Establishing a private equity fund as a founding partner is the objective of thousands of practitioners across the industry. For the fortunate few, success has involved talent, good timing and perseverance combined with industry growth that has supported the entry of new firms. With the market continuing to mature, what are the hurdles, and what will it take to successfully start a private equity shop going forward? A leading private equity fundraising adviser and two leading investors with extensive experience advising and backing new private equity firms discussed these issues with members of the Wharton Private Equity Club (WPEC).
Greg Myers is managing director of the Private Fund Advisory Group at Lazard. He has 12 years of experience advising private equity firms across Europe, the United States and Asia on fundraising transactions. Currently based in London, Myers is responsible for Lazard’s European and Asian fundraising origination and execution activities.
Mike Pilson is director of Private Equities at DuPont Capital Management. He has 12 years’ experience in private equity fund investment and investment banking. Pilson currently oversees a $3 billion portfolio comprising over 100 private equity fund interests.
Rick Slocum is director of Private Investments at the Robert Wood Johnson Foundation. Slocum has 27 years of experience across private equity fund investment, direct investment and investment banking and was most recently senior director of investments at the University of Pennsylvania. He currently oversees a $2.5 billion portfolio in commitments with investments in private equity, venture capital, growth equity, distressed investing, opportunistic credit and real assets.
WPEC: In your experience, what are the different profiles of new private equity firms, and what motivates new general partner (GP) teams to set up shop?
MP: New private equity firms typically come in one of a few forms today. First, a spin-out of a sub-group of partners from an existing firm–for example, West Hill, a recent spin-out from the established U.S. buyout firm J.W. Childs. Second, a spin-out of a group of partners from different firms that have teamed up, such as Vitruvian Partners, a European private equity firm that was established last year by ex-Apax, BC Partners and Bridgepoint investment professionals. Third, a new firm formed by individuals that have been practicing private equity-like investing in a non-fund format, such as Intervale Capital, which was started recently by Charles Cherington and Curtis Huff.
In each scenario, the motivations are different but the goals the same: to have your own shop–one where you have designed the investment process, strategy and team economic structure to achieve the best team-based decision making, cohesiveness, transparency and, ultimately, the best returns. Most spin-outs today are the result of younger partners developing into full partners with the desire to have more of the carry and more influence within their respective firms.
GM: Another major profile of a new firm that can attract institutional investor funding is a spin-off from a bank. Merchant banking spin-outs are often driven by strategic change in the mother organization; for example, issues with conflicts of interest or balance sheet risk considerations. Metalmark Capital, for example, was spun out of Morgan Stanley in 2004. The firm went on to be acquired by Citigroup in 2007 as the bank made a strategic decision to rebuild its exposure to the private equity business.
The second motivating factor is similar to the private equity firm dynamics Mike describes. Either the whole investment team, or a subset, seeks independence from the mother organization for reasons including economics and ability to form and execute an investment strategy independently.
RS: I think that Mike and Greg have provided a good summary of many of the motivations one sees in forming new private equity firms. Another format I’ve seen includes an ex-CEO or CEOs getting together to form a new fund, sometimes with sponsorship from an established group. Operational expertise, particularly when combined with investment experience, can be an attractive format. Also, new areas for investment–for example, private equity real estate investing in India–will attract investors who may have skills in other markets that they believe can be applied in new locations.
WPEC: Private equity has emerged as an asset class of its own over the last 25 years. Historically, what has driven the demand for investing in funds advised by new firms? In your opinion, are the same demand factors driving the market for new opportunities today?
RS: If you go back to the 1980s, buyout funds could be established to exploit the inefficiencies in both the financing markets and the corporate sale process. Auctions were less frequent for awhile, while the idea of buying companies with significant leverage was pretty novel. As a result, professionals with strong financial skills and good access to Wall Street could raise funds to exploit financing inefficiencies. Strong returns could be generated by successfully cutting costs and reducing leverage of strong cash-flowing entities. Today’s market is much different, and, at least in the U.S. and now Europe, is looking for strong operational and business-building skills. In addition, popular investing themes–where skill sets might be somewhat different–include investing in the emerging markets and in real assets.
MP: Private equity has emerged from a cottage industry into a fully fledged asset class over the past 25 years. The driving reason is the consistent alpha generation to institutional investors as a result of market inefficiencies left by other investment and ownership models that private equity addresses. Historically new firm creation was driven by the ” new new thing.” The new investment idea–for example, industry-specific, buy-and-build or operationally focused funds–or the ability to back a new star investor, for example, J.C. Flowers in 2002 after he left Goldman Sachs, or new geographies–for example, the emergence of Europe, Latin America and Asia. As the market matured, the number of ideas has grown exponentially. I believe the same forces continue to drive the growth of private equity today. Investors will continue to look for the new new thing.
GM: After years of rapid growth, I believe that we are now at an inflection point in the industry. Many established shops are maturing with potential team succession issues looming. Simultaneously, institutional investor allocation to new managers has decreased as relationships with established managers have matured. The new wave of firms will be driven by the next generation of private equity firm partners–newly energized and highly aligned, and with innovative ideas for embracing new market opportunities. Silver Lake is a good example: Formed in 1999 by partners from private equity and technology backgrounds, the firm identified the opportunity in the technology sector early. Success in this strategy attracted significant institutional investor interest, helping the firm become among the largest new players in the industry.
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