Ripley's Believe It or Not

Yesterday, I went to a friend’s place for dinner. This friend of mine works in one of the biggest domestic investment banks in India. As always, we started our discussions on how poorly paid we are, how overworked we are and how a lot of our senior colleagues, though completely undeserving, earn far more than what they should be getting.

We concluded that how some people, by just being at the right place at the right time ride economic cycles and create wealth that would have been so difficult, if not impossible, to make in the normal course of events. I have to admit that some of the cynicism and criticism was unwarranted and harsh from our side. However, we started recollecting the interesting faux pas that we have faced in our professional lives. Some of it was because of the genuine mistakes of the concerned persons; the others reflect the professional caliber of the seasoned people (usually senior professionals) in the financial services industry.

Here is a small list (each one of the below is a real incident):

- A partner in a fund was evaluating a project; his CEO had already given a consent to the deal and the partner was making the financial model of the project. He knew the deal had to be done and so he wanted the projections to justify the valuations that the fund had agreed to. The analyst working on the transaction prepared a DCF model, used aggressive assumptions and did what ever he could, but could not bring the desired valuation. The partner gave him many suggestions to pump up the valuations but after trying everything also, no significant progress was made. Exasperated, the partner finally asked his analyst if he could do a DCF of the PAT instead of the cash flows to see if that gave a better result? (unbelievable but true!)

- Two partners in a fund were discussing the valuation of a company where the fund was about to infuse money; there was some confusion as to whether the USD 350 mn company valuation was pre money or post money. A lot of debate took place and after a series of emails over 2-3 days, they realized that it was a secondary transaction!

- A investment banker was having a brainstorming session with his client. The promoter needed funds in his company but did not want to dilute equity. The company did not have the repayment capacity of expensive debt and given the market conditions cheap debt was simply impossible. After a long and draining brainstorming session, the banker suggested that the promoter issue ‘convertible equity’ which could be issued as equity and then later be converted into debt. In this way, he could both retain control and not pay high debt cost in the immediate future. The promoter was stunned!

- In this case, a financial investor had made an investment and exit from the investment in less than 6 months. He had barely managed to recover his capital in the process. While preparing a track record of his performance he listed down each investment and the corresponding IRRs achieved in the same. For this specific investment also he calculated the IRR using the XIRR function in MS Excel. To his utter delight the XIRR function threw up a high double digit IRR ! His joy knew no bounds. My explanation to him that the IRR as method of return computation cannot be applied on investments of less than 1 year duration fell on deaf years. The compendium of track record was shared with the global board of the financial investor.

- My colleague was trying to raise debt for one of his real estate projects. He met senior bankers working in a MNC bank. During one of the discussions, they were evaluating the repayment capacity of the project and how much overall cash the project would throw up. To my colleague’s utter surprise, the bankers were using the PAT figures to assess the project’s repayment capacity. He protested saying that the total cash flow of the project should be considered, i.e., PAT + equity, as that is indeed the total amount of cash flows the project would generate. The idea was shot down by the bankers as they claimed that equity would be “used up in the project” and hence the free cash flow available would only be PAT !!!

The Emperor's New Clothes

When I was a kid, I read this beautiful story by Hans Christian Anderson about a foolish emperor. The story (called “The Emperor’s New Clothes”) is about an emperor who cares for nothing but his appearance and attire and hires two tailors who promise him the finest suit of clothes that is not visible to anyone who is unfit for his position or stupid. The emperor himself cannot see the clothes but pretends that he can, lest he appear unfit for his position. Wearing the “suit”, he comes out in a public procession and everyone keeps up the pretense praising the emperor for the fine suit. However, a child in the crowd cries out that the emperor is wearing nothing at all. The emperor is embarrassed, realizing that the child is correct, but continues with his procession.

Alas this is just a story. In this real world, the child is severely punished by the emperor. What else can explain the sudden resignation of Deven Sharma, the president of rating agency S & P? His historic decision to downgrade the AAA rating  of USA evoked strong responses from everyone. While some praised him for having the courage and conviction to take on the might of the US government, many others, including US policymakers and economists like Paul Krugman, criticized him publicly. The US government alleged that S &P overestimated future government debt by $ 2 tn. S & P countered by saying that the US government had become "less stable, less effective and less predictable". Global markets have remained volatile ever since.

