Carried Interest

Dentsu's Ten Rules of the Demon

 

I've had this list of rules on my desk for about 15 years.  It was given to me by my first really great boss.

A Japanese visitor recently noticed it and was amazed to see a copy translated into English . . . sitting in Sydney, Australia.  He told me that in Japan the list is known as the Ten Spartan Rules— I like that.

1.  Create work for yourself; don't wait for work to be assigned to you.

2.  Take an active role in all your endeavours, not a passive one.

3.  Seek out large and complex jobs.  Trivial tasks debase you.

4.  Welcome difficult assignments.  Choose them.  Progress lies in accomplishing difficult work.

5.  Once you begin a task, complete it.  Never give up.

6.  Lead your fellow workers.  Be an example for them to follow.

7.  Set goals for yourself to ensure a constant sense of purpose.  This will give you perseverance and hope for the future.

8.  Move with confidence.  Confidence gives your work force, focus and substance.

9.  Find new solutions.  This is the way we ensure satisfactory service.

10.  When conflict is necessary don't shy away from it or be afraid.  Conflict is the mother of progress and the source of aggressive enterprise.  If you fear conflict, you will become timid and servile.

Lesson Learned #5 - There's No Place Like Home

  

There's an old myth that a Silicon Valley VC won't back any start-up based more than 30 minutes drive from Sand Hill Road.

I'm not quite that lazy.  In fact I'm posting this from the Qantas lounge in Auckland.  But I've learned the hard way that distance is not a friend in private equity, and these days I expect potential investments based more than a couple of hours away from Sydney to clear a higher hurdle.

Distance is a minor nuisance when a portfolio company is performing well.  You get on the phone, send emails, fly to the factory for monthly board meetings and management offsites-- no drama. 

But when the wheels come off, or just wobble a little, distance can become a big problem for a PE investor.  When a company underperforms it's not always obvious exactly what's going wrong.  You can feel the momentum slipping away, but without spending plenty of time with the team, without "living the business", it's hard to quickly get to root causes and make correct decisions.

Was the rework problem in May really a one-off?  Who's telling the truth about quality issues, the Sales Manager or the Plant Manager?  Why is the CEO suddenly slow to return calls?  Is there a good headhunter in Kalgoorlie?

These issues are even more acute when you start investing internationally and barriers like language emerge.  It's dangerous to delude yourself that you can project the capabilities of a small PE team into another market. 

A thought: I'm normally skeptical about the mega-buyout firms and the scale benefits they claim to enjoy.  But their size does allow them to deploy locally recruited teams in many geographies (like 3i did in the UK).  Perhaps that's a genuine advantage they have?

Leason Learned #4 - Always Include Grey Hair in Your Due Diligence

Photo credit:  AFP/Getty Images/Thomas Lohnes

Private equity due diligence has become more sophisticated over the past decade.  These days the information package that gets handed to the banking syndicate may include:

1. Market and strategy analysis by a consulting firm to test and validate the commercial thesis behind the investment  (In Australia, active players are LEK, HUB Consulting, BCG, Crescendo)
2. Financial and tax review by an accounting firm (The Big-4, Grant Thornton)
3. Legal review (Freehills, Corrs, Clutz, etc)
4. Insurance analysis  (Aon, WSP)
5. Environmental risk assessment (ERM, SKM Consulting)
6. Management team background checks and capability review by an HR consultant.

When you're paying for all this big city "brain power" it's easy to forget the single most valuable source of business wisdom:  a grey-haired industry veteran. 

McKinsey may do a great job of mapping out the market structure, analysing segment profitability, testing growth assumptions, and so on.  But there's nothing like having a recently retired CEO by your side when you tour the factory, interview customers, or hold question and answer sessions with management. 

He'll be the person who notices that the overhead cranes in the workshop belong in a museum and need to be replaced immediately.  Or warns you that a major supplier has been bought by the competition and will probably cut off distribution.  Or remembers that this particular company always had a problem keeping good sales reps.

Is Private Equity the Next F!cked Company? (Part 2)

 

Coller Capital just released the latest edition of their twice-yearly Limited Partner survey.  The LPs believe that 23% of buyout firms will be unable to raise a new fund in the next seven years-- in other words they will go out of business.

That's not surprising when 84% say they have declined to re-invest with one or more of their existing GPs over the last 12 months (in Summer 2005 the figure was just 45%).

It's depressing stuff, but still a lot less gloomy than the doomsday industry meltdown that BCG was predicting last year.

Green Shoots?

 

Is the fund raising environment thawing?  Funds of funds certainly appear able to get new commitments from their LPs.

According to TheDeal.com, over the past two months fund-of-funds managers have closed on roughly $5.1 billion in fresh capital to invest in private equity, venture capital and real estate vehicles.

No surprise to see that much of the money is heading towards distressed asset or special situation PE funds!

Lessons Learned #3 - When In Doubt, (Quickly) Throw Him Out

Like most private equity investors I am far too slow to make tough decisions about portfolio company managers.  I procrastinate.  I blame market conditions,  I blame wet weather,  bad luck . . . anything to avoid the painful conclusion that THIS GUY MUST GO NOW.

My advice to a new general partner would be this:  the second time you find yourself questioning whether you have the right manager in the chair, start the search process.  And never make an investment where the shareholder agreement limits your ability to replace the CEO.

Lessons Learned #2 - Don't Be Greedy

It's usually a mistake to reject an attractive exit opportunity because you believe that "in a couple of years we'll get far more for the business." 

In a couple of years the share market could have collapsed, a new competitor may have launched, the CEO could have died, the price of oil could have doubled . . . risk is real.

If someone offers you 2x after two years . . . take it.  41% IRR and the profit is banked.

Lessons Learned #1 - The Exiting Founder

A new series which documents some of the more painful lessons I've learned over a decade or so spent in private equity.

Lesson 1:  Avoid investments that include an Exiting Founder

For my firm, without exception, these have been disasters.  Let's face it, the wily old bugger who has built a business over thirty plus years knows exactly when to sell.  The situation is particularly dangerous in a small business, where the processes, customer relationships and commercial judgment tend to sit in the founder's head.

I'll still consider investments with a transition plan that allows a founder to exit over a period of time, particularly if the deal includes some form of earn-out or retained equity stake. 

Time to Use Your Annex Card?

   

A reader asks:  "what is is an annex fund?"

Annex funds (also known as top-up funds) are making a reappearance thanks to the global financial crisis.  PE firms are being forced to hold portfolio companies for longer than planned and to support them with extra capital.  This money might be needed to meet an equity cure or just to provide working capital for tough times.  Unfortunately some PE funds are starting to run out of cash.  I recently wrote about Bain Capital's response to this problem.

An annex fund is a bit like a rights issue.  It's usually offered pro rata to the PE fund's current LPs, but is established as a standalone legal entity.  Like a normal PE fund the limited partners commit a certain amount of capital to the annex and the money is then called down as required.  Sometimes annex funds are allowed to invest in new businesses, but more typically their mission is to protect and maximise the value of an existing portfolio. 

Annex fund politics can get ugly.  Those LPs who are unable or unwilling to commit their pro rata capital get very sensitive about the valuations at which the annex fund injects new money into the existing portfolio.  And the LPs who did participate feel they should be generously rewarded for making valuable capital available and protecting the past investments.

I think it's fair to say that annex funds are more common in the venture capital world than in private equity land.

Jim Rogers Speaks, I Listen

 

Source: Channel 4 News