Snow balling - the art of making close calls

One of the many things that Private Equiteers lose sleep over are close calls - viz., calls where they are indifferent to the alpha and beta errors (viz., they cannot decide if the investment opportunity is poor enough to let it pass without a blink or compelling enough to justify a scamper).

As a sheer coincidence, I have been reading Snowball about the life of Warren Buffet for the last two weeks. The book is a nice read and a strong recommend from my side. This one is extremely special since it potrays him as an ordinary human being with the pulls and pressures from various walks - the sacrifices his wife and family made, the mistakes he made with investments and of course, the surprising gamut of emotions that lies behind this witty, numbers driven legend.

We keep coming across this all the time in real life as well - it seems most people handle this by procrastination or asking for more and more data (which only serves to deepen the agony because data after a certain point is hardly conclusive. For every good reference you get, there is a so-so reference as well).

Buffet seems to build on the same pithy-ism that Lincoln used many years ago "Reputation is like fine China. It takes a lot to build but one small mistake can make it come crashing down."

Warren Buffet's take on this is simple. If the investment goes wrong, what is the worst damage that can happen to your reputation ? Or in other words, if the company throws up a year later, are people going to tell you " See, I told you so; The guy/company was no good.." or are they going to say " hmm... the guy was good..may be just tough circumstances".

Remember, that an investor can never substitute a manager just like the converse is true. A lot of investors expect positivities to flow in to further their "alpha" like market multiples, new innovations, growth beyond the company's comfort zone etc. Buffet's take on this is simple : Do not budget for these - if they happen, it is a windfall. But do not plonk money on the table assuming angels from heaven will come and help the investment grow. Simply put, do not expect significant increases in managerial capabilities drive investor's alpha.

Hmm..Simple but powerful insights. I guess the difference is in execution, as always.

~Varadha (varadha.r1@gmail.com)

Gin and the art of banker maintenance

I caught up with an investment banker (who I know fairly well) to get his thoughts and perspectives on the relationships he has with various stakeholders - entrepreneurs, lawyers and of course, PE funds. As the evening progressed, it became more clear to me that this eco-system seems fragile and delicately balanced. While most PE funds are of the view that investment bankers hamper deal making efforts, bid up prices creating a swirl in this entire system. But a more realistic world view would give them credit for the subtle/subliminal influence they exercise over market and decision makers.

The are responsible more often than not for market creation (seeding and germinating the thought of raising further capital to grow and manage"commercial expectations" - it is a pity they do not get paid for it; Quite ironic really since management consultants get paid tons for the same type of "intangible" advice; Imagine if McKinsey told GE that they needed capital to grow and tap emerging markets - do you think they would give it for free ?); Bankers also help improve market intelligence, help compare notes/offers, provide easy reference checks for everyone in the system( promoters to do a ref check on funds and vice versa), notes on competing offers, honesty around expectations and suggestions on deal structuring.

However, I gather that there is a lot of bitterness that flows back and forth in this banker-PE relationship which I think is a sign of immaturity and inability on both sides (with PE taking a larger share of the blame) for their inability to carry the other constituent along - sort of like what happens in a democracy. A parochial, short-term urge would tell you things would be so much smoother and faster for you if the other party did not exist but an objective, long-term, libertarian view would suggest otherwise.



So, what is the morale ? Be nice to bankers and pray they would realize your value as well. You never know which phone call of theirs can uproot all of your hard work and when. All the stuff I had talked about a professional relationship holds, more than ever for a banker.

Of course, it remains to be seen what bankers as a tribe hold about their PE brethren. That is a story for another day by another soul ! That is best left unsaid by me.

~Varadha (varadha.r1@gmail.com)

Retail participation in Private Equity

There has been a lot of press in recent times about the surge in retail participation in Private Equity in India. I recently got a call from my Relationship Manager at my bank who wanted to check if I would be interested in investing (a minimum of INR 1 Million) into a Private Equity fund floated by a reputed business house. What was shocking was the complete lack of knowledge about the product, the risks it posed and the liquidity window for the fund. He kept insisting that my investments would grow at about 25% every year and I could pull out the money after 5 years. There was pretty much little else he knew - nothing about how NAVs would be calculated and how frequently, and what would be modus operandi for providing liquidity, what type of companies would be invested into and how would they be monitored and how would the carry be shared with the GP (was the hurdle rate 10% at an individual deal level or at a collective fund level).

I did find out that he was getting incentivized 2% of the money raised as his commission. Apparently with mutual fund commissions having dried up (because of SEBI's ruling), there are a lot of banks that are peddling these products to almost anyone and everyone.

Hmm... this got me thinking about the great ULIP scam in the earlier part of this decade. Every bank (under the garb of bancassurance) sold unwitting customers an investment cum life insurance product called ULIP which was, guess what, intended to make everyone (except for the customer) happy. With an administrative fee that ranged from 30-60% on the first year premium (half of which rolled back to the banker as incentive) and a steady trail of 8-10%, it sure did make money - but not for the customer. I must have been one of the biggest suckers - for inspite of being a retail banker, I got sold this product by one of my fellow bankers who promptly quit (after collecting his big, fat bonus). The worst part of it was that I could not surrender the product for 3 years because of a lock-in clause - so I had to throw good money after bad money, to get some of the good money back.





Cutting back to the chase, I am not against improving retail participation in Private Equity funds. But I am against it first time investors investing into first time funds without understanding the risks and the time horizon associated with it. To top it all, there is no one to regulate this - I am not sure if this falls under the purview of SEBI. I feel strongly that there ought to be a strong regulation to improve disclosures and ensure that there exists a certain level of mandatory disclosures upfront and on an ongoing basis before investors can plonk down their money.