However, the US government seems to have the ‘shoot the messenger’ attitude rather than focusing on the real issue here. It’s not as if one fine day S & P woke up from a deep slumber and downgraded USA. This had been coming in for a while. The following is an extract from an article on S&P’s website dated April 18, 2011.

“ On April, 18, 2011, Standard & Poor's Ratings Services affirmed its 'AAA' ratings on the United States of America(AAA/Negative/A-1+) but revised its outlook on the rating to negative. Our opinion of the recent and expected further deterioration in the U.S. fiscal profile, and of the ability and willingness of the U.S. to soon reverse this trend, was the driving factor in our decision to revise the outlook to negative.

What Our AAA/Negative/A-1+ Sovereign Credit Rating On The U.S. Means

A Standard & Poor's sovereign credit rating represents our opinion on both the ability and willingness of aparticular sovereign government to pay its market debt in full, on time, and according to the terms of the obligation.

For the U.S., our sovereign rating applies to the $9.0 trillion in publicly held debt issued by the U.S. Treasury outstanding as of Feb. 28, 2011.

According to Standard & Poor's ratings definitions, an obligor rated 'AAA' is one that, in our opinion, has extremely strong capacity to meet its financial commitments. 'AAA' is the highest issuer credit rating we assign. By comparison, when we rate an obligor 'AA', we are expressing our view that the obligor has very strong capacity to meet its financial commitments. Under our ratings definitions, the creditworthiness of a 'AA' obligor differs from the highest-rated obligors only to a small degree. We may assign a plus-sign modifier ('AA+') to what we consider to be the strongest 'AA' obligors.

Our negative outlook on our rating on the U.S. sovereign signals that we believe there is a likelihood of at least one-in-three of a downward rating adjustment within two years. We currently expect that if we do lower the rating, it would be by no more than one notch to 'AA+', reflecting only a small degree of deterioration in our opinion of the U.S.'s creditworthiness.”

The real issue of discussion here is the massive US debt (expected to be close to 75% of GDP), the corresponding deficits and how difficult it would be to close it out. Debts, taken to stimulate the economy in the wake of the financial crisis, have almost doubled since 2007 (as a % of GDP). In the meanwhile, the government has neither been able to raise taxes nor been able to reduce expenditures; nor is there any ideological consensus between political parties on how to handle this situation.

Given this backdrop, S &P’s call, though questionable, cannot be drastically wrong. It could only be right or marginally wrong. The fact that US faces a severe financial challenge is  unquestionable.

Having borne the brunt of public anger and criticism in the sub prime crisis of 2008, the rating agency seems to have learnt its lessons. They do not want to be caught in the same situation as 2008 where they kept on giving high ratings to structured financial instruments only to see them crumble like a pack of cards later.

However, given what we have seen in Greece and Ireland in the recent past, there is no denying that there is a serious threat on the ability of nations to repay their sovereign debt; and the US should be no exception. So Uncle Sam, instead of shooting the messenger, you should focus on getting your house in order and figure a way out to get out of this financial mess.

Bubblegum

Some crazy stuff is happening here. Recently, I read an article on vccircle that left me completely stunned. Flipkart, a company with FY11 topline revenues of approximately Rs 6 crores per month, is raising private equity funding at a $1 bn valuation. I have to admit though that I have no idea about the profitability of the company; but just the thought of a company with a $ 16 mn turnover having a $ 1 bn valuation seems bizarre. Just to give a comparison, Infosys reached a market capitalization of $ 1 bn some where in 1998-99 when its revenues touched $ 100 mn (and this was public market valuation, which are generally much higher than private market valuations)

Hot Internet companies seem to be commanding astronomical valuations these days; both domestically and internationally.

Facebook, the poster boy of the new dotcom frenzy, is currently expected to have a shocking valuation of $ 100 bn when it goes for its IPO later this year. Zynga, the social-network games company, has been valued at $9 bn. Profitless Twitter is said to be worth $10bn. Groupon, the pioneers of group buying, rejected a $6 bn offer from Google and is considering an IPO with a valuation of $15 bn.

It seems that investors are desperate for growth and hence are willing to take on more and more risks. One measure of the frenzy is the astronomical share prices for these Internet stocks relative to their earnings.

