Success in PE ?1

Like they say deal-making is about managing 3 E's - Egos, Emotions and Expectations, this wonderful piece of article I came across in the blog The Private Equiteer throws light on what is needed in a mid-market PE fund. For once, I have very little to add except to shamelessly plagiarize the link and post it.

As said elsewhere in the post, the recipe for success is to be truly amiable and tenacious. PE deals take a lifetime to complete (in the context of finance where trading can make you as much in a month if not a year). Softer aspects like rationality, friendship, temperament and a X-factor (what does the team think of you ? Go or a no-go ?). I have been in situations where the sheer patience and ability to hang in there to the relationship has been a deciding factor for either side (assuming of course the price is in and around the fair zone - no one is a sucker). Sure, you may not consummate anything but the mindspace one occupies is sure to guarantee you a look-in in the future as well.



On the stuff about portfolio management, can't agree with the stuff any more. Remember you are only a general physician - so please do not get into cardiac or arthritic territory. Acknowledge your lack of expertise (self-deprecate and direct them to a specialist) and focus on generic issues which can be de-constructed easily (people, systems, process issues than technology or product or market dynamics). Remember no physician ever held onto a patient (and his trust) by monkeying around with his health !

~Varadha
(varadha.r1@gmail.com)

Dr. Jekyll Investor & Mr. Hyde Manager

One of the great many chasms that every single PE manager worth his salt has to go through is to figure out the delicate balance between the role of an investor and a manager without becoming disruptive.




How deep does one dive in ? How strong does the understanding of the organizational DNA have to be ? How strong should the technical/domain knowledge be ? For a relationship to blossom into one based on deep trust and commitment, the PE investor needs to move beyond the role of an investor who can bring in generic perspectives and become a trusted confidante; Being a trusted confidante automatically means ability to add value to the technicalities of the business/organization as also to the "mental orientation" of the promoter. May be the investment manager needs to ask himself if he can hold fort should the promoter vanish for 6 months which would mean answering the following questions for oneself:

• Do I understand the business in granular detail ? Sales structure, organization, productivity, sales cycles, supply chain, mark-ups, commercials, quality issues, customer expectations
  
• Do I understand the organizational DNA ? Is it driven by individuals or teams ? What are the motivation levels amongst lower rung employees ? How strong are the company's processes and systems when compared to its peers ?
• How is the market place evolving ? What are competitors doing that we are'nt ? What stage of the curve is the industry going through- early growth, heavy competition, consolidation or mature growth ? How well prepared are we for the next phase ?
  

An investor's role as a manager is like what someone said " it is not that you would, but you could". It is my firm belief that as one starts thinking about these, the value addition on business specifics tends to flow automatically strengthening the relationship that exists. Contrary to popular belief, I tend to believe that being an investor and a manager are not two different roles at different points of time. A good investor needs have a realistic managerial perspective and a strong manager needs to understand the way an investor sees things - you may be running the most salient business on earth, but if you cannot carry along your investors with you, it does not mean much.

~Varadha
(varadha.r1@gmail.com)

Right fund size ?!

This interesting article from KPMG that talks about the PE industry in India raises a pertinent question. What is the right fund size that marries the market opportunities with the economics of running a fund ? Seems like there is a difference between the perception of LPs and GPs (page 5). If 30% of the LPs want a small fund ($ 100-200 mn) 35% of the LPs want a fund that is in the region of ($ 200-500 mn) (vis-a-vis 20% and 35% for GP, it sure is an interesting combination.


I guess the question that LPs are asking themselves really is that in PPP terms a $ 200 mn fund in India would be the equivalent of a $ 1 bn fund in US (which pre-2007 was fairly common place), a significant size even the world's largest economy, especially if you are focussed on "classical private equity" (unpolished, unlisted companies). That means a $ 100 mn deal size assuming a portfolio of 8-10 companies (which means company revenues of anywhere from $ 50 -250 mn and PAT of $ 20-30 mn) - not pushover numbers in any case.


Dissecting the onion another way, the micro fund category (sub $ 100 mn) seems grossly under represented, given the fact that this is the sweetest spot in terms of risk-reward (get into companies with minimal concept risk but significant execution risk). However, it seems that the jury thinks it is unviable given the bandwith issues involved in managing the portfolio (I think this is an area that will get changed along the lines of the Silicon Valley model - where you could have a roster of operating partners that devote a part of their time to grooming companies thereby reducing the burden on the fund management team).

Given the current circumstances, I would think the ideal size for an economy like India (which is far more broad based, driven primarily by entrepreneurs, not the Government and hence has a larger range of opportunities) ought to be in the region of $ 200-300 mn.- if one were to marry the overheads of fund management with the opportunities available in the market). Of course, this will also depend on the style of investing (preference of size of stake, operational involvement).

