The subtle shift in Private Equity

So I notice this subtle shift happening in the PE industry.

As more and more funds enter the Indian market, it gets tougher and tougher to find “diamonds in the rough.”  Coupled with rapidly deteriorating global cues, PE funds are cagey about signing deals and don’t hesitate to pull out, a practice that was once considered sacrilege. Already we’ve noticed even the frontliners reneging on commitments.  But this can’t go on; a solution has to be found. What could be that?

I suggest looking at the problem from a different angle.  Before the next opportunity shock springs up, make a new beginning by avoiding some pitfalls.

a) Stop competing with other funds:  Control investment ego. In terms of exit and capital return (to LP investors) decisions, the funds that faced tough competition while making their investments take longer to mature.  Often funds under pressure to invest make more marginal investments that take longer to liquidate.

b) Raise funds when markets lag:  The corollary is never raise funds during a boom era.  This reduces the psychological pressure of having to invest while valuations are stretched. Most real estate and infrastructure funds face this problem. In the end, investors will supply capital to PE funds until their risk adjusted expected returns equal the opportunity cost of capital. So scan the worth of other opportunities available to the investor.

c) Commitment v.drawdown – Research has shown that most funds can draw only about 16%, 20%, 20% of the committed capital during the first 3 years before they slow down, why then accept large commitments upfront? By the end of its cycle, it is seen that even some of the best soak up only about 93% of committed capital on an average. Not all LP investors would see this as prudence, they recognize it as inept judgment if not gawky fund management.

d) Develop strategic skills fast: Learn on the run – from every roadshow, every investment and every exit. PE fund managers (arguably though) are expected to possess unique venture skills that are not duplicated overnight.  The skills in question include screening investments and monitoring managements. Steven Cohen, Carl Icahn, John Doerr, Michael Moritz, Stephen Schwarzman, Steve Bondermann all keep a hawk eye over their portfolio companies.  It’s worse than a public company undergoing SEC or SOX watch, yet for all the right reasons. The message is clear – never dither on shareholder commitments. Ed Zander of Motorola learnt it the hard way.

e) Dump that slack – Returns are rewards. They don’t come without extracting sweat. Fund managers give scant respect to reports from portfolio companies and read them only on the eve of a board meeting. While they arm themselves with questions, they have little to offer by way of solutions. They develop this distinct `slack’ post investment and pick it up only a few years down the line, when it’s time to return capital. By then, even Viagra can’t get it up for you!

Act while you can. Develop innovative deal scouting skills.  Go do some propreitary research. Have your skin in the game.  Trust me. I talk from experience.

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Yes, we carved our own destiny

I ran into my old friend and classmate from college, K.P.Vishwanath, now a Vice President with Microsoft at Mumbai Airport. “Vish” as we called him fondly has been a terrific guy, a little reserved but very helpful even in those days.  We did catch up on a lot of stuff but then meeting after 24 years, we felt we had hardly scratched the surface.  We tried harder, dashed out of the airport, squeezed in a pub crawl and a couple swigs later, I dropped him back at the airport just in time to catch his connecting flight to Singapore – just as we did things in college, in the nick of time.

From carefree college life to where we got ourselves, it’s been a long journey for us both.  We seem to have sauntered alike in the way we followed our natural instincts.  On my way back, I scrapped it all in my mind, especially on areas where we converged that yielded material for my blog post.  Here I go.

We both had our fair share of great opportunities that disguised as unsolvable problems. It took a curious, creative mind to go after those. The intuition propelled action and curiosity drove pursuit. That singular focus inspired people around us to join in and simplify the pursuit. Between stimulus and response lay our freedom to choose.  We were careful in choosing and involving people that mattered.  I love to involve people in everything I do. Tell them, they’ll forget; show them, they’ll remember; involve them, they’ll understand.

Creativity is the process of discovering something you did not start out with.  Sometimes in the process, you may reach a dead end.  It’s a mistake if you think your journey has ended. It’s just a signal for you to retrace your steps and continue. Nature has its own way to present you with complexities, when you’d think you’d just solved the most intricate.  So there’s nothing called a dead end. They are just temporary suspensions.  Nothing is exciting if you know what the outcome is going to be. Even the woodpecker owes his success to the fact that he uses his head and keeps pecking away until he finished the job he started.

I remember some lessons from my days in the trenches, which is about often, given the creative hack that I am.  Everything new stirs my interest and I take off without notice. Often I tend to think future as a static goal and worked towards it. The closer I got, the farther it gets. The goal post kept shifting and it took a while for me to realize that in the process, I’ve too been growing.  I had developed a better sense of judgment, a refined process of thought and had significantly improved my clarity of perception. I began to sense risks early on and ward them off in advance.  Vish said I spoke his mind and flashed a Peter Drucker quote – best way to predict the future is to create it !!

