While many things about the private equity industry have changed over the last 45 years, several things remain the same. Private equity remains a people business and, at Adams Street, we understand that the people we invest with are of paramount importance. Spending time with them is an important part of developing real relationships based on trust and mutual respect. Nothing has changed in that regard and these relationships are a critical part of our investment process. The characteristics of successful private equity firms are the same today as they were decades ago. It takes mutual respect, independent thinking, and an optimal mix of experience and energy. At the heart of all enduring firms are good investors who have time to work with their companies, an international awareness and network, and a differentiated deal flow edge.
I am very proud of what the private equity industry does. We generate above average returns for our investors while also providing capital to finance business growth. This financing cuts across a wide spectrum of company stages, industries, and geographies. The end result is greater growth in job creation, wealth, and GDP than would otherwise be possible.
CLOSING
PE as an asset class continues to grow and evolve, both in developed and emerging markets. Business operators the world over – from entrepreneurs looking for start-up funding, to SME business owners with global ambitions, to management teams interested in buying out a corporate division – often find the right partner in PE funds to invest in their ambitions. As a result, PE is deeply entrenched in the economic model and will remain an important driver of business transformation globally.
KEY LEARNING POINTS
● PE is a simple business – buy a stake in a company (minority or majority), improve the business and sell it after a (limited) holding period.
● The preferred method employed by PE firms is to raise and invest individual funds, which they manage on behalf of investors (LPs). PE funds are typically structured as closed-end limited partnerships that require investors to commit capital for a period of 10 years or more.
● PE funds differ from traditional asset classes due to their illiquidity and the unpredictable cash flows generated from their investments.
● Both the fee structure and profit sharing arrangements in PE ensure alignment of interest; incentives change as the funds mature.
RELEVANT CASE SUDIES
from Private Equity in Action – Case Studies from Developed and Emerging Markets
Case #1: Beroni Group: Managing GP−LP Relationships
Case #3: Pro-invest Group: How to Launch a Private Equity Real Estate Fund
Case #6: Adara Venture Partners: Building a Venture Capital Firm
REFERENCES AND ADDITIONAL READING
Gompers P., Kaplan S. and Mukharlyamov V. (2015) What do Private Equity Firms Say they Do? HBS and NBER, April.
Guide on Private Equity and Venture Capital for Entrepreneurs (2007) An EVCA Special Paper. European Venture Capital Association.
InvestEurope (2016) European Private Equity Activity—Statistics on Fundraising, Investments and Divestments, May, http://www.investeurope.eu/media/476271/2015-european-private-equity-activity.pdf.
Private Equity Principles, Institutional Limited Partners Association (ILPA).
Topping, M. (2014) Evergreen Alternatives to the 2/20 Term-Limited Fund, White & Case LLP, Emerging Markets Private Equity Association.
Vild, J. and Zeisberger, C. (2014) Strategic Buyers vs Private Equity Buyers in an Investment Process, INSEAD Working Paper No. 2014/39/DSC/EFE (SSRN), May 21.
2
VENTURE CAPITAL
From iconic brands, such as Google, Facebook, Uber and Alibaba to blockbuster biotech or renewable energy companies, venture capital (VC) has funded and nurtured some of the most influential companies in today’s global economy. Along with these runaway successes, however, VC has also been center-stage for some of the more spectacular flameouts in modern finance, from the bursting of the tech-bubble at the turn of the millennium to the storybook valuations of numerous billion-dollar “unicorns”25 a decade and a half later. This “hit-or-miss,” “all-or-nothing” character of venture investing drives both the mystique of the industry and on-the-ground decision-making bias of VC investors.This chapter explores the dynamics of the VC industry, starting with the defining characteristics of VC investing and the unique elements differentiating it from growth equity and buyouts.26 We then turn to the other side of the table and briefly touch on fundraising for early-stage firms and start-ups; first-time entrepreneurs preparing to raise funds will find this chapter useful to understand the dynamics inside a VC firm before entering into discussions with one of its partners.
VENTURE CAPITAL DEFINED
VC funds are minority investors betting on the future growth of early-stage companies – defined as pre-profit, often pre-revenue and at times even pre-product start-ups. Despite the lack of a controlling stake, VCs are among the most active investors in the PE industry and use their capital, experience, knowledge and personal networks to nurture and grow young companies. VCs may invest in specific verticals, technologies, and geographies, and often specialize in a distinct substage of investment, referred to as early-stage, mid-stage or late-stage VC funding. While every VC firm is unique, a few defining attributes apply to most, as detailed in Exhibit 2.1.
Exhibit 2.1 Defining Characteristics of Venture Capital
START-UP COMPANIES: VC funds invest in start-ups and guide them through their early years of development, as they seek to establish defensible market positions in rapidly expanding industries by disrupting existing products and services through innovation. A start-up can range from an early-stage company with a limited operating history – i.e., an entrepreneur, an idea, and a PowerPoint presentation – to a late-stage company with a fast-growing business. As a result, the capital requirements of start-ups vary widely, from a few thousand dollars to facilitate the development of an early prototype to significant injections in the tens or sometimes hundreds of millions of dollars to drive revenue growth at companies with billion dollar valuations.
Start-ups all face one common challenge: reaching the next stage of development and raising fresh capital before running out of cash. A negative monthly cash flow and high burn rates are the order of the day at a start-up, and regular injections of capital are needed to maintain and expand operations. This requires a management team that can carefully balance aggressive growth targets with the reality of a company at the pre-revenue stage. As such, venture capitalists carefully assess the founding team as much as the business concept of a start-up and prefer backing experienced entrepreneurs. A VC firm’s knowledge in a given vertical and its ability to add value through mentorship and active engagement can be critical elements of success for the start-up; for entrepreneurs, this expertise is a differentiating factor when choosing from a group of potential investors.
HIGH RETURNS AND HIGH RISKS: Research shows that on average two-thirds of the investments made by a VC fund