A minority investor’s perspective on assessing and managing a key perceived risk.
A minority investor’s perspective on assessing and managing a key perceived risk.
Risk lurks around every corner in our industry. If risk is topical (and, unfortunately, it always is), then let’s explore one particular risk that consistently preoccupies our investment committee members’ collective imagination: the risk that is inherent in business relationships.
Company financial metrics, industry trends, and Donald Trump’s latest tweet aside, relationships represent one of the biggest possible pitfalls in the private capital investment world. This is especially pronounced for us, as we typically operate as minority investors rather than control investors. As such, we place what some may deem a disproportionate focus on the relationships required in any new investment.
This relationship is typically with the founder, family, or management team we are backing (and is often a combination of all three). In this context, the relationship becomes a critical driver of investment outcomes.
At the simplest level, human relationships have four outcomes over time: win-win, win-lose, lose-win, and lose-lose. These outcomes translate directly into the investment world, as shown in the graphic below.
It’s clear where PE firms want to reside and, at RMB Corvest, we know that our circa 223 deals over 35 years – with approximately 165 (mostly) successful exits – have only been achieved because ‘win-win’ has been the predominant relationship outcome.
Relationships are dynamic and temporal. They evolve continuously and exist through time, rather than at a fixed point. This means that rarely, if ever, is there a distinct outcome that is definitively ‘win-win’; instead, investors must strive for ongoing positive relationships.
A hallmark of private equity is the ability to compound returns—we all know the cliché: ‘keep backing the winners.’ In our view, this principle applies to relationships first and foremost, which typically correlates directly to financial returns. Our ultimate ambition, therefore, is to maintain ‘win-win’ relationships for as long as possible, allowing the mathematics of compounding to do its work.
But this is no easy feat. Can one foresee, before investing, how a relationship will unfold over the long term in the challenging environment of doing business in South Africa? Very unlikely. Especially when the best partners, in terms of investment outcomes, are often maverick personalities. However, institutional knowledge, experience and deep networks can provide an edge in this regard.
Let’s assume a new investment opportunity arises. All the usual analyses are conducted to assess its quality—industry, business model, financials, etc. Crucially, relationship risk is also evaluated. If all goes well and the investment is completed, how is this relationship risk managed on an ongoing, post-investment basis? This may be even more important than the initial assessment for two key reasons: (i) without being able to rely on the upfront risk assessment as an exact science, post-investment behaviour becomes critical to investment outcomes, and (ii) the South African market is small, and the feedback loop on investment firm behaviour is short. The types of partners we seek are those who care deeply about how we’ve behaved with others before them.
One effective principle for managing these critical relationships is this: prioritise outcomes over ego. This requires the discipline to focus on the ultimate goal, rather than falling into traps such as being ‘right’ or ‘wrong’ in countless ongoing interactions. Avoiding arbitrary battles for the sake of proving a point (or worse, to score points) is essential.
It seems simple: a primary driver of investment outcomes as a firm is human in nature; human relationships need to remain ‘win-win’ over time to enable the inevitable compounding of returns; and this often relies on our investment team’s deliberate focus on outcomes over ego. In theory, this forms a straightforward yet effective risk management regime for one of our key risks. The practice, of course, is another matter.
Risk lurks around every corner, but when it comes to relationship risk, a thoughtful approach can mitigate much of the uncertainty.
Wilmot is an Executive | RMB Corvest.
