(“Brick by Brick – A case for high-growth non-tech innovators” was originally published on Keenan’s Substack. Read more of Keenan’s published works here: https://substack.com/@ksugarte)
Over the last few years, many traditional investments have been ignored by investors due to their lack of ‘venture-like’ returns. When we look at opportunities that are non-tech with strong fundamentals, we get the same response from most Venture Capitalists (VCs), and it goes something like this:
“It just doesn’t give venture returns”
“A lifestyle business with strong cash flows”
“No tech angle means a lack of scale”
There are more versions of this, but you get the picture. When VCs say they want venture returns, they mean extreme growth to compensate for the risk they incur. When I say growth, I mean 10x your money or more, depending on who you speak to and the type of VC you deal with. Why? A big percentage of their picks end up being duds, so they need a return that appropriately compensates them for the risk. It is justifiable. In the US, 90% of startups fail, and this is due to the high-risk nature of tech startups.
The question I ask is: are all startups created equal? From a portfolio management perspective, they are treated as such. VCs tend to categorize companies under a single umbrella to consider the entire portfolio. I don’t blame them, as VC funds operate on behalf of wealthy individuals or institutional funds (Limited Partners), and their performance is evaluated based on an overall return over a 5-7 year fund life. Even if one company achieves a 20x return on investment, if the overall fund fails to deliver an appropriate return, it’s considered a failure. This is why VC funds tend to shy away from businesses that either lack ‘venture-like’ qualities or fail to provide the necessary liquidity within the expected timeframe (typically 5-7 years). If you’re a founder with ambitious long-term goals, your vision may fall short of meeting the VC criteria.
To summarize, most VC funds seek startups with the following qualities:
- Must possess a tech angle.
- Founders must be open to some form of exit within 5-7 years.
- Must demonstrate extreme growth within a relatively short period (think hyper-scale).
If your company doesn’t meet any of these criteria (with a few exceptions), securing VC funding becomes challenging.
Let’s go back to the question: are all startups created equal?
The Tech Disruptor
Tech Disruptors usually serve the market with a unique service or product based on technology. They typically possess qualities that enable rapid scaling with technological leverage (think SaaS companies such as Microsoft and Salesforce). Ideally, you would want strong unit economics and a low marginal cost of expansion. The former is often hard to achieve as most startups face some form of competition in the early stages. This is where the balance between speed-to-market and unit economics becomes a major consideration.
These companies tend to exhibit extremely high revenue growth but low operating income, and this dynamic can persist for some time if the burn rate justifies growth. Companies that fit this profile include Amazon, Microsoft, Facebook, and Uber. In Southeast Asia, we have examples like Gojek, Grab, Lazada, and Shopee, to name a few. Whether these companies have justified unit economics is another topic of discussion, and I am not here to judge their business models. It’s safe to say that these companies prioritize (1) extreme growth, (2) immediate liquidity (with a relatively near exit horizon), and (3) possess some ‘tech’ quality within their business. They all fit the VC mold.
In the Philippines, most, if not all, VCs seek these types of returns. If a founder truly loves his or her business and prefers to retain most of the equity and grow it long-term, they will have to make some sacrifices to meet the ideal trajectory. This is what VCs call ‘Venture Returns’—short-term in nature, characterized by extreme growth, and tech-oriented.
The Innovative Cash Generator
The question I often ask is: are there early-stage companies out there that fit a different mold? These are the companies that are non-tech but demonstrate high-growth qualities, strong fundamentals, with exit optionality.
When you look at the Forbes list in the Philippines, you will see a common trend among the richest individuals: they all serve the mass market. What do I mean by mass market? The Philippines has a total GDP of roughly $450 billion. Mathematically, if one serves the Philippine market in its entirety as a single monopoly (hypothetical case), it is impossible to generate value in excess of this amount. Depending on whom you speak to, the mass market (which includes minimum wage workers to the lower-middle class) is estimated to be between $80 and $100 billion. I can’t provide an exact number, but it is safe to say that it is a large market, and it doesn’t take rocket science to figure this out. Some companies represented in the Forbes list that serve this market include Cebuana Lhuillier, SM, San Miguel, JG Summit, LT Group, Jollibee, and Double Dragon (the founder of Mang Inasal), to name a few. Since Forbes lists individuals based on public information, there are a number of up-and-comers who should be part of this list should they decide to go public.
