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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