Thoughts, any one ?

~Varadha

Private Equity : Absolute Vs Relative return

Coming on back of this great article I read on investing across Geographies, I am tempted to ask ourselves the question - is Private Equity an absolute or a relative return asset class ?

Most people investing in India over the last five years would tell you that private markets have had a much higher volatility and have underperformed the public markets overall (extremely illogical, no reason why size and liquidity premium should be negative). As things stand, if I were allocating assets I would be hard pressed to answer as to why I should choose Private Markets in India over public markets or better still, why I should choose India at all ?

Going by the flights/hotel test (Indian hotels are overpriced and yet overbooked and similar is the case with flights), it seems like India is seeing a bubble, at least for the time being. So are you better off betting on a star-fund manager in India (for the uptick provided by his alpha) or are you better off investing into the beta of a new market. Tough call, is'nt ?



Even in this era of globally mobile capital and minimal information asymmetries, the first movers stand to make an inordinately high return. With internet, new age media and mobile, the window of opportunities are becoming smaller and tighter which also means the rewards for the birds that spot the window are that much higher.

However, as an institutional investor are you looking to maximize returns in the medium term (3- 5 years) or in the long term (15-20 years). It seems like a lot of people are willing to stick their neck out for the long term and back fund managers that deliver superior alpha than piggyback on the next market beta wave. I guess the underlying logic must be sustenance of outperformance in the long run than a flash of brilliance in the medium term.

~Varadha (varadha.r1@gmail.com)

J-Curve and the art of "Indian valuations"

Amidst the usual riff-raff of "Oh ! Dealflow has started thawing but so have valuation expectations, if so, even more", I thought it is best to discuss the concept of "Indian Valuations" since they always seem far removed from the rest of the world in terms of logic (or the lack of it). Ask anyone in the primary/secondary markets and they would tell you the same thing - India is always an expensive market when compared to the rest of the emerging markets as well.

In the PE world, more than ever, valuations seem to be dependent on ever increasing projections with an explosive growth budgeted for in the first 12-18 months post fund infusion and a steady 40-50% growth (?!) post that. However, IMHO, reality is far removed and completely counter-intuitive. Most companies I have seen have slow build-up of momentum and the torrent comes gushing out only after 2-3 years (what is known in technical parlance as the J-Curve). Why ?

• Transition of "Vision" and mindset: This is singularly the biggest roadblock to the immediate blossoming of an organization. Most often, PE deals take so long that promoters want to get into operations immediately thereafter and often a gush of liquidity is just the right medicine they need to go after the product/client/business they have always dreamt of. But what next ?
• Organizational build-up: Most entrepreneurs have always bootstrapped during their formative years - so MBAs and industry veterans were always given a pass because they cost too much. Even if fresh money has come in, it takes anywhere between 3-6 months to staff the key positions and another 3-6 months for the new recruits to be brought to speed to deliver.
• Market delays: Governmental clearances for the new land acquisition pending ? MoU submitted with vendors/customers yet to translate into commercials ? Temporary loss of demand for the product/service ? Undercutting by competitors ? You name it and it happens
• Business learning curve: Going after $ 5 mn contracts is not the same as going after $ 50 mn contracts. You may the right people but the smartest people still take time to understand nuances of what the customer wants and how the end product needs to be packaged/presented.
• Cultural/integration issues:In most cases, PE funds, being the "progressive animals" they are, induct fresh, young, smart talent who often come at better designations and higher salaries. This tends to cause a cultural rift within the organization with the old folk resenting this treatment. This leads to involuntary attrition/execution roadblocks within the organization.

As thumb rule, my experience has been that projections tend to be put off by one year in the best of teams and by 2-3 years at the other end. So, there goes the effect of J-Curve. Needless to say, the smarter PE funds have started baking it into their projections and have tended to adjust their valuations accordingly.


Regards
Varadha
(varadha.r1@gmail.com)
+91-9940670064

PE fund - Single Vs multi-owner funds

With Entrepreneurship budding in the PE world as well, there are a few PE firms individually owned that are popping up as well. The background of the key persons in question varies from wealthy individuals to ex-partners in larger PE firms. For quite a while, I have been chewing as to whether it is appropriate for one single person to be the "driving force" in a business like Private Equity.





To my mind, PE is a business of perspectives - it is about making intelligent choices, gut calls balanced with a nuanced appreciation of risks and mitigants. It’s hard for a single individual to have a deep understanding in all of these areas - in most knowledge driven businesses, it pays to have a strong team with a strong "bench strength" - a group of motley individuals with heterogenous perspectives who can argue their guts off with no display of "one upmanship".


In addition, here are a number of other important considerations regarding single-owner firms:

1. It's a one man army at the end of the day - chances of you having a Zimbabwian disaster are as much s the chances of you having a Singaporean Utopia. One needs a check on his/her own emotions, persuasions.