Yes, we carved our own destiny.

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Fixing B-school models

Akkshay Mehta, an IIM-A graduate says “There is hardly anything in the B-school curriculum that prepares students for such rapid change.”  I say Amen.

If anything, they are good at *brownnosing* their way to the top.  They almost follow it as a dictum – more you rub nose with influential rumps, higher you go in the organizational ladder. They call it tact. Could they have learnt it at B-School? 

I’ve always held leadership can never be taught. You become a leader when your thoughts are so refined and others `get it’ better in its light than on their own. The prescriptive structural model followed by B-Schools motivates folks to score straight A’s than stimulating their creativity.  What it ignores? Capturing attributes like drive, curiosity and intuitiveness in the future leader.  I don’t think any evaluation process to be complete without sizing up those. That can’t be figured out by tests either. You’ve got to see them in real action where they are. Current institutional and tutorial models are easier on the faculty, allowing them to get away doing a shoddy job. Recast it with one of self-learning and heuristics.  Just watch how they perform at work and you’ll see how many still manage straight A’s. Begin with Wall Street and see their warped intelligence busily pulling down banks with utmost ease.  If that’s difficult, just check out authors of subprime debacle. It will be a tell all.

Update :  Here’s what Subhiksha CEO R.Subramonian, IIM-A graduate (1989) has to say on B-school model.

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When you gotta’ spend, spend. Don’t save…

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It’s budget time again for us.  Content starved news channels and half baked analysts will run riot for days together over this non-event.  Industry associations and business bodies will hold lectures and seminars to enjoy their annual few hours of fame. Few days later, there could be noise of rollbacks and the dust will settle. Man on the street will still be worse off.  Hardly does he care either.

What is certain is we’ll hear more of the `D’ word again – Deficit. It riles me no end to think we are in perennial deficit mode while our neighbor lends money to the Americans to spend and consume.  Where are we missing out? 

The Atlantic figured it out here. 

“China has a high savings rate describes the situation without explaining it. Why should the Communist Party of China countenance a policy that takes so much wealth from the world’s poor, in their own country, and gives it to the United States? To add to the mystery, why should China be content to put so many of its holdings into dollars, knowing that the dollar is virtually guaranteed to keep losing value against the RMB? And how long can its people tolerate being denied so much of their earnings, when they and their country need so much?  

The Chinese government did not explicitly set out to tighten the belt on its population while offering cheap money to American homeowners. But the fact that it does results directly from explicit choices it has made—two in particular. Both arise from crucial controls the government maintains over an economy that in many other ways has become wide open. The situation may be easiest to explain by following a U.S. dollar on its journey from a customer’s hand in America to a factory in China and back again to the T-note auction in the United States.”

When you gotta spend, spend… Don’t save !

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Inadvertence is sin

During my career spanning over a couple decades, I’ve come across several carelessly drafted legal documents. It takes painfully close combing and sanitizing to weed out the malcontent and a pair of wide open eyes to build in seemingly innocuous omissions before presenting a clean set of documents for clients to sign on.  Often on my way back home after such clean up efforts, I meditate over its outcome had the slip up gone undetected.  But then it takes a callous client to sign a document before it’s sufficiently vetted.

Here we have one such outcome. SET India, (of which SONY Japan is a 61% majority holder) which operates channels like Sony, MAX, SAB TV and AXN, recently asked its minority shareholders (32%) to infuse fresh equity of $40 million (Rs 156 crore), which they turned down. Now they are considering suing SET India terming the capital call illegal. The capital is to finance SET’s commitments to the upcoming Indian Premier League tournament, for which the company has won the broadcasting rights with another agency. 

I say this is the silliest of omissions on the part of minority shareholders. Silly because, they got into bed with a monster not expecting to get screwed.  This is normally the route taken by majority shareholders to buyout minority holders on the cheap. This is precisely why in most JV agreements, you’ll find a clause that mandates unanimous shareholder approval BEFORE critical decisions are taken on proposals for major new investments. There will also be mitigating covenants like “all dissenting shareholder(s) be protected by a call/put option at pre-agreed premia or should be exempted from participating in the fresh round [with] or [without] anti-dilution guarantee or that a new class of shares be issued to raise fresh funds without altering the rights/status of dissenters”. 

In this agreement between SET India and its minority shareholders, I suspect inadvertence. They will go thro legal hell.  Deservedly.

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Have you stopped by my other blogs, lately…?

