Frontier Investing: The Venture Capital Due Diligence Guide

For a while now, investing has been about margins and optimizations. Squeeze in the fee here, have a better timing of the market there, and you have an investment thesis. But what if there is an opportunity in a market that is wholly overlooked -- like in frontier markets? Frontier markets are a subset of developing countries that are too small to be considered emerging but growing at a rate to merit attention.

Under this definition, India would not make the cut because you have startup success stories already like Olacabs, Snapdeal and Flipkart. China, home to giant success stories like Alibaba and Baidu would also not fall under the umbrella of developing nation. However, Sri Lanka or Bangladesh, considering the room for explosive growth, are very much frontier markets. Locales lend well to investing since the barrier is often too hard to overcome for established fund managers and players. Local funds, groomed in investing principles can make a gargantuan impact to these frontier markets ideally capturing a good deal of value for themselves. So how do we start? By investing in local startups!

Startup Investments are an Asset Class

Startup investing is arguably the newest asset class that has been formed in the major financial markets. In Silicon Valley, startup investing is well understood and fairly operationalized. There are volumes of material on capital allocation and fair price for startups. Location and liquidity benefits startups in the Silicon Valley; prime location and the resultant network effects have been kind to returns here. Some might describe this as an unfair advantage but it is just the asymmetry of information benefiting some and demoralizing others in what is inherently a zero sum game, especially given the many private equity entrants into later stage rounds of large startups.

Startup Investing is Democratizing

Startup investing is vying to become more democratic and transparent with the passage of Title III of the JOBS act. The JOBS act and online platforms like Angellist which use syndicates will eat away at previous margins making the landscape of startup investing in the US a little less lucrative.

Currency Arbitrage is Your Leverage

The dollar is as strong as it will be for quite some time. It is held in high esteem and with the economy crumbling as you look eastward, and the EU dealing with some housekeeping under the Eurozone crisis, the dollar looks set to keep its pole position in the world of global currency.

These three trends fuse in a way that makes frontier investing especially timely.

What if you could invest in building an empire that serves a frontier market? With a dedicated war-chest that is high value in dollars and investment theses honed in the US, there is a real chance to be at the forefront of frontier markets poised for breakouts. There is no shortage of offices opened by US VC firms in Asia Pacific. VC offices typically open when market economics become compelling enough to merit the maintenance of a team. But frontier markets are not yet large enough to prove out their investment thesis. Frontier markets will fly under the radar and there is a real opportunity to define a market before heavy investment rolls in.

Preparing for the Journey

For the pioneers with an interest in frontier investing, this is our best advice and the most important questions to ask before getting involved:

Understand Your Community Deeply

Founding Questions: What do college kids aspire to do? Is Mark Zuckerberg the ultimate role model? Is entrepreneurship considered viable?

Don’t worry if the answers are in the negative: you actually want the answers tilting negative because that would mean you got to the market first and before it truly went past the inflection point.

Understand Local Finance & Investment Regulations

Founding Questions: What can you invest in? Is there a minimum for investment? Are there existing rules and policies for single member investing that you need to know about?

Typically these markets will not be highly regulated. Nor will they be policed. So you can move faster with your money if you choose to invest.

Invest Responsibly, with a Ceiling

Founding Questions: What is the most you can afford to lose if all your investments go south and the investment thesis is invalid? What do you do when the returns are not attractive?

Being responsible with your money is a prerequisite to any investing strategy. Know your limits and adhere to them.

These are high level strategic questions that you should ask yourself. Once you have answered these at a high level, here is what you can do to help get the operation underway:

Getting Frontier Investments Started

Have a Kick-Off Strategy

A manifesto sounds elitist. A party doesn’t. Take a trip to the market you choose to invest in and sound out your friends/connections. Throw a get together for like minded people and get to know them.

Look at Graduates, Learn the Economy

College grads are a barometer for where the markets are headed. Also interesting: look at the typical trends in people switching jobs. Is the move towards autonomy (freelance, small and medium business) or safety (large mega corporations)?

Rely on Trusted Locals

Typically your connections should serve as a recruiting channel to find someone running the operation on the ground. Find someone you trust and entrust them with the targets you are looking to hit through this investment.

Learn the Investment Cycles

Incubators come in batches because of the ability to learn from peers. Your operation might attract very little interest at first, so you are not gated on investing just because the US investments are in series.

Debt v/s Equity - Your personal ceiling is not subject to the rigors of a Buffet-esque portfolio. You can get away with a market return rate along with an income stream and some equity. Options can work in many ways that are advantageous for you.

Proof Out Your Concept

Given all else is equal, the cost of doing business is way lower in frontier markets. So, with rent and living covered, can you charge an exorbitant Elrich Bachmann rate of equity for your operation? And charge for consulting to bring the product to market?

Startup investing due east has picked up steam - and it’s usually expats parting with a reasonable amount of cash, getting a board seat and taking a large chunk of the company that they invest in, often not knowing what to do with it after. These practices range from the amateur-ish to the juvenile. The ecosystem has been maturing but hasty decisions and poor follow through has been fairly rampant. You can help make this better

If you earn in dollars or run a fund that is denominated in dollars, you enjoy a pretty massive advantage in terms of conversion rates. You also have the knowhow of being plugged into an ecosystem that is constantly evolving. Diversify your own efforts - don’t just look around, look above and beyond. Your origin story might provide the greatest source of your income. Don’t be shy and don’t be afraid to take the plunge!