Take-Aways
- A framework for better decision making: Harbright’s believes that our thorough due diligence processes help us identify the best possible investment opportunities for our shareholders.
- Improved returns on investment: Robust due diligence improves early-stage capital returns by 5.9x or more1. Harbright rigorously evaluates each investment opportunity for portfolio suitability.
- Real, Win and Worth: Harbright’s Real, Win, Worth, (RWW) evaluation approach is a conceptual framework that distills investment analysis down to three key questions that must be satisfactorily answered to move forward: [1] Is the product/company real? [2] Can the product and team win? [3] Is the opportunity worth the valuation and other terms offered? While we consider many factors when making an investment, Harbright believes the best investment opportunities yield strongly positive answers to these key questions.
Background:
Investing in early-stage, privately held companies offers the possibility of earning highly attractive returns.
Top quartile venture capital firms have produced outstanding annualized returns and significantly outperformed the S&P 500 over multiple time horizons 1,2:
Top Quartile VC
S&P 500
Increased Due Diligence
A report published by Robert Wiltbank (Wilamette Univ.) and Warren Boker (Univ. of Washington) demonstrated a strongly positive correlation between the amount of time spent in due diligence and early stage investment results. The survey revealed that investors that spent greater than 20 hours of diligence achieved a multiple on invested capital 5.9x higher than investors that spent under 20 hours (the median amongst survey participants). Additionally, investors undertaking more than 40 hours of due diligence per opportunity saw a multiple on invested capital roughly 7.1x that of investors that spent less than the median of 20 hours4. The results from the study are compelling and reinforce Harbright’s belief that our thorough due diligence process will yield better results over the long term.
Harbright’s investment in Ascyrus is one example of thorough due diligence paying off for our investors (insert link). We logged well over 40 hours in due diligence over the course of the Ascyrus engagement and our investors were rewarded with multiples of 4x-9x on their invested capital.
Real, Win, Worth Framework
- Are the product and market Real? Is there sufficient evidence to believe that the product will be commercially successful? Is the addressable market large enough to support significant growth?
- Will the product/service, business model, & team Win given the competitive landscape and other conditions in the market?
- Are the securities offered Worth an investment given the deal terms and risk? Are valuation, business upside, liquidation preferences and other considerations commensurate with the risk of an early-stage capital investment?
Harbright seeks investment opportunities that yield strongly positive ‘yes’ answers to these questions. While these aren’t the only considerations in our due diligence process, we believe that Real, Win and Worth must be satisfactorily answered to move forward. A deeper dive into Real, Win and Worth follows.
Real
At Harbright, we start all our investment analysis with a simple question: Are the product and business real (viable)? We analyze product and business viability across a number of dimensions:
- Product development stage & commercial availability: We typically look for companies that have products/services that are at or near commercial availability. Harbright will consider companies that have products in earlier stages of development, but we feel that ‘market ready’ products/services have a lower risk profile and are more investment ready.
- Market Validation: We look for evidence that a company’s product/service will succeed in the marketplace. In addition to evaluating any existing sales data, we speak with current and prospective customers to get their impressions of a company’s product(s). These opinions weigh heavily in our decision making.
- Total Addressable Market (TAM): We look for companies offering products in markets that are sufficiently large enough to support significant revenue growth.
- Scalability: We look for companies with products and business models that can be scaled rapidly.
Win
Evaluating a firm’s ability to ‘Win’ is the most challenging and complex part of Harbright’s due diligence process. We consider both internal and external factors when evaluating whether or not the conditions are right for the target firm to be successful including:
- Competitive Advantages: Are products sufficiently differentiated and do they offer meaningful advantages over competitors? How does pricing compare? Do distribution, know-how, or the business model offer advantages over incumbent firms?
- Barriers to adoption: What are the barriers to adoption for the company’s products and can the target firm overcome them?
- Market Environment: Is the environment right for the company to succeed (timing, regulatory/legal, macroeconomic picture)?
- Team Considerations: Do we believe in this team? Do they have the experience and talent required to make the venture a success? Have they demonstrated shrewd decision making, a deep understanding of their respective marketplace, a clearly articulated plan to achieve goals, and are they coachable?
- Financial Picture: Does the firm have, or can they raise, the cash required to (a) Support their burn rate and (b) Reach strategic goals?
- Intellectual Property: What protections do the firm’s IP and know-how offer? How easily can the product or service be replicated? How easily can patents be designed around? Is the firm in a position to defend itself from IP challenges?
- Exit Considerations: Is there a clear pathway to exit? Have financial or strategic buyers been identified? What is the business case for a strategic or financial buyer to purchase the company?
Determining whether or a firm can ‘Win’ is challenging, but we believe that answers to these and other questions greatly help us gauge whether a firm can win in its market.
Worth
At Harbright, we consider the following when assessing the worthiness of an investment in an early stage company:
- Price:The price (valuation) of a company’s equity
- Terms: Other terms we negotiate (liquidation preferences, anti-dilution provisions, Pro-rata investing rights, board seats, and information rights).
- Upside v. Risk: The upside of the business measured against the risks it faces
- Timing: The anticipated length of time Harbright investors must hold an investment affects our perception of risk. The longer the holding period, the greater the risk.
Balancing risk/reward is a complex part of our analysis and extremely important to Harbright. To the extent possible, we reduce downside risks, while investing in opportunities that provide the significant upside potential commensurate with early stage opportunities. Liquidation preferences, anti-dilution provisions, board seats, and information rights are put in place to protect our investors from suboptimal outcomes. We believe a company is worthy of investment when valuation and other key terms can be favorably negotiated.
Conclusion
Sources:
- Antal, Luke. Venture Returns Outperform Public Markets Over Many Periods. December, 2019
- Cambridge Associates. US Private Equity and Venture Capital Index Returns. June, 2020
- Ritter, Jay. Initial Public Offerings: VC-backed IPO Statistics Through 2020. June, 2021
- Wiltbank, Robert, and Warren Boker. Returns to Angel Investors in Groups. 1 Nov. 2007,
