelines which will tell you how to execute your project. If everything goes well: how much will you be selling in 5 years, what will your margins be, and, therefore, how much would your company be worth?

Let’s go back to the original question: How much do I get, and how much do the investors get? To solidify the idea, I’ll use a hypothetical example:

Let’s imagine there’s one investor with 2 million Mexican pesos to invest. According to your financial model, your company could, in 5 years, have an EBITDA margin of 10 million pesos, and your Prince friends have told you that, historically, that kind of companies are valued 5 times their EBITDA.

In other words, your company could be worth 50 million pesos in 5 years (5 x 10 = 50. Just so you don’t get starstruck by the level of sophistication of the Princes). Here’s where the expected risk and return come to play. If the investor expects to receive a yearly compound return of 30%, what part of those 50 million in value should belong to him?

2 million pesos in a 30% annual yield, for 5 years, amounts to 7.43 million pesos. Therefore, that investor would expect to own, at least, 14.85% of your company, in order to reach the expected return. Additionally, you must consider the risk of not achieving your goals, or that things won’t have the expected outcome (which happens 99% of the time haha).

What’ll happen if you don’t reach your goal? Better said, what’s the probability of things happening the way you expect? The higher the risk your investor perceives, the bigger the percentage of your company he’ll want. This is to increase the possibilities of reaching his expected return of 30% if things don’t come out as outlined in your business plan.

The valuation talk can have millions of different scenarios, but as I said at the beginning, offer and demand are the most important things. I’ve witnessed, more than once, how the FOMO leads to irrational valuations. But, since that’s not our job, in the following columns, I’ll invite some Princes so they can share their point of view.

Resuming our entertaining story; after meeting with Alan, he referred us to his partners: Luis Rance, and Pablo Padilla. Luis it the type of guy you want to take out for a beer. Quite sharp, extremely funny, and obsessed with sports. Pablo, on the other hand, is like a mad scientist. It took a couple of meetings to catch up with them or, at least, clearly understand what they wanted to tell us haha. It reminded me a little of ITAM’s students, who seem to get an award every time they use a mathematical function in a sentence. We hit it off with Pablo, and Luis; they seemed very interested by the end of our meeting.

On the other hand, another one of Zorro’s brothers-in-law, Eduardo Pesqueira (the perks of having 4 older sisters), better known as “El Doctore,” had heard of our plans, and kindly referred us with Fernando Nieto. Fernando had a lot of experience in the credit card market, because he had directed VISA in Mexico, and worked several years for BBVA. Fernando is the banker stereotype: haircut like a Christ’s Legionnaire, Hermes tie, well-ironed impeccable suit, and terribly serious. He caught interest in our project, and referred us to Lorenzo Gonzalez, who is in charge of Temasek’s Private Equity Fund in Mexico, and had previously been the head “Prince” of Barclay’s Mexico.

The dream of every investment banker “Prince” is to go from a bank to a fund. On the one side you “take orders,” and on the other, you get to decide how the “dough” will be invested. As the great Memo Mascarenas would say: “Mr. OPM” (Other People’s Money). It’s almost like being rich, but you have no risk of losing your money haha.

If you remember my first columns, Zorro had a job offer as an associate for Barclays, in Sales and Trading. Now, we were heading with the former boss of all of Barclays’ “Princes” to pitch the idea of becoming our partner. This balanced the scale for Zorro to reject the job offer, and turn into an entrepreneur. His reasoning was something like this:

“I’m about to get a job in a place in which, to speak with a dude like Lorenzo, I have to ask for an appointment with one month of anticipation, and never look at him in the eye, because he’s a demi-god. But now, I’m about to offer him the opportunity to enter a project in which we’ll be partners, and we’ll be interacting in equal ground.”

Being treated as a deity gets to this Princes’ heads, and Lorenzo was not an exception. During the meeting, he ended up speaking more than us, taking us “for a drive” through all of the super deals he’d closed (which are stupidly impressing), and basically told us how we had to execute our idea. As we walked out, we thought: “This dude is Mexico’s finest, and he might become our partner…Holy fuck!”

If you’ve read my previous columns, most likely you’ve formed a certain image of my personality. For those who haven’t, let me tell you that a lot of people describe me as weird, bitter, and (lately) lame. Some others think better of me, as my wife Andreina, who says I’m an arrogant, unbearable, know it all (when she’s in a good mood). I like to think of myself as excentric haha.

Some of the things that helped me earn this perception of myself are my “truth games,” of which I’ve already talked about; a big aversion to pretentious little dinners with cheese, and wine (as described by Eric Barrio), or a thing for mistrusting people who talk a lot. I’m more of a beer, and pizza, guy.
My thing for mistrusting people who talk a lot would have come handy during this time. I’ll tell you why in my next column.

See you, and we’ll read each other next month. If you have any comments, questions, complains, or suggestions, nag me on Twitter. Find me as @Javivelop.

P.S. Never in your freaking difficult and bitchy life surrender!