There are now a few companies growing that will eventually reach this coveted status (if they decide to go public), besides GCash, and these include DALI, Chooks-to-Go, Andok’s, and Mercury Drug. I’m sure there are more out there, but I’m using these names to make a point. These are traditional brick-and-mortar high-growth companies that fit the Private Equity (PE) mold and have proven to create multigenerational wealth. Mang Inasal started in 2003 and reached revenues of Php12 billion in 2015. Since 2010, when it was sold to Jollibee at a value of approximately $100M, it has grown to over 500 stores. There are rumors that Chooks-to-Go has over 1,600 stores with revenues in the low-to-mid nine digits (USD), and they started operations in 2008 (16 years ago). DALI currently owns 500 stores across Luzon and started only 4 years ago. Based on back-of-the-envelope assumptions, I would bet with anyone that they are close to being a unicorn.
I’m not sure how you would define it, but these results outshine any typical ‘venture return,’ and they don’t stop growing. These companies, whether they go public or not, are generating multi-generational wealth for their shareholders, and are backed by some of the leading private equity firms such as Creador, Navegar, and CVC. Other examples outside the Philippines include Mixue (ice cream) and Panda Express (Chinese food).
When I speak to investors, there are usually two areas that they focus on, depending on their ideal stage of investments: (1) high-tech, early-stage, low-cash, extreme growth, short-term exit horizon; or (2) non-tech, mid-stage, high-growth, strong cash flows, medium-term liquidity. VCs meet the former criteria, while PEs meet the latter. When I tell investors that we (1) hold positions forever (unless we get attractive offers), (2) like non-tech and high-growth, and (3) invest directly and even start companies, they look at me dumbfounded, asking how that can be.
At some point in time, the companies that currently meet the PE criteria were once small and yet were ignored by early-stage investors (except for a few angels). Why? Because they don’t meet the VC criteria. They are (1) non-tech, (2) high-growth, and (3) long-term in nature. For example, Chooks-to-Go was once a single store, as were Mang Inasal, Jollibee, and DALI, and their revenue figures suggest that despite their non-tech nature, they exhibit venture-like returns albeit with a longer runway. On top of that, they offer a much better risk/return profile compared to the typical tech startup. A typical chicken stand costs about Php500k to Php700k to set up with some certainty of revenue. The question revolves around Return-on-Investment (ROI) as opposed to complete failure. It is easy to downsize and offers optionality with a low option cost. The one big trade-off is TIME.
In the first graph, we showed how VC candidates need to demonstrate a short-term exit horizon. What the second graph above shows is a longer runway, but with exponential growth at the later stages, a result of compounding due to the high cash nature of brick-and-mortar businesses.
I remember asking a number of investors the following: would you rather have $100 million tomorrow or $3 billion 20 years from now? You get very interesting responses, but it is a very important question. If you are shorter-term in nature, VC is the way to go. If you want to build multi-generational wealth, patience is required.
“Investing is where you find a few great companies and then sit on your ass.”
– Charlie Munger
There is a category of investments in the US called Micro PE, but most of the definitions I found online covered SaaS and internet businesses, and none really talk about brick-and-mortar or even venture building around this space. I believe there is a tremendous opportunity to unlock this asset class in a place like the Philippines, where there exists a sizable and severely broken mass market. Not only that, the lower ticket sizes for this asset class allow more individuals to invest at relatively lower risk compared to tech startups.
While I’m not discounting the importance of technology, I believe it has its place, particularly in developed economies such as the US, where markets are more efficient and where technology is required to push into new frontiers. In such contexts, launching a new burger or chicken chain would be extremely challenging when competing against giants like McDonald’s, KFC, or Chick-fil-A. In fact, it would make more financial sense to invest in overlooked small-cap stocks rather than starting your own food chain (unless you truly have a kick-ass burger or fried chicken).
This is where it makes sense for technological leverage to enhance returns and efficiencies across all sectors, and to back new inventions that have not been seen or tested before. That is why tech returns in Silicon Valley are not 10x, but more like 500x. The market is much larger and the disruptions are much greater. The Philippines is decades away from Silicon Valley and still has room for fast-growing, high cash-generative brick-and-mortar companies, and hopefully, the occasional tech unicorns.
ABOUT THE AUTHOR
Keenan Ugarte is Managing Partner at DayOne Capital Ventures, an independent private holding company based in the Philippines that partners with entrepreneurs across a wide range of industries. He is the Co-Founder and Director of The Independent Investor.