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

Why some PE funds do better than others

For once, I do not have to write a cent from my own thinking in a post. The Mckinsey Quarterly article (though dated but clearly in with the theme of these times) sheds light on why fundamental outperformance is the only sustainable source of value creation (very very cliched, but terribly true).

Assuming there are no free lunches, there is so much to the arbitrage a PE fund can seek at the time of entry. A proprietary relationship built on trust and commitment can get you a discount but is not going to entirely contribute to an arbitrage opportunity. Of course, the smarter, seasoned ones can spot smart "buys" or smart "sells" in special situations (how many times a century are you going to have Goldman or a GE with a bowl in front of your house giving you a 10% preferred ?! or dump everything before a bubble ?) but for the majority of homo sapiens, the arbitrage opportunities are not worth too much salt.

Of course, pushing for outperformance means the obvious nitty-gritties - kicking tyres all the time to understand ground realities, understand organizational levers, spending quality time with top management and focussing on continuous improvisation.

But as a Private Equiteer, the piece de resistance is the fact that you can go to sleep every night assured in the fact your investment has appreciated (and is appreciating) even if a gale force hits the markets. That's priceless !


~Varadha
(varadha.r1@gmail.com)

Aftermath of a deal - Managing the monkey on your back

In continuation of the earlier post, I will try and cover some of my perspectives in terms of what entrepreneur's management of the investor.

• Inducting the investor into the organization:Too often, the promoter forgets that the investor means nothing to the rest of the people in the organization. These are precisely the people who would have to interact with the investor in minutiae like financial reporting, compliance, business metrices, MIS-es etc. I have often found that a town hall meeting equivalent (post the deal) helps induct the investor into the organizational maze and helps in setting a context for what is to follow.
• Creating an atmosphere of credibility and transparency: I have come across promoters who often "massage numbers" before sending them out to investor or simply turn a blind eye to the investor (to the point of exasperation). While this might provide for gratification in the short term, it is important to understand that one needs the investor's buy-in in the medium term (for raising further capital, key strategic decisions etc.) and an acrimonious relationship does no good to either. I have seem promoters who were known for their utter disdain come back to the investor eating humble pie. What goes round surely comes around !
  
• Managing expectations: Post the money exchanging hands, there is no time for bravado. Remember, the investor is as much a part of the boat (sinking or flourishing ?!) and he has as much stake in the upside. If there is a problem, acknowledge it - often a collective reflection (with the benefit of an outsider's perspective thrown in) can help devise simple solutions. The later this happens, the tougher it is to get out of the maze.
  
• Using an investor as a sounding board: I have seen too few Indian promoters push their investors - remember that an investor can bring value to progressive steps like baking in market intelligence/ competitor information, recruiting senior management, instituting processes and systems, because they have the benefit of a wider network and a larger perspective across businesses. Very few boards make everyone of the board members make a case for the value they added at the end of each year (Ala Infosys). A board in which everyone contributes often works wonders (as the investor realizes the rigours of the business and the entrepreneur realizes the expectations of the investor) in driving change towards a collective vision. I recently came across an entrepreneur who wanted me to help him out with the detailing of an overseas acquisition - the risks, valuation, deal and pay-out structure - that is a progressive step and that is the way it is meant to be !
  

Ahhh, all this serious talk is getting too boring. Let us talk about something a little more interesting next week.

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

The morning after - aftermath of a deal

Great - you've executed the deal you have always longed for. What do you do next ? One of the most important things I have observed (with my limited perception) is that the way in which the handshake is executed post the money exchanging hands is one of the key determinants of value creation. It determines if you will wake up with a hang over not worth remembering or if it will be a relationship worth cherishing.

Often the counterparts get drained out by the time money changes hands that there is often a period of quietude following the transfer of money. So the entrepreneur at his end, often thinks it is free money he has got and the fund manager thinks this fresh money would be the elixir to all of the company's problems - past, present and future. Sounds familiar ? Nothing could be further from the truth.

Call this a post-nuptial, if you will. A robust marriage, after all, does call for a set of rules that both of the counter parties promise to abide by. Often, the set of rules (said and unsaid) and the implicit, taciturn understanding that is developed during this period are the most critical to long term sustenance.



In a two part series, let us look at some of the thins a fund manager has to make clear at the beginning of a relationship.

• Creating credibility in the minds of the promoter: Small details like returning phone calls, responding to mails, developing a rapport with the rest of the management team, taking the initiative to understand the softer aspects of the organization go a long way in making the promoter more accommodating and lessening his distrust.
• Exercising influence: The smartest fund managers are the ones who seem to balance the drive towards results with the team building/interpersonal skills. More often than not, fund managers take one of the two extreme stances - throw a fit during meetings on the numbers or do not raise any questions at all (irrespective of the performance !). This simply cannot be !
• Understand the business in detail: Adding value to a portfolio company is not about discovering new markets, new M & A opportunities (the promoter is in the field and he should have a ring side view after all) but is to help facilitate a path towards putting together the building blocks that help you get there. For eg., it is about watching out for the risks that you need to watch out for in an M & A, how do you transition someone in senior management out etc. rather than identifying M & A targets or
• Explaining the requirements in detail: Do you need monthly numbers or quarterly numbers ? How frequently would you want to do a review ? How deep an insight would you want to get into the business ? Would you want to talk to the rest of the senior management team also on a periodic basis ? Would you exercise your consent rights on every single major capex (land, building purchase) or would you be alright okaying them post facto in a quarterly board meeting ?
• Assimilating yourself into the organization: One perspective (that of the promoter's) is never going to give you adequate insights into the organization or the market. For you to get a well rounded perspective, you need to be on first name terms with at least 4-5 of the senior management (and ensure they feel comfortable sharing any controversial views/insights/perspectives). One can never underestimate the importance of this and this helps envisage problems ahead of time.
• Driving change early: There is never a better chance to drive change (ranging from to be completed post the deal to process changes to augmentation of senior management) than the early days of marriage. With passage of time, change becomes that much more difficult to enforce - the later you do it, the more time it takes (because your tolerance level increases as well 'coz you are used to it anyway!)