2. Balancing fund raise Vs deployment : I strongly believe that fund deployment and fund raising may be two sides of the same coin but are too difficult for one single individual to manage. An individual who spends

3. Succession planning : What happens if the GP gets hit by a truck ? How does the second layer find fulfilment over the longer term if they know it would always be the "owner" who would call the shots ?


4. Checks and balances : Who decides what are the priorities at any given point of time ? How does one ensure that superior governance and transparency especially at the mid-market end where not much information is available publicly anyway

My sense is that a strong core team is an indispensable tool to start with in any knowledge driven industry and PE being at the pinnacle of the same is no different. So, it is a "team-driven" firm all the way !


~Varadha
(varadha.r1@gmail.com)
+91-9940670064

Anthropology of Indian GPs

One of the nicer things of being a part of a "cross-border business" is that it gives you perspectives on people from different cultures and backgrounds. This has led yours truly developing a passing interest in the anthropological characteristics of the Indian GPs and the similarities (or the lack of it) with his Western counterpart.






Reading "The Argumentative Indian" by amartya Sen only strengthened my conviction about how Indians seem to be so different from the rest of the world. So, here goes my observations on the flop side:


Wildly optimism: If ever there was an olympic sport on Reckless optimism, I am sure Indians would win it hands down. This trend seems even more so prevalent amongst every stakeholders. when one takes stake in the long term, it is not uncommon to find every single parameter ranging from time to completion, projections, valuations, number of issues being stated on other side of caution by a factor of at least 2 (and in the worst cases 10). If an Indian told you he would meet you in 30 minutes, 45 minutes is par for the course, 60 minutes acceptable and 90 minutes is when you should begin to SMS as a courtesy (saying "Running late. will be there in 10 minutes." when you are at least 30 minutes away from the destination).
This seems to stretch across all projections - case in point,being the controversy around completion of commonwealth games.

A lot of GPs too seem to have this DNA firmly baked in - I have heard of at least one GP talking about plans to go IPO for a company that apparently was on the verge of bankruptcy.



Joy of debate/Equating time with work: Ask any LP visiting India what his favourite irritant is and he would complain about all meetings in Indian running way behind schedule. Right from LP conferences to review meetings, if you are not getting exasperated by the amount of information (most irrelevant and harmless ! as in Douglas Adams' speak) by the length of the day, you certainly are not in India. Even in several offices I know of, people equate hauling themselves ass in their chairs all day to the equivalent of working hard. Ask what was accomplished and you will get everything but the answer.

Tardiness and lack of attention to detail: Somewhere down the line the Gandhian philosophy of "Simple living - big thinking" seem to have been equated with tardiness. Our attention to detail and respect for other people's lives and times seem to be low and could certainly do with a lot more attention. A lot of reports I am told are mere improvisations and "word smithing" over the previous period's reports keeping in line with our credo of "recyling" - it looks like we have misunderstood it quite a lot !

Did I miss anything ? Well, it does not look so - not certainly after the conversations I have had with my counterparts in other PE funds - we are all in the same "slowboat".

~Varadha
(varadha.r1@gmail.com)

GPs and the art of progressive reporting

If one were to go back to the fundamental reasons for the blossoming of private equity as an industry, the tightened regulations that were the aftermath of the Enron/worldcom tragedy would certainly be paramount. The other day I ran into someone who runs a small cap company in NYSE (which has a Mcap of < $ 300 mn). He estimated the direct cost of reporting/compliance alone to be in excess of $ 4-5 million. Anyone, of course, would tell you the level of reporting sophistication in India (barring a few like Infosys) is still some way off the international standards.

Ask any GP in India, and one of the foremost things he would talk about is how his PE fund has been working with the promoters of portfolio companies to improve governance, compliance and sophistication of reporting. However, unlike in the West, where the industry has evolved to a level where reporting standards amongst PE firms have been templatized (also partly due to the fact that most of the portfolio companies are public companies being taken private and hence are used to a much higher reporting standard in any case),

This in particular is a problem for LPs, (like Fund of Funds, Endowments and the likes) who I presume must have uniform reporting standards, irrespective of their geographical allocation. I have of course, met a couple of "Indian LPs" and they seem to be far more forgiving in their ask for information (which is not necessarily a good thing in the long term).

This brings me to the following questions :

• Can there be different reporting standards for different geographies in PE ?
• How does one have a smooth upgrade in the quality of reporting without being too stifling at the beginning and too lax in the end ?
• How do you capture “significant, material intangibles” in a templatized form ? For eg., expected attrition amongst senior management, materiality of pending law suits, forex risk etc.

It would be interesting to hear the voices of a few LPs on this.

~Varadha