Best Practices of Private Equity Funds in Originating Investments Where Are the Deals?! “Cold Calling?” from http://www.flickr.com/photos/23439761@N03/3258313816/sizes/l/ David Teten Partner, ff Venture Capital ffvc.com blog: teten.com New York, NY [email protected], @dteten July 12, 2011
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Best Practices by Private Equity Funds in Deal Origination
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Best Practices of Private Equity Funds in Originating Investments
Where Are the Deals?!
“Cold Calling?” from http://www.flickr.com/photos/23439761@N03/3258313816/sizes/l/
David Teten Partner, ff Venture Capital ffvc.com blog: teten.com New York, NY [email protected] , @dteten July 12, 2011
We have presented our research to many investor conferences, private equity funds, and investment banks. • Association for Corporate Growth (ACG) Intergrowth, and Capital Connection Chicago • Alliance of Merger & Acquisition Advisors • CFA Society of Los Angeles • Columbia Business School Alumni Club of New York • Financial Executives Networking Group • Golden Seeds (US angel group) • Harvard Business School Club of London • Harvard Business School Association of Southern California • Kauffman Fellows program participants • Keiretsu Forum • Wharton Alumni Club of Northern California • Yale Club of Singapore • Singapore Venture Capital and Private Equity Association • CFA Singapore • Women’s Association of Venture & Equity • Leading investment banks, private equity funds, venture capitalist funds, and hedge funds
David Teten recently completed the first-ever research project on “Best Practices in Private Equity and Venture Capital Deal Origination”. His coauthor for some of the research is Chris Farmer, Venture Partner, General Catalyst, and formerly Vice President, Bessemer Venture Partners.
David and Chris have published their findings in the Journal of Private Equity (Winter 2010); Mergers & Acquisitions (December 2010); Institutional Investor (October 2010); and Harvard Business Review (June 2010). These slides provide some of the learnings and underlying data from the research study.
Evalueserve, a global research firm and the acquirer of David’s former company (Circle of Experts), provided supporting research and analytics in the initial phases of this study. We also thank Yujin Chung (Andreessen Horowitz) and Neha Kumar (Anklesaria Group), our research associates who provided invaluable support, and interns Corentin Roux dit Buisson, Dan Clark, Nitin Gupta, and Nikhil Iyer .
David Teten Biography (teten.com) • Partner, ff Venture Capital, early-stage technology venture capital fund. Over 150
investments in over 55 companies. • Founder and Chairman, Harvard Business School Alumni Angels of Greater New York • Founder and Chairman, Navon Partners, startup focused on sourcing deals for private
equity funds • Managing Director, Evalueserve, through September 2008. 2,500-person finance-focused
research and analytics firm. • Founder and CEO, Circle of Experts (investment research firm), sold to Evalueserve • Founder and CEO, Teten Executive Recruiting, sold to Accolo, #42 on 2007 Inc. 500 • Founder and CEO, GoldNames, domain name investment bank, based in Israel • Technology/Defense Investment Banking, Bear Stearns (#1 group
at Bear investment banking by revenues) • Lead author, The Virtual Handshake: Opening Doors and
Closing Deals Online (TheVirtualHandshake.com) • Harvard MBA 1998, Yale BA, both with honors. • Contact: [email protected]
Navon Partners (NavonPartners.com) We help investors to identify investment opportunities in illiquid assets.
We obtain our data from: • major data vendors; • licensing from niche data vendors; • non-traditional sources, e.g., web scraping from the ‘dark web’; and • our data-based financial extrapolation, e.g., estimating revenues based on
headcount. Our initial target market is helping private equity funds to identify proprietary deals which are predictably attractive long-term investments. Our rigorous, data-driven algorithmic process is modeled on the datasets and process used by quantitative hedge funds.
Minimal outbound origination programs targeted outside of Venture Centers
Firms in venture centers (Boston/NY/Silicon Valley) outperform with investments outside venture centers. Performance gap is larger for late stage (20.7% vs. 15.7%) vs. early stage (15.1% vs. 11.3%)*.