In the next part, I will talk about how an entrepreneur needs to manage the early days of a relationship from his side.

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

The Curious comparison of Private Equity and Bagger Vance

Apropos the comment on value addition in one of my earlier posts is well taken. Agree to the fact that as long as the promoter treats you as a partner and there is a high element of trust and transparency in the relationship, there are not too many reasons why the marriage (PE infusion is is a marriage) should fail.

I would like to believe that a PE fund is similar to the support crew for a marathon runner or a caddie for a golfer (could not help comparing it with the movie "The Legend of Bagger Vance" I saw the other day). The comparison does sound a little corny, but here goes nevertheless...



Not too dissimilar to the relationship between Bagger Vance (Will Smith) and Junuh(Matt Damon), the relationship is not permanent, but not fleeting either. Ultimately, it is the golfer (read promoter) who calls the shots. The Caddie's core job is to carry the golf kit (and in the case of capitalism, bags of cash ! - argh, that was quite tacky, wasn't it ?!).

The caddie can only help exorcise demons in the minds and bring in perspectives that otherwise might elude someone who is focused on his job. So what does a caddie bring in ?

Peripheral vision: What are your other competitors doing ? Is there a better way to do what we are currently doing ?

Order and discipline: What is the best way to position a ball before hitting ? How would you want to proceed on taking into considering the terrain, weather and the competition ? Who keeps track of the spoken and the unspoken ranging from body language to quality of each shot to hits and misses ?
Confidante and sounding board: Temperance of of the highs and lows of essential are necessary for consistency of performance. Often, a person who is emotionally attached to his sport might find it difficult to distance himself from it. It is the caddie, who serves as the shoulder for the golfer to lean on, during times -good and bad.

Suffice to say the golfer knows his game better than the caddie (otherwise why would the caddie be a caddie, after all ?). We must remember that a caddie is not indispensable but often can lead to that marginal extra that can prove decisive in the long run.

What say readers ?

Varadha

(Varadha.r1@gmail.com)
+91 9940670064

4 F's of Value Creation

Given a lot of Indian Entrepreneurs have a lot of fire anyway, I was wondering what differentiates the Suzlon's and the Infosys-es of the world from the also-rans. Here goes my thoughts :




Focus : I have seen the case of more than one excellent entrepreneur who tends to take his eye off the ball. Too often, there is another opportunity that comes along that for the right reasons, looks far more lucrative. Can you imagine a Sachin Tendulkar switching to football because he has achieved everything in sight ? Can you imagine Tiger Woods playing anything but golf even 20 years from now ?

Typical distractions are real estate, restaurants, schools etc. that also give you an added social tag. The focussed ones refuse to take the bait and instead improvise/innovate on their core business. The others inevitably regret it. The ones that successfully juggle different businesses are not the ones that micro manage, but find the right people to delegate to and manage by reviews and numbers.

Finesse: This is probably the most under rated quality that the most successful entrepreneurs possess. Too often, the ego, the past successes weigh heavily in the minds of entrepreneurs and force him/her to take a decision that may not necessarily be the best for everyone in the eco system. For eg., " I have dealt with unions before - let us shut this factory", "We need to do this acquisition at any cost " etc. The good ones know where to draw the line. They know how to treat their customers and employees well. That creates a virtuous cycle . More importantly, they know how to self-promote their company by touching the right wires in the eco system - case in point being Infosys whose PR machinery is always working overtime without necessarily giving that impression to the outside world. These become even more so important during critical occasions like an IPO, acquisition, investors' exit etc.

Flexibility: There is a thin line that differentiates Flexibility from Focus and the good ones seem to know it by magic. If the demand for your product is not as great as you would expect it to be, would you find the markets that can give you the demand ? Or would you tailor a new product that has a larger demand in the existing market ? Needless to say, there are no easy answers. The good ones take a periodic check on the business (both internally and externally) and often take calculated, mid - course corrections. For eg., who would have thought Steve Jobs would make success of iPod when it was released in 2001 ? A standalone music player in an era of convergence ? From a company known for its computers ?

Fast & Decisive: Someone famously said "A half executed idea is better than a paper vision". The good entrepreneurs move fast and decisively. Too often, I have seen issue like " We recruited him. He is not performing upto expectations. What do we do ? " persisting for a long time, board meeting after board meeting. Either you augment his skill sets with other people (sub-ordinates or peers) or get a better guy or help him to upgrade his skills.

Any thoughts, anyone ? Is there more to it ?

~Varadha
varadha.r1@gmail.com
+91 9940670064

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