I always hated finance because in this sector people are only focused on numbers and on gaining more without a real interest in what they are buying or selling. A domain where speculation has a dominant role, shareholders are just interested in making a quick and immediate profit rather than looking for a profit based on a robust growth. At least, this is my opinion and, maybe, I am wrong.
Ray Dalio (Co-Chief Investment Officer & Co-Chairman – Bridgewater Associates) says that “in order to be an effective investor, one has to bet against the consensus and be right. And it’s not easy to bet against the consensus and be right.”
Well, I found my way to be against the consensus of that finance and I am enjoying of being right.
Motivation and Purpuse as fuel for business
Dan Pink (Author) mentions an interesting study of Dan Ariely (Professor of Psychology and Behavioral Economics at Duke University): “In eight of the nine tasks we examined across three experiments, higher incentives led to worse performance” and “As long as the task involved only mechanical skill bonuses worked as they would be expected: the higher the pay, the better the performance. But once the task called for even rudimentary cognitive skill, a larger reward led to poorer performance.”
Thus, money is not the best way if you are looking for high performances from your employees. This is true for people and it is true for companies as well.
Companies born and die all time, but there are companies that more than others are able to survive crisis and arduous periods and can generate more profits. A study led by sociologist James Baron (Professor of Management at Yale) on two hundred high-tech start-ups showed that the failure rate of those companies with a “commitment blueprint” is zero. It is interesting how commitment, purpose and vision are elements that you cannot measure, but give you a high return of investment.
Companies with a clear vision, simply do not care of what others (speculative shareholders) think or want, they only care of why they are doing what they do. These companies are committed with their mission and when employees make it their own they over perform.
I agree with Simon Sinek (Founder at Start with Why) when he says that the main priority for CEOs are not customers or shareholders but “ensure that there are people on the team who believe what they believe and know how to build it.”
It is sad to see how many companies do not have a clear purpose.
The three Ps in a company
A company is composed of three parts: product, processes and people. But it seems we are more focused on another “P”: profit. Profits are good, otherwise we could not pay the bills, but companies that overweight it have very high chances of stopping the innovation and failing, as studies and real cases showed us.
When Henry Ford was completely focused on processes (assembly line) ignoring people’s value, Toyota revolutionized the car market with its lean production (Toyota Production System). Toyota gave people a higher weigh on the company’s value and he conquered the car market.
But we are losing this equilibrium in the last years. Only properly rebalancing these three Ps we could increase profits and build companies able to innovate and survive over time.
How can we do this, if the only thing that people consider are financial reports? An answer comes from Integrated Reporting. There are other Ps to consider like environment and society, and an integrated report aims to give the right balance to all of them. Before giving you more details about this new wonderful tool, I would like to give you an overview of angel investing because, you will see, there are very interesting similarities.
Angel Investing to foster business’ growth
“Angel Investing” is an expression used to gather all business angels’ activities. Business angels are wealthy and experienced people that decide to invest part of their money in very young companies generally named as start-ups. A business angel provides four things to a company: funding, knowledge, networking and credibility, so not just money as many people could think. Investing in so young companies is a very risky activity, indeed, 5 out 10 investments fail, 3 reach the parity, 1 goes well and 1 very well. Thus, with only 1 investment the investor has to gain enough money to cover the losses. So, how much can you gain with a so risky activity? David Rose (Founder of Gust) affirms that “the average return for a comprehensive, well-managed angel portfolio is between 25 and 30 percent internal rate of return (IRR)”, Dave Berkus (Angel Investor) got a 97% IRR. Interesting, right?
Such young companies, sometimes these is not even a formal entity, cannot be valuated via the classical valuation methods used for well established companies as you can suppose. Indeed, angel investors use a different approach. Honestly, there is not a magic formula or tool for the start-up’s valuation and as David Rose says: “it is a cross between black magic, hard math, market dynamics, investor returns calculations, and entrepreneurial hubris.” Each business angel has his/her own “formula” and they continuously share opinions and feedback to each other.
But, what are the elements that an investor considers in a company?
Few years ago, when I was at EBAN, I did a picture titled: “A start-up is an egg” showing the three main elements that constitutes a start-up:
- A good solution that solves a real problem (read product in the three Ps);
- A great team that make the idea reality (read people);
- A strong execution that protect solution and team from competitors (read processes).