Lots of interesting stuff in there….

www.go-rhythmic.blogspot.com  (Mile high view of the ground)

www.sequellventures.blogspot.com (Tech trends /business ideas)

www.gpsurvivalkit.blogspot.com (India PE/VC, I-banking stuff)

www.sequelventures.blogspot.com (My business card) 

I recommend a catharsis

Why do I get this feeling that human beings just weren’t built for capital markets? I agree with Barry Ritholtz somewhat.

“We have numerous design flaws that work against us in the investment process. But once you become aware of how they impact your thinking, you have a chance at avoiding some of the more damaging behaviors. At the very least, you can try to work around some of these hard-wired foibles.”

Think of ego that don’t let you acknowledge a stupid pick. It’s not so easy to suspend your conviction that led you to it. Ego is why we selectively perceive data, why we emphasize that which confirms our prior views. It helps us ignore new data that may contradict our preconceived notions. It even facilitates our forgetting information that is inapposite to our viewpoint.

We might have enjoyed 10 good GDP reports in a row, but let one bad one slide out and we become fearful and nervous.  Could that be the case?  Not likely.

Then, the famous twins – fear and greed. These are the best-known market emotions, and they cause all sorts of problems for investors. Driven by the hormonal effects of dopamine and adrenalin, our passions have an unfortunate tendency of getting the better of us at exactly the worst possible moment. It’s not merely chasing hot stocks at the top or getting panicked out at the bottom that’s so problematic: It’s the impulsive destruction of our investment strategy and long-term plan.

Don’t think of getting some serious brain damage just yet.  But I would certainly recommend a catharsis !

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Have a curmudgeon for a friend, any day!

Sometimes just acknowledging the cranky, bilious soul is more effective than drowning it in bland sweetisms.  Perhaps I liked Jon Winokur’s portable curmudgeon because of that. 

As Jon Winokur sees it – 

“A curmudgeon’s reputation for malevolence is undeserved. They’re neither warped nor evil at heart. They don’t hate mankind, just mankind’s absurdities. They’re just as sensitive and soft-hearted as the next guy, but they hide their vulnerability beneath a crust of misanthropy. They ease the pain by turning hurt into humor. They attack maudlinism because it devalues genuine sentiment.  Nature, having failed to equip them with a serviceable denial mechanism, has endowed them with astute perception and sly wit.

Curmudgeons are mockers and debunkers whose bitterness is a symptom rather than a disease. They can’t compromise their standards and can’t manage the suspension of disbelief necessary for feigned cheerfulness. Their awareness is a curse.

Perhaps curmudgeons have gotten a bad rap in the same way that the messenger is blamed for the message: They have the temerity to comment on the human condition without apology. They not only refuse to applaud mediocrity, they howl it down with morose glee. Their versions of the truth unsettle us, and we hold it against them, even though they soften it with humor.”

It’s natural to align curmudgeons to a minority, abhorred by a mediocre mainstream that thrives on hypocrisy and fawning duplicity couched as obeisance. They are quick to prejudge, not recognizing a curmudgeon’s focus that invariably discards on purpose, social hierarchy and exaltedness, ending up calling many a pretender’s bluff. That dislodgement is often so violent and a true curmudgeon executes it with such a finality and precision that the vicissitude of the victim is complete. 

The vanquished is left with not much scope for redemption except to recoil into its favorite pastime – brand the curmudgeon as an aggressive, or even arrogant zealot caring for little else beyond their own business. 

Precisely why I am in awe of them.

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Clarity of perspective

Stuff that separates a great leader from the good….?  Sample this. 

“Roberto Goizueta, the late longtime CEO of Coca-Cola, proved that there is no such thing as a mature business. His critical insight was an ability to define exactly what business Coke was in–a task that is far harder than you think. For instance, he taught his executives that when they set goals for market share, they needed to focus on the share of stomach, not the share of carbonated beverages. His adversary was water, not soda. By this definition, Coke’s 40%-plus market share became 3%, changing the company’s view of growth.” 

That’s clarity for you….  Hats off to those great leaders !

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Dislike something enough to sell it?

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What do you do when you get bored of something? You try to get rid of it ASAP.  In other words, you become a good salesman. So when you are hiring your sales team, make sure they are not particularly in love with your product.  Shocked…? 

That’s the freakish insight I got from this FT story. 

Ad Scheepbouwer, CEO of Dutch telco KPN said this while declaring his pitch for iPhone franchise in the Netherlands –

“I had one [iPhone] and I thought it was a pretty useless phone, to be quite honest.  The battery ran out in no time. I didn’t like the touch screen….“We’d be more than happy to sell it.”

That’s snarky enough twist…ain’t it?

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