Keeping It Simple

We have been experimenting with private credit here in Kazakhstan. Because we generally look at SMEs, we found that we could structure credit instruments in pretty interesting ways while aligning ourselves with the companies we seek to support.

For instance, we could tie ourselves to a % of revenue (effectively buying a royalty revenue stream) while having good collateral. This instrument would allow us to have equity-like upside with credit-like downside. We talked to several local lawyers and thought we had a good outline for what these deals would look like legally.

We have found, however, that many local entrepreneurs are simply not ready for any sort of investments / financing from 3P capital. For example, we were looking to finance an architecture design firm that was severely restricted in capacity but which had clear visibility on revenue if it could expand on that capacity. The firm needed capital to refurbish its new office (a requirement given the high-end clients it was serving) as well as hire several new designers and managers. The company had recently landed a very high profile client (with a large check) and we could see it continuing to build on this momentum going forward. In short, we could see the business doubling revenue in 2-3 years while maintaining strong margins and pivoting to higher revenue customer cohorts.

One of the key elements of the deal was us taking on land the entrepreneur owned as collateral. The land was high quality collateral in our capital city where we had tangible benchmarks on pricing.

Pretty soon stuff fell apart. We found out that the entrepreneur did not actually own the land as he implied but rather had development rights (a very different type of collateral) and was only willing to put up the land as collateral for around 5 months (despite our initial agreement of having it for the duration of the loan). On top of that, the owner proposed we took on the company’s AR instead of land. This was a dealbreaker for us. The company gets paid in installments over around 3.5 - 4 months. On top of that, it was at the cusp of meaningfully increasing its operating expenses by leasing a larger office and growing headcount. Simple modeling quickly showed us that having receivables as collateral (where we would place received cash in escrow upon collection) would essentially bankrupt the business. The fact that the owner even proposed this shows either a lack of alignment or basic business incompetence. We very quickly passed and stopped negotiations.

This dynamic, in a nutshell, is one of the main things we have so far encountered over our 6+ months. Local businessowners in Kazakhstan have pretty meaningful deficiencies in what we refer to a “financial logic.” Another owner we talked to has built a huge fitness studio mostly financed on incredibly expensive debt (30% COMPOUND interest) and is now facing meaningful cashflow problems. We think the studio will last a couple more months at best.

These stories and many others have led to yet another iteration on our model. We find that there is an incredible gap in terms of managerial and entrepreneurial talent between the best and the mediocre founders. We also find that in an ever evolving tax and regulatory landscape, the easiest path for us is to keep it simple (for now). So far we have proposed to invest in 3 companies (out of 100+) and are investing in 2 of the 3. Both companies are leaders in their respective space, have founders with a proven track record, have succeeded in developing pretty meaningful competitive advantages, and are generally competing against vastly inferior management teams.

In the first deal (a B2B education provider which we view as essentially a monopoly / duopoly in the space) we are investing at very attractive valuations (4-6x net income) and think we can add meaningful value through optimizing their backoffice, developing and cross-selling new products, and acquiring and also cross-selling horizontal providers within the existing customer base.

In the second deal, we have partnered with a #1 niche fitness franchise to help them build out their network in Astana, our country’s capital. In their main market, Almaty, this company generally sees 1.5 - 2.5 year payback periods, is probably several times larger than their closest competitor, and has a proven model which we are looking forward to implementing in a new city. Astana’s local players are fragmented, are not ran by strong management teams, and have not yet developed what we view as the right model for the market. Because we are not committing capital at a given valuation (purely paid-in cash), we think we will see very strong IRRs as well as longer-term exit opportunities.

We think we can add meaningful value to both companies, and are especially eager to see what we can build with the first business.

As a side note, we have also been talking to local tech startups about which I would like to rant a little. With the exception of just a few management teams, I would say that our view of local startups is extremely poor. For one, founders are not localizing their fundraising strategies to match local capital dynamics. Our capital markets are EXTREMELY shallow. I personally think only a handful of LPs account for the majority of capital deployed into startups so far, yet local startups are comfortable burning capital Silicon Valley-style without any attempt to reduce their burn rates. The average local VC check is $100-500k. Some of the big LPs are quasi-government institutions with very long sales cycles and capital commitment periods. For a startup burning $300-500k per year (of which there are plenty), that would essentially mean relying on a handful of VCs to raise from a handful of LPs within a very limited time frame. Some will get by just fine, that’s not the main issue for us. By far the biggest turn-off for me is the mentality with which local tech founders operate. Businesses doing just over $1mm in ARR talk as if Musk or Bezos are among their peers. David Vélez, overseeing perhaps the best fintech in the world, is incredibly humble and operates like a madman. Local guys here have 1/8,000 of the business size, 1/10,000 of the competence, and 1/100,000 of the business quality and yet have no sense of urgency or no “Day 1” / paranoid mindset. This is even worse when you consider the fact that all Kaspi has to do is choose to enter their space for their business to be completely obliterated within 6-12 months. Valuations are absurd. Commodity SaaS firms are raising at 12x+ revenue valuations despite a severely restricted market size, OK growth rates, and decent but not exceptional management teams. I really, really dislike management teams like these for purely philosophical reasons, if not practical ones. The best companies we’ve come across are those that have bootstrapped their growth and that remain humble with a “building a business” approach vs a “praying for an exit” approach. I sincerely do not see how anyone expects to generate decent IRRs entering something at 12x revenue when the market is so restricted, adjacent opportunities are scarce, and successful geographic expansion remains extremely illusory for 99% of local companies. Why look at anything like that when you have stuff like Meli or Nu which are growing much faster (they really are) and have exponentially better businesses and management teams. Time will tell but we are extremely skeptical of local startups as a whole delivering strong results to their investors from current valuations.