“Why “looking to the left” is one of the most important lenses to analyze investment opportunities”
Lately, we have been presented with a lot of independent sponsors and third party investment opportunities. This differs a bit from what we typically look at where we are the investment originator.
When analyzing an investment opportunity, the natural tendency is to “look to the right”. To focus on the outcome. What is the expected IRR? What is the MOIC? Does it seem reasonable? How much will the sponsor make? Is that payout fair? What will my ownership be after the payout?
These are all typical questions most people ask when analyzing investments presented by third parties.
While it is tempting to focus on the right side of the document, the outcome, I force myself to “look to the left”.
What is looking to the left?
Focusing on what happens if things do not go as planned? How much do I lose if this deal does not work out as penciled? Can I afford that loss? What does the sponsor lose if this does not work? Are we aligned? How much are they making for simply putting the deal together? Does that seem fair?
When we raised capital for our US HoldCo, we presented an opportunity that would appeal to us as investors.
We offered a convertible debt instrument that paid 8% from day one and could convert to common equity at the investor's choice. My partner and I put up 30% of the money ourselves as equity. Our money was at risk initially. If things went south, our money would be lost first. With a more than 5:1 interest coverage ratio, for the investor to lose capital, the businesses had to completely collapse. Yet we invest in businesses that have decades-long track records of producing consistent cash flows.
Notice that I did not initially mention the 20%+ IRR our investor could expect or the more than 3x MOIC in ten years they could look forward to. Of course, those data points were in the presentation, but the focus was on what could go wrong and how they were protected. How my partner and I could lose. How we were all aligned.
It is natural to initially focus on the outcome of any opportunity. That is what is generally being presented to you. That is the narrative.
Change that narrative. Ask the hard questions. Focus on the left to find clarity on the merits of the investment and the risk management strategy of the sponsor.