Take the example of Linkedin. It had a successful IPO in May 2011. It went public at $45, and the stock increased about 109% on its opening day to reach a price of $94.25. The current price of the stock is close to $80 with P/E ratio of 1200. That compares with an average P-E of 14.2 for the S&P.  For the 12 month period ending on 31/12/2010, Linkedin had revenues of $ 243 mn, net income of $ 15.38 mn and operating cash flows of $ 55 mn. However, the current market cap of the company is $ 7.5 – 8 bn! In the Marwadi school of economics (that I learnt in Kolkata), one of the basic methods of evaluating a business is to see the cash payback period from the business. Even if you assume that the cash flow from operations grows at an annualized rate of 50% per annum compounding (though that is a mathematical impossibility for any extended period) it would take close to 10 years to just recover the capital.

Take an another case - MakeMytrip (MMT) . For the 12 month period ending on 31/12/2010, MMT  had revenues of $ 122 mn and a net income of just $ 4.83 mn. This is the first positive PAT that it has reported; the previous 3 years were losses at the EBITDA level. Cash Flow from Operations is a negative $ 6.33 mn. However, the market cap of the company is an astounding $ 700mn ! In fact, the company has practically had negative cash flow from operations every year for the last 3-4 years (although the revenues have trebled in the last 3 years). Its currently trading at a PE multiple in excess of 150 !! Theoretically, if I buy the entire company today at $ 700 mn and if the revenues keep growing at 50% per annum compounding, then, at the same profit margins, it would take at least 10 years just to recover the capital ! Forget about the returns mate.

Maybe I am missing some big trick here that other shrewd investors are able to see. Coming back to Flipkart, if some investor is giving them a valuation of $ 1 bn now, and assuming that they want to exit in 3-4 years, then say at a 40% IRR, the company is expected to achieve a valuation of  $ 2.7 bn in 3 years in $ 3.8 bn in 4 years. Could be possible, given the way the markets are. 

Caveat Emptor

Let me share a recent case regarding illegal construction and sales. A close friend based in Mumbai bought an under construction apartment in Thane in 2010. It was one of those rare instances when he made a big decision in an instant. As soon as he saw that sample apartment, he fell in love with it. Immediately, he booked an apartment on the 22^nd floor; got a bank loan approved, paid the initial lump sum out of his hard earned savings and got the flat registered. He was happy; after all, registration meant that the paper work was properly done and with the property prices going up, he thought that he had made a wise decision.   

However, after a year or so, there was an article in the newspapers about the same builder having constructed some other project illegally and the local corporation body threatening to demolish it. Although, his specific project was not mentioned in the article, he decided to examine the approvals of his project in detail. Only then did he realize that his project did not have a CC (Commencement Certificate) beyond the 14th floor. In effect, he had bought an apartment that not only did not exist physically, but also did not exist in paper. The most shocking part was that the same had been registered as well!!

He was in such a hurry that he did not bother checking out whether the builder had proper commencement certificate or not. He skipped the necessary homework to close the deal quickly, a decision that gave him sleepless nights later! As a real estate investor, I am aware of many such cases. However, my intention is not to put off or scare buyers; rather the intention is to explain some of the process involved in construction approvals so that one is conscious about them while taking property decisions. 

Buying a property without ensuring that the developer has the necessary approvals is one of the most frequent mistakes that buyers make. Home buyers tend to let their emotions and dreams get the better of their senses, fall in love with a beautiful advertisement and make rushed decisions. Buying a property is perhaps the biggest investment that most people make and they should be extremely careful so as to not get duped by corrupt builders. Below, I am laying out a broad list of construction approvals that every buyer should be aware about before signing the dotted line. (Please note that these are construction approvals and have nothing to do with land; which is a separate subject altogether. For reference, I have used Mumbai as an example but it would be as applicable in any other city)

As far as the city of Mumbai is concerned, the Municipal Corporation of Greater Mumbai (MCGM), Mumbai Metropolitan Regional Development Authority (MMRDA), Slum Rehabilitation Authority (SRA) are the Planning Authorities under the Laws pertaining to the Town Planning. All the projects of construction whether residential or otherwise are required to be submitted to the concerned Authority and the plans are sanctioned by such Authorities.

Approved Plans   
First and foremost, please see the approved plans of the project. The local planning authority approves the plans of any development. The approved plans are issued in duplicate, i.e. copies to the owner & architect.

The approved plan bears signatures of owner, architect, municipal stamp of approval with case / file number, date of approval and is signed by the authorized officer of the Corporation. Validity of approved plan is one year and requires revalidation every year thereafter.