Investing into Private Equity is far far riskier than investing into a listed stock or even into a close ended mutual fund (where one can cut one's losses and pull out the money should things go wrong) and one has the ability to monitor NAV's at regular intervals of time. Putting money into a blackbox which promises a high return.

This presents more than ever a case for a "smart intermediary" like a mutual fund - who can pool in the capital and add the smartness that is ever so required. This is critical when there are already increasingly strident voices from the existing LPs on making money in India.

Would love to hear other's views on this...

~Varadha
(varadha.r1@gmail.com)

Culture of a VC firm

The other day I ran into a peer of mine who works in another VC firm. He casually remarked that the only difference in the performance of VC firms in the Silicon Valley eventually boiled down to the culture of the firm. I was quite bemused with this comment - the rationale being the top VC firms have uniformly "Top decile" talent, access to the same network (with marginal differences that crop up from time to time) and have a hugely overlapping set of smart investors (LPs). So, it eventually boils down to execution (as in any other industry). Of course, the discerning would know that in a small, staff driven firm (as in consulting/mutual fund/hedge fund), it comes down to the culture of the firm:

- process Vs results driven
- democratic Vs dictatorial
- meritocratic Vs gerontocratic
- open, transparent Vs opaque, hierarchical
- hierarchial Vs matrix
- conceptualization Vs execution
- homogenoity Vs heterogenity




There obviously are no easy answers for this on either side. It is a delicate balancing act and the better ones know how to mix and match this concoction according to the needs of the market. A sampling of the behavioural patterns can often give you valuable insights about which way the culture is inclined towards. Similar to what Malcolm Gladwell says in the Blink, the subtle differences are those that can be thin sliced and observed more through guttural signals than rational calls.

For example, how do the sub -ordinates react in presence of their superiors ? Is there a natural deference (through a turning of head towards the superior) after every point they make ? Is there eye contact with the others in a meeting ? Is there a forced fitting of roles based on hierarchy in a meeting ? Is there a complementarity of perspectives or do some people end up cuckoo-clocking what others say ? What deliverables is each person responsible for and is the monitoring process transparent ? Is there discord between the picture the outside world sees of the firm and the self-image the firm has of itself ?


It is amazing to think as to how meeting 2-3 people from a VC firm together/individually for even 5-10 minutes can tell you so much about the firm, its culture, the quality of people and most importantly, the quality of its investments.

Getting back to the beginning, apparently one measure of how VCs benchmark themselves on their culture is on the number of sparks that fly during a meeting - how tough is the questioning on individuals, portfolio companies and completion of tasks; Point certainly to ponder over.


~Varadha
(varadha.r1@gmail.com)

Conducting an effective board meeting

A news article in Mint this week (which is definitely one of the better newspapers in my opinion - one of the few that has insights rather than old fashioned sensationalized reporting) carried an article about the Top 10 trends in VC/PE industry. Very appropriate and in with the times and not too dissimilar to my earlier post.

Keeping in mind the anthropology of Indians (overpromise and under deliver) and having lived through more than 30 odd board meetings, there are a few insights I have developed on what makes for an effective board meeting.

A board meeting ( or for that matter a performance review meeting) is meant to be a plan for the medium term (3 months - 1 year) and to that extent is forward looking. But most board meetings start off as a prolonged post mortem - what's worse is the collective wisdom of all people in the room is channelized, not into inferring from the results, but in doing the autopsy. That is because most people glean through the numbers for the first time during the board meeting.

There are very useful post on this by Brad Feld and also by Guy Kawasaki which make for useful reading in a different cultural context.



Advance preparation : Most board meetings meander for the first one hour because people are turning over pages of the board pack for the first time and making notes and asking for clarifications on minutiae (what USD rate have you used, what is our accounting policy when it comes to product development costs etc.) which are simply inane and are a drain on everyone's time. Advance preparation by the company and also by the board members helps roll back at least an hour of everyone's time (which should be worth a few tens of thousands of dollars in any case).

Have the CEO/keyman drive the show: This is really the way it needs to be driven in India where legacy/loyalty/"outsider-insider" issues tend to fire up the NIH (Not Invented Here) syndrome. ("Oh no, it is too difficult to try and it does not work in this case"). However, it is important to work on the CEO's mind and ensure that he develops the flexibility and openness of mind to listen to others and try out new ideas. Bonding with the rest of the team over lunch/breakfast informally and drawing on their perspectives and views (on the company, industry, new ideas, immediate priorities etc.) is a necessary add-on to complete this piece.

No open praises: Indians by their very nature tend to have a very high opinion of themselves. By patting someone (unless the company has re-defined all expectations), you are asking for even more complacency down the line. You would expect senior management of any company to be self-driven and not look for external stimuli to propel them on. Would'nt you ?

Lay down immediate priorities: Ah, this more often than not, is the single biggest bummer that makes the meeting feel like a matinee show. Too often ideas that are discussed are chimerical (5-10 years ahead) or are too far off the organization's skill sets (for eg., if discussing about customer behaviour tracking in a retail chain). This is where the succeeding point comes into play - priorities have to get converted into actionables that are tracked meeting after meeting;

If you the company has a vision to serve a million customers in 5 years, a 100,000 next quarter surely won't hurt. So what needs to be done to serve 100,000 customers next quarter - what are the implications for sales and distribution, product, pricing, promotions, marketing, manufacturing, supply chain and inventory. If this does not get translated into actionables and is followed up meticulously, the vision will remain, not surprisingly, a vision forever.

Convert agreed upon priorities into action items: "what gets monitored truly gets done" - Need I say more ?

Have a great new year ahead and this year should be sure fun to watch for the PE industry.

~varadha.r1@gmail.com