Origination programs targeted outside of Venture Centers
Leading Late-Stage Tech Investors Portfolio by Geography, 2000-1Q2010
Success rate shown is defined as % of VC portfolio which leads to IPO. Results are similar when success is defined as investment either leading to IPO or acquisition. Only IT & related sectors. Battery & Sequoia data is only late stage/growth equity deals. *“Buy Local? The Geography of Successful and Unsuccessful VC Expansion”, Chen,Gompers,Kovner,Lerner
These funds are typically top-quartile performers; almost all have raised funds equal or larger than their preceding
Case study: Castle Harlan, $3b PE fund, studied correlation between different sourcing strategies and returns.
Castle Harlan
• Castle Harlan completed an internal study in 2009 of the sources and returns of all their completed transactions (68 deals, 38 exited).
• Firm management asked the deal team on each transaction to rate the importance of seven proprietary strategies to winning each deal, on a scale of 0-10 (10=maximum).
• For example, "finder" and "industry expertise" were two of the strategies. "Finder" was score-weighted in a binary way, with either a 0 for no finder involved or a 10 for a finder playing a key role in sourcing the transaction.
• Across all deals, the mean total "proprietariness" score was 21.2 out of a maximum possible of 70, and 44 of the deals (65%) scored above 25. Most of these 44 deals fully exploited (i.e., 10 out of 10) at least two proprietary strategies, and benefited from some other strategies as well.
• The most proprietary deals (“proprietariness” scores of 31+) had a somewhat higher return than non-proprietary deals, while at the same time the firm tended to pay on average a premium for these proprietary deals.
• Includes: Deals sourced through affiliated investors; through relationships with current management; and/or through relationships with non-incumbent management.
• This implies that these companies were higher quality than non-proprietary deals; Castle Harlan perceived a lower uncertainty risk; and/or the fund was able to add more value to these transactions after a transaction closed.
• By contrast, deals characterized as being sourced through finders were associated with lower entry multiples, but also relatively less attractive realized outcomes.
• Only 9 investments (13% of the total) had a "Finder" score of 5 or more.
Castle Harlan origination study shows higher multiples for proprietary deals.
Profiled initially 20,850 2,500 1,394 NA NA 550 Target Selected 1,315 500 261 8,000 10,000 [vi] 190 Met 1,047 NA 20 750 1,000 NA Negotiated with NA NA 14 NA NA 28 Detailed due diligence
577 100 20 NA NA 17
Acquired/ invested
541 20 3 10 to 12 10-20 10
Deals as % targeted companies
33.5% (2.1% of
submissions)
4.0% 1.1% 0.1%-0.2% 0.1%-0.2% 5.3%
[i] Available at http://angelsoft.net/a/venture-valuation , as of twelve months ending March 17, 2010. [ii] Aktihanoglu , Murat. “NYC Entrepreneur Week Events Take-aways.” May 3, 2009. http://centrl.com/blog/?p=53 .
[iii] Rudd, Amber. “A Kind of Magic.” Corporate Financier, October 2006. [iv] Economist, Global Heroes: A Report on Entrepreneurship, March 14, 2009., p. 9. “Targets selected” figure indicates number of business plans received.
[v] Bruner, Robert F., Applied Mergers and Acquisitions. New York: John Wiley & Sons, 2004., p. 183. [vi] Number of business plans received.
Closing one deal requires sourcing 80-100 deals. Investment Search Process (# Companies)
Deal Sourcing Strategies: Please describe if your sourcing strategy has changed, how it has changed,
and how you expect it to change in the next 3 years.
The most common sourcing strategy is to combine in-house/direct with sell-side intermediary. 40% of firms plan to move towards more in-house/direct in next 3 years.
<10%
10%-19%
20%-29%
40%-49% 50%-59%
30%-39%
* “Other” includes broken auctions, tangential relationships and well connected individuals. Parthenon Group
David Teten, Chris Farmer, Evalueserve, Yujin Chung, Neha Kumar Responses for Don’t Know/Cant say is excluded from the analysis. Percentages may not add up to 100 due to rounding off.
% of Funds With At Least One Person Tasked Specifically and Primarily with Deal Origination
Specialist originators are more common in more developed markets.
• Persistence, or "hanging around the hoop" • Personality • Business judgment • Adequate financial sophistication • Seniority and appropriate title • Internal power • Creativity
The best originators are aggressive, indefatigable, and personable.
Lossen, Ulrich, “The Performance of Private Equity Funds: Does Diversification Matter?” Munich School of Management, Institute for Innovation Research, Technology Management and Entrepreneurship. June, 2006. Ernst & Young. "How Do Private Equity Investors Create Value? A Study of 2006 Exits in the US and Western Europe". New York, NY/London. 2006.