Intimation Of Disapproval (IOD)           
Along with approval of plans, the local corporation issues a letter of approval. In Mumbai it is popularly known as the IOD. (Intimation of Disapproval). People get confused with the term IOD. In fact even though it is termed as intimation of disapproval, it is to be read in its positive form; which means the IOD is a letter of approval subject to compliance of terms & conditions mentioned therein.  Validity of Letter of approval (IOD) is one year unless revalidated yearly.

The intimation of disapproval is issued with a list of NOC’s, which the applicant must obtain separately from various departments and government authorities. Final clearance to construct is given once the developer obtains all the NOC’s. The NOC’s assigned to the intimation of disapproval are case specific. However, it would generally include NOCs from the Tree Authority, Storm Water and Drain Department, Sewerage Department, Environmental Department (concerned with debris management), Traffic and Coordination Department, CFO (Chief Fire Officer - Fire clearance)         

Please note that only approval of plans and issue of IOD, is not a development permission unless it is clubbed with Commencement Certificate. However, most developers do start excavation work once they secure the IOD

Commencement Certificate                 
On submission of all required NOCs mentioned in the IOD and on compliance of the IOD conditions, the Commencement Certificate is approved. It is a development permission issued by the Local Planning authority. It is generally issued together with approved plans & letter of approval in other cities except in Mumbai. Validity of Commencement Certificate is typically one year from its date of issue. Only after obtaining the commencement certificate is a developer entitled to start the work.

High Rise Committee Approval

The High-rise committee was set up by the Maharashtra state government due to the surge in projects a few years ago and concerns about the effect it could have on the environment and infrastructure. It studies and clears every building being erected over 70 metres. According to the BMC's construction norms, a high-rise is any building more than 70 metres tall. Usually this means the building has at least 18 to 21 storeys, depending on the height of individual floors, which can vary from 3.2 to 4.2 metres in height.   

Environmental Clearance

The principal Environmental Regulatory Agency in India is the Ministry of  Environment and Forests (MoEF).  MoEF formulates environmental policies and accords environmental clearance for the projects. Broadly, all projects have been been classified in two categories. Some projects require Environmental Clearance from the Central Level Impact Assessment Authority at MoEF, New Delhi whereas others require Enviornmental Clearance from state level Environmental Clearance authority i.e., State Environment Impact Assessment Authority (SEIAA).

Construction Projects for Environmental Clearance fall under two categories- Category 8(a) Building and Construction projects and Category 8(b) Townships and Area Development projects. No environmental clearance is required if Built-up area of the project is less than 20000 square meter (sq.m) for Category 8(a) and if project area is less than 50 hectare and/or built up area is less than 1,50,000 sq.m for Category-8(b).

Clearance from SEIAA is required for Category-8(a) projects if the built-up area is between 20,000-1,50,000 sq.m and if it exceeds 1,50,000 sq.m then clearance is required from MoEF.

Also, please remember that environmental clearance is required to be obtained before commencement of any construction activity.

NOC from Airport Authority of India

With a lot of construction coming around airport in many cities in India, this is increasingly becoming important. A NOC for height clearance is required for construction projects, such as high-rise buildings or communications masts, which fall within 20 km of an airport. As per norms, construction within a radius of 20 kms around airports is regulated by AAI which issues no objection clearances for the height of buildings. In the funnel area of runways, height restrictions are stricter. 

Plinth Completion Certificate

Once work commences on the site and is completed up to the plinth level, the developer has to submit a proposal for Plinth completion Certificate to the local corporation. The local corporation after verifying the construction work done on  site up  to the plinth level may either accords plinth completion certificate & permit to carry on further construction work as per approved plans  &  conditioned mentioned in CC or refuses to grant plinth completion certificate, if any  deviations found than the approved plan.  In such cases notice are given to stop further work and to get the revised plans approved.

Occupancy Certificate and Certificate of Completion                      

Occupancy Certificate evidences the completion of the building as per the approved plan and compliance of local laws.  Without the Occupancy Certificate, it is difficult to get the water and sanitary connection. The Occupancy Certificate allows the developer to occupy the building but is not considered a final document because it still requires the Certificate of Completion. The Completion Certificate is considered to be the final document to fully occupy the building and connect to utilities.                  