Solution-Team-Execution are the main elements of a start-up, but a business angel analyses much more than you can expect. They look at the founder team’s attitude: if they are open to the dialog and learning; their vision: why they are doing it; their objectives: what they want to accomplish and how; the impact of the product on the society and economy: if it challenges the status quo; the current status: how sales are going.
Therefore, the financial statement is important to demonstrate the economic interest of the company; however, it is not the only reason why a business angel decide to invest.
This is the reason why I like angel investing, because you can make money helping companies to grow and entrepreneurs to make reality their vision. Hopefully, with a positive impact in the world.
Integrated Reporting to enhance business’ practices
Now that you have a brief overview on angel investing, I would like to list the main characteristics of integrated reporting, so, you can better understand the connected points.
Let’s start with the definition of integrated report: “An integrated report is a concise communication about how an organization’s strategy, governance, performance and prospects lead to the creation of value over the short, medium and long term.” Thus, this kind of report aims to collect in one single document company’s performance in terms of both financial and other value relevant information, and to show to providers of financial capital how a company (organisation) creates value over time.
Therefore, an integrated report wants to go further classical financial statements, so Profit (cash flow) is not the only element in a company’s valuation.
It is important to underline that in an integrated report resources and relationships are defined as “capitals”. These capitals are categorised as financial, manufactured, intellectual, human, social and relationship, and natural capital. Moreover, all these capitals interact with each other and with the society and external stakeholders, these interactions are part of the report.
This topic is much more than this and if you are interested in knowing more, please feel free to look at the web. But, what I want to pass on you is that the value creation process depicted in the Integrated Report Framework gathers and connects all the elements of a company (vision, governance, business model and external environment) in a way that a typical business plan or a financial statement simply does not do.
Connecting the dots
In conclusion, an integrated report is able to rebalance the role of the three Ps (product, people and processes) adding environment and society, without forgetting profit. I am sure, this will revolutionise account reporting and finance, as well as Toyota did in business.
Maybe you do not know, but an Italian entrepreneur, Adriano Olivetti, reached the same conclusion of the Integrated Reporting far before any others (at least in Europe and Americas). His company was super prospered and failed only when outsiders’ financial interests overcome his vision. I am not looking for credits, I just wanted to present a case as demonstration.
In angel investing, investors are, we could say, obliged to consider more than the financial statement for obvious reasons, whereas, integrated reporting does it per purpose. But, both of them changed the status quo.
At this point, you could add: “angel investors are not very interested in the company’s impact on society and external environment.” I am glad to reply that it is not completely exact because inside the business angel community there is a group of investors focused on Social Impact Investing.
Social Impact Investing, very often shortened in “Impact Investing”, is a branch of Angel Investing where investors consider the impact on society and environment as well as the other key elements of a start-up.
What should not surprise you, after reading this long (sorry for this) article, is that research and statistics show that impact investing is just as (if not more) profitable as traditional investing (source EBAN).
It is time, now, to sum up the content of this argument.
- A company should have a clear vision and work to make profit and to increase value within it and outside.
- Companies born with a strong commitment of the team resist to crisis and are more profitable.
- Integrated Reporting is disrupting the classical valuation statement introducing principles and values and rebalancing the weight of the key components in a company.
- Integrated Reporting strongly integrates vision in the company’s valuation. Moreover, it highlights connections between capitals.
- Angel investing values companies using not classical valuation methods and does not concentrate the valuation only on the financial statement (often there is not one).
- Angel Investing is a very risky activity; however, it is able to generate profit, beside a logical approach would avoid it.
- Investors focused on Impact Investing consider and measure companies’ impact in the society and in the environment.
- Integrating Report does not consider the company as stand-alone entity, but as part of an environment. Interactions with and outcomes on external entities are considered and measured.
Integrated Reporting and Angel Investing use different tools and approaches, however, both of them value companies on very similar elements.
Can Integrated Reporting support Angel Investing? And, can Angel Investing support Integrated Reporting? Is there a potential transfer of knowledge between these two worlds?
Yes, I do believe so!
And you, what do you think?
Are you against the consensus and are you right?