• The rate of return of PE funds declines with diversification across financing stages…
• but increases with diversification across industries. • Diversification across countries has no systematic effect on performance. • In an Ernst & Young study of the largest PE deals of 2006, US investors
reported that sector focus was an advantage in 2/3 of their deals, establishing credibility with management and helping to evaluate the growth potential of the target.
• In Europe, investors reported that sector focus was an advantage in 25% of deals.
• In both regions, these sector-focused deals performed above average.
Social Signals Network Next Steps Warm – Lukewarm – Ice
Partners Intellectual property Intellectual Ventures Spinning out processes from within Fortune 500 companies and setting them up as independent ventures
Exigen Capital
Deep focus from early to late stage in narrow vertical Andreessen Horowitz, Healthpoint Capital Minority-owned businesses AP Capital, ICV Capital Partners
Women-owned businesses Hypatia Capital
Family-owned businesses Heritage Partners Film financing Relativity Media Buying Western companies and outsourcing operations to China Crimson Ventures Distressed Searchlight Capital
Social Signals Network Next Steps Warm – Lukewarm – Ice
• Have a clear point of view and area of expertise
• Develop and publicize quotable white papers and other thought leadership pieces
The best reason for deals to come to you is reputation. However, the bad news is: of 109 journalists surveyed, zero rated private equity firms “excellent” in communication.
Haynes, Bill. “Making Media Count”. PrivateEquityOnline, April 7, 2009.
Recommendations: Journalists’ Evaluation of PE Funds’ Communication Skills
Social Signals Network Next Steps Warm – Lukewarm – Ice
U.S. Funds That Typically Partner with Executives to Execute a Transaction and Bring in New Management Upon Investing
Data based on firm websites. Frontenac AUM based on last two funds. # Investments/Year based on mean activity level over firm’s existence, with some adjustment for growth of fund over time.
Partnering with operating executives is a successful strategy which is a focus for only a small number of funds.
Private Equity Fund Founded AUM ($m)
Cum. # Investments
# Deals/ Year (est.)
GTCR 1980 $8,000 100 7 Wind Point Partners 1984 $2,000 80 5 Frontenac Company 1971 $875 200 5 Housatonic Partners 1997 $1,000 50 4 Prospect Partners 1998 $270 35 3 Red Diamond Capital 2002 $150 8 1 Post Capital Partners 2004 $100 7 1
Social Signals Network Next Steps Warm – Lukewarm – Ice
We expect an increase in executive-led transactions in 2010-2025. Many motivated sellers • Wave of baby boomers who must sell their businesses. >$10 trillion enterprise value of
businesses to change hands in next 10 years. • High pent-up demand to divest by corporates.*
Highly inefficient and undercovered market • Current players in Executive-Led Transactions niche small and financially
unsophisticated.
Easier to execute executive-led transactions • Large pool of senior executives who are un/underemployed, some of whom want to be
owner-operators with PE backing. These executives are difficult to reach through conventional means.
• Recent decision re: John Q. Hammons Hotels enables noncontrolling management to consummate MBO without searching judicial inquiry.**
* PEP Digest, http://www.pepdigest.com/index.php?option=com_content&view=article&id=2990:better-deal-flow-in-2010-as-corporates-to-increase-divestitures&catid=34:news-to-know&Itemid=24 ** “Decision May Help Revive Management Buyouts”, Steven Davidoff, NY Times, http://dealbook.blogs.nytimes.com/2009/10/19/decision-may-help-revive-management-buyouts/
Social Signals Network Next Steps Warm – Lukewarm – Ice
David Teten, Chris Farmer, Evalueserve, Y. Chung, N. Kumar. Ernst & Young. "How Do Private Equity Investors Create Value? A Study of 2006 Exits in the US and Western Europe". NY/London. 2006
In-house relationships are the #1 source of transactions. Unsurprisingly, PE investors rely on intermediaries far more than VCs.
Primary Sources of Investments
Similarly, Ernst & Young found that ¾ of the largest PE investments in 2006 resulted from proactive deal origination strategies; only 11% of the deals resulted from PE investors starting work during the formal sale process. "Better preparation, strength of relationship with target management, and sector focus were the most important factors cited in winning a deal."