Guide to successful investments II

I recently met someone from a renewable energy start up fund that is simultaneously tying up its anchor investors and is looking to make its first investment in India. We were generally discussing about the investment climate and the experiences that private equity investors have had in the last 4-5 years. She then asked me about my experiences and the learning that I have had during this period. That comment prompted some introspection and hence this blog; an attempt to capture my learning in a structured manner. This blog is also a continuation of the first blog I wrote on August 3, 2010 titled, ‘Guide to successful Investments’.

Pricing Power is the key:

Warren Buffet said he rates businesses on their ability to raise prices and sometimes doesn’t even consider the people in charge. “The single most important decision in evaluating a business is pricing power,” Buffett told in a recent interview. “If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”

A number of factors go into determining the pricing power of a given good or service, including quantum of demand, uniqueness in the marketplace, competition from similar products, consumer perception of the quality of the product etc. Generally speaking, companies that have strong brands and exclusive product or service have good pricing power.

In the real estate private equity market, most funds are now flocking to look for deals in the residential space. This is no surprise; there is far greater pricing power in a residential product where there is large demand and one has to deal with a retail consumer rather than a retail or commercial product where demand is limited and one has to deal with institutional buyers.

The other thing that I have learned is that in a recessionary/stagnant economy, though pricing power might not enable one to raise prices; it certainly gives a business the preference in the mind of customers. In a growing economy, pricing power enables a business to raise prices comfortably. For example, the recent recovery in the markets has enabled all real estate developers to raise residential prices (where they have pricing power). However, no significant price rise was observed in the commercial/retail market where developers do not have the pricing power.

Exit strategy must be clear from day zero – Put/Drag:

Private equity investors, at the time of entry, must be very very clear about their exit options.  Profits accruing to private equity investors can only be monetized on exit and therefore investors should be prepared right at the outset. For a long time, the primary mode of exit has been an initial public offer. However, successful IPO depends upon a lot of factors (besides the performance of the investee company) including global business environment, the economic cycle, capital market conditions, flavour of the markets etc. Because private equity investors have a defined life cycle (unlike entrepreneurs who can continue for a life time); if they are unable to go through an IPO for any reason, exit becomes very difficult and they could be forced to sell at distress values so as to achieve their exit. This (difference in time horizons) is also the genesis of big cultural differences between entrepreneurs and investors.

Post the recent recession, private equity investors are looking at alternate options.  These options include mandatory buy-back or redemption of shares, put option on the promoters or in some cases even a drag clause to sell the company to achieve its exit. One should explore such structured exits, even if it means a slight compromise on the valuations/IRRs.

A strong structure cannot compensate for an inherently bad project/asset

There are many ‘structured’ deals floating around in the markets these days. Structured deals are a very wide encompassing phrase. Typically a structured deal could refer to skewed profit sharing to the fund till it achieves its returns or a back ended promote to the entrepreneur or tight agreement clauses in the form of performance guarantees that have inbuilt incentive/penalty clauses or even guaranteed leasing/revenue from another group company of the promoter. These deals look delightfully straight forward and attractive. The apparent reason of having structured deals is to give some comfort to the investors about the investment or even persuade them to cough up a higher valuation.

In my limited experience, at best, a structured deal can provide some justification for an initial high valuation for an otherwise inherently strong performing asset/project/company. However, structured deals can not and should not be used for justifying investment in an essentially bad project/asset. The reason being that should things go wrong, it is very difficult to actually implement any of these structures in India. The question you should be asking yourself is this: “Would you be doing this deal if this structure is not available?” If the answer is an emphatic no, then please do not proceed. However if the answer is an emphatic yes or a close yes, then one can explore the structures.

Promoter lock in

In most private equity deals, promoter lock in is present as a standard clause. The simple reason for a promoter lock in is that investors draw confidence from the entrepreneur/promoter (along with the business) before making the investment. The investment is as much about the individual as it is about the product/services. The standard way in which this lock in is structured is by putting in a clause that the promoter shares in the investee company are locked in and cannot be sold till a particular milestone is achieved. This works in most cases.

However, in some cases, I have noticed that the promoter is not a direct shareholder in the investee company and holds his shares through a series of holding companies. In such a scenario, it is important that the lock in runs through the entire chain till the link with the promoter is established. You certainly do not want to be in a situation where you have locked in the shares of the investee company but the promoter sells his stake in the holding level companies. Without the entire chain, the lock in becomes meaningless.

Experience of the entrepreneur

There is no substitute for the experience of an entrepreneur. A new guy (even though he has an established brand) can assemble a great team by hiring the right consultants, managers, contractors, vendors etc but, a team is as good as the leader leading it. If the entrepreneur has the relevant experience he would categorically know how things are done, who to get it done from and most of all, why should it be done in the first place!

