How do you answer the question "what do you think are the key risks associated with the investment thesis?"
In other words, what is the investment thesis hinging on, and what are you most worried about? What are some example responses?
Stagnating core market means the company must continue to make add-on acquisitions, which always involves deal making risk and may pose integration challenges?
Secular market headwinds?
Management projections?
Well, first ask yourself what are your thesis assumptions, and then think how these assumptions might actually be wrong
I would think about what the key risks were then list them
It depends entirely on the company, business, model, industry, etc. I admit this is a common problem — bankers aren’t typically trained to think about what could go wrong so much as what could go right (after all, they representing the sellers). However, as was mentioned above, try to think about what needs to happen (or be true) in order for the investment thesis to play out. Then think about what could happen that would stop the thesis from playing out. There are your risks.
Sure, there are cookie cutter responses that apply to every company (management team quits), but you’re going to really struggle in PE if you need to follow a template and cannot come up with risks and mitigates catered to each specific opportunity.
Some ideas to get you started:
This is immensely helpful. Thank you!!
So let's say my answer to this question is: the key risk is that there is
1. There meaningful competition in this market. Adoption of this product is already at 90-95%, meaning that most of the growth will come from winning new accounts (from competitors) and increasing share of wallet. Market competition means that winning new accounts will be increasingly difficult, while increasing share of wallet (e.g., cross-selling) is discretionary and dependent on market conditions (e.g., customers don't need to use the "platinum" bundle)
2. The investment thesis is also heavily dependent on M&A, which presents risks in terms of 1) asset availability and 2) execution risks with post merger integration.
A natural follow-up question is "well, you recommended this company. so what makes you comfortable with these risks?"
The only answer I can think of is referencing the company's performance over the last few years—low churn, of the 15% p.a. revenue growth, X% came from new accounts, Y% came from cross-selling. They have a history of successful M&A.
Thoughts on if this is a respectable response?
Yes, this seems like a very thoughtful response. You could also look at win-loss rates/competitive takeaway data and market feedback (expert calls, customer calls, etc.) to validate their market positioning and right to take share from existing players given the heavily vended market.
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