Social Signals Network Next Steps Warm – Lukewarm – Ice
Private equity funds use expert networks to originate deals in three main ways:
Based on interview with Michael Duran, Gerson Lehrman Group, and other sources
• Facilitate top-down, “rainmaker” sourcing strategies. Connect to senior industry executives.
• Support bottom-up, “boil the ocean” sourcing strategies. An investment team can exhaustively call experts to identify all the companies in a target sector or geography.
• Enable thematic sourcing strategies. Identify experts and consultants to help develop investment themes, map target markets, and engage market-leading firms.
Social Signals Network Next Steps Warm – Lukewarm – Ice
We expect transaction volume and value in the secondaries market to increase. For unregistered securities in private companies, secondary transaction volume declined approximately 57% to $2.4 billion in 2009 vs. $5.7 billion in 2008.
• Approach a fund directly, particularly one that is in distress.
• Look on the markets for secondary interests, such as SecondMarket, NYPPEX, and the PORTAL Alliance.
• Approach investment banks specializing in secondary interests, such as Cogent Partners, Probitas, and Triago.
Where to Buy Secondaries
NYPPEX Private Markets, "2009 Secondary Private Market Review and 2010 Outlook". New York, NY, January 8, 2010.
Social Signals Network Next Steps Warm – Lukewarm – Ice
We recommend also using traditional marketing techniques.
Westshore Capital Partners; Weinbach Group
• Use physical collateral. The best collateral has a long life, is creative, and has a tie to your funds’ model or portfolio.
• Choose targeted names. e.g., iFund, GreenTech (KPCB), FbFund, MailRoom Fund (Accel), and FTV Capital (FinTech)
• Leverage existing brands, e.g., recruit prominent leaders to your fund: Kleiner Perkins (Ray Lane and Al Gore), Maveron (Howard Schutz), and Polaris (Bob Metcalfe).
Social Signals Network Next Steps Warm – Lukewarm – Ice
• Focus on geographies/sectors that are undercovered by peer firms. • Maintain clear criteria and metrics to ensure that the relationships being
developed have a reasonable likelihood of yielding investments, and stick with them.
• Institute a formal CRM system, tied to a formal deal tracking program. • Directly tie compensation to developing and maintaining the database;
volume of flow; and quality of flow. • Require regular follow-up with priority companies. • Organize scheduled reviews with partners and sector teams. • Maintain consistent dialogue with key prospects and sources. • Use multiple outreach methods: phone, email, fax, overnight mail, etc., in
order to get the attention of the person you’re targeting.
Key Steps for a Successful Cold Calling Program
Social Signals Network Next Steps Warm – Lukewarm – Ice
Sample Market Mapping Approach Market mapping is a powerful way to identify competitive white space.
# Stage Example 1 Choose industries and geographies of initial interest Global growth equity fund with focus on North American and
Japan. 2 Define your proprietary point of view. Thesis: Population in developed countries is aging rapidly. 3 Translate into investment theme for specific industries
and/or geographies of interest. We expect growth of financial services providers with low-risk investing products.
4 List major players in target industries/geographies, and how each will be impacted by investment themes.
Asset managers with expertise in annuities and fixed income products will likely benefit.
5 Iteratively improve market map based on feedback from industry
Publish elements of the market map to key sector players through industry forums and mass media.
6 Determine which activities along the value chain offer the highest return (typically the proprietary ones).
Develop deep ties in the brokerage community that distribute low risk financial products.
7 Identify areas of future growth. Fund researches bolt-on acquisitions while diligencing its primary target.
8 Assess fit with Fund’s strategy. Local geographic leader that would benefit from Fund’s global reach.
9 Regularly update the market map based on market feedback and lessons from investment prospects.
Maintain internal wiki or database regularly updated with key market data and insights.
Effective use of social media and other research tools allows you to filter for companies who are flashing signals that they are interested in your capital.
David Teten and Scott Allen, The Virtual Handshake: Opening Doors and Closing Deals Online (www.TheVirtualHandshake.com)
Ch = Character Co = Your Firm’s Competence R = Relevance of the contact S = Strength of your relationship I = Information N = Number of people D = Diversity
= D * ∑ (Chn*Con *Rn* Sn*In) N
n=1
Corporate Network Valuation Formula
Social Signals Network Next Steps Character – Competence – Relevance – Strength – Information – Number – Diversity