However, I do not want to say that all new kids are failures; all I am saying is that there is a cost of making them experienced, and someone has bear the cost of their learning! The limited point is that investors have to be conscious of this fact.

Ownership structure of vendors/service providers:

One of the important things to do during the asset management phase is to verify the antecedents of the key suppliers/vendors/service providers of the investee company. Expenses are the easiest and probably the only way through which promoters take out money from the investee company (unless there is scope of collecting revenue by means of cash). I have heard of some many cases of bogus vendors/suppliers getting paid by the investee company for goods/services actually never offered. Usually this is done through multiple small contracts so that it does not come into the materiality net. I have even heard of a case from a friend where the promoter became a silent partner in one of the service providers and encouraged the service provider to charge a higher fee in the investee company! These kind of cases can even be difficult to trace.

More on this topic later! Happy and careful Investing to all of you!

Start up Snob

MBA students are increasingly falling into one of two categories—those hungry to rush into careers as private equity/venture capitalists, and those eager to found a venture-funded start-up. My advice to all of them: Please give due respect to a regular corporate job and please do consider spending a few years working for a large corporate player first.

These business school students and young venture capitalists frequently share common misconceptions about start-ups in this heavily publicized sector. Part of the myth is fuelled by the B schools themselves by feeding hunky dory stories about how quick bucks (ESOP value growing manifold) and careers (big responsibility and fancy designations very early in the career) can be made in start ups.  People joining start ups are seen as star risk takers and a corporate job is seen as one of those ‘regular/methodical’ types. Nobody seems to talk about how badly people lives and careers get affected when start ups fail and sometimes the damage is permanent or the fact that even though the start up might be successful, making money at a personal level could be completely different.

Please don’t get me wrong; I am not a doomsayer. Rather, I am a big risk taker at a personal level and the intent of this blog is to help people take objective and well balanced decisions and not be swayed by bull talk.  Following are the few pointers that young minds should definitely consider while thinking of joining start ups:

Truly understanding the business model of the start up: Please understand the primary business of a business is a product or a service and making money comes along with it. It’s not the other way round. Please please stay away from get rich quick companies. The get rich quick companies almost aren't worth discussion. I've often found anyone who contacts me with more passion and enthusiasm than actual information and conceptual facts about their business, doesn't have one. It usually goes hand in hand with them talking extensively about how much money everyone involved is going to make, and that alone should be why I should or anyone should be involved. This is first sign of warning.

Credibility of the person (including his personal nature): Please check on the credibility of the entrepreneur and specifically his experience of the business/or as an entrepreneur. Please go an extra mile and talk to people who have worked with him in various capacities. Also remember, sharing a personal rapport is very important in a start up. If your boss is not your personality type, you can still get away in a corporate job, but in a startup it becomes really difficult. Remember, most start ups are one man shows and if you cannot get along with that man, the going gets tough even though you may be very good at your work.

Get your ESOPs: Get your ESOPs allotted on day one. This is important. Get it documented. If you hear any of the following, “Oh! We will allot the ESOPs in due course, don’t you trust me? ”, or something like, “Oh, we are still working out the legal structure and have appointed one of the Big 4 firms for the same”, then it is a clear sign that you will most probably never get the shares. Remember it is easier to get the shares earlier rather than later. There are so many cases of promoters/entrepreneurs going back on their promise and the employee being helpless because of lack of any specific written document/agreement. Most of them are also not willing to create an issue about it lest it affects their careers and they be perceived as ‘troublemaker’ employees. Also remember that during this period salaries and bonuses are low because of the uncertainty of cash flows in a start up.

Team building capacity – willing to share wealth and grow: What is the senior management team that the entrepreneur has built? Does he have the ability to attract senior industry talent? This is a big sign of confidence and the proof of the fact that he is willing to share wealth and grow.

Circle of Influence: Check on the immediate circle of friends and business associates of the entrepreneur. This will also help you to get an idea on the both the business and entrepreneur himself.

Passion, spirit, dynamic, an actual business model, experience in the industry they are entering are just a few traits. They know how to command a team, have realistic ideas about what it takes to start a company, how long it takes to really ramp up revenues, and what expenses they'll incur.    

Any thoughts? Agree, disagree, think I'm a startup snob?