Tag: private capital

Jim Strang 2

Jim Strang, private markets – the inside track

Fund Shack
Fund Shack
Jim Strang, private markets - the inside track

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Jim Strang is chairman of HgCapital Trust, a senior adviser to CVC Capital Partners, independent director at the Business Growth Fund, a senior adviser at Bain & Company, an advisory director at Campbell Lutyens, a Fellow at the London Business School, and a senior adviser at Hamilton Lane.

Back by popular demand, this is Jim’s second time on Fund Shack. We talk about the state of private markets and how the industry grows from here.

Mirja Lehmler-Brown

Mirja Lehmler-Brown, Hayfin

Fund Shack
Fund Shack
Mirja Lehmler-Brown, Hayfin

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Mirja Lehmler-Brown is the founding managing director of Hayfin Capital Management‘s Private Equity Solutions investment team.

She previously worked with Hayfin founder Tim Flynn (listen to his Fund Shack podcast here) at Goldman Sachs, before moving into PE fund investment with Aberdeen Asset Management and Scottish Widows.

Ross Butler (00:00):

You’re listening to Fund Shack. I’m Ross Butler. And today I’m speaking with Mirja Brown, a managing director with Haven capital management. Mirja started out in investment banking with Goldman Sachs and then worked in asset management with Scottish widows and Aberdeen. She joined Hayfin to establish and build its private equity solutions business. We talk about setting up and growing an investment function from the ground up manager selection, direct secondaries, and investment opportunities across Europe. Welcome to fund shack. You joined Hayfin in 2018. I think that’s correct. Tell me, how did you get involved with it

 Mirja Lehmler-Brown (00:38):

Started quite a long time ago, Tim Flinn, our CEO, and founder worked at Goldman Sachs.

Ross Butler (00:45):

Who we’ve had on Fund Shack 

Mirja Lehmer-Brown (00:46):

Yes, and we work together at leverage finance. In fact, we’re sitting next to each other and I left, Goldman Sachs to move, up to Scotland. My husband is Scottish, but we stayed in touch over the years. And so I, heard the story evolve from him leaving and then coming up with the idea to set up, HayFin. And, you know, we exchange ideas and views and, and shared learnings up in Scotland. I started to invest in private equity with Scottish widows initially. And that experience from an LP perspective was also interesting, you know, to Tim when we started out. So when he sat up, he, had discussions with a few different private equity funds and he asked my views on who they were and what potentially could be a good partner for him early doors. So, that then turned into him growing, uh, or him and his team growing the business.

 Mirja Lehmer-Brown (01:47):

And in 2070 that institutional investor changed to British Columbia investment management corporation. And he’d grown the business from lending and other different products within the credit space and never, ever kind of, I guess, before considered the equity, opportunity. And that’s where I then spent over 10 years up in Scotland. And, so he asked me if I would want to, what would I do if I would set up a private equity mid-market business for, British Columbia? How would that look? And would I be willing to do that on his platform? So I did that and come up hopefully with a compelling strategy because British Columbia certainly thought it was a good idea. And that’s why I moved over in 2018 to start from scratch with, with no team, no processes, but a fabulous platform and brand in form of Hayfin.

Ross Butler (02:49):

So that sounds like a great opportunity, but, quite an unusual one, because you had a very large institutional background. So you sat next to Tim and you were doing presumably were doing credits at the time, is that correct?

Mirja Lehmer-Brown (03:00):

Correct? Yes. So Goldman Sachs, but from Scottish widows. So when I started, there was only private equity, only Europe, predominantly mid-market and across the spectrum from funds investing from co-investing and also secondary investing, which is three of the larger group of investing that you can do in the private equity market as an LP investor.

Ross Butler (03:24):

So why did this kind of more entrepreneurial opportunity of setting something up from scratch appeal to you?

Mirja Lehmer-Brown (03:29):

Very good question. I come from the middle of nowhere, in Sweden and I’m actually the first person in my family to go to university. So arrogance and Politics are something that I can say I’m allergic to. And in a large institution, I think when you start out working you’re so focused on delivering a good job that you don’t notice political aspects. I think as you grow older, more experience wiser, you start to figure out that it’s not just about that delivering. It’s not just about the excellent, it’s lots of other things going on as well. And at that point, after 10 years in a consolidating Scottish asset management market, it’s been a number of combinations that we had gone through much larger group and, the firm had become very political and that again is something that’s really frustrating. And I also just in itself, for me, I’m driven by delivering really good investment return based on facts.

Mirja Lehmer-Brown(04:35):

And in that, the energy really needs to go to originate, discuss ideas, pick the best investing. If you need to worry about Politics, how you need to behave or not challenge or challenge. There’s so much energy leakage out of a team or an organization. So that frustrated me and triggered to think, well, if I start from scratch and I can set the culture, I can handpick a team. I can obviously ensure that we have none of that, that we can be a group of individuals with different backgrounds that burn from the same purpose in delivering those returns very often for pensioners, but in a way that then avoid negative aspects such as Politcs.

Ross Butler (05:29):

And so you’re only what three years in that state. I mean, how’s it going from a cultural perspective? Have you been able to, introduce that kind of different culture?

Mirja Lehmer-Brown (05:39):

Yes. It’s, it’s um, it’s going really, really well. I mean, you know, back into the entrepreneurial aspect, it can be scary too, when you haven’t done that before. And you can question yourself whether you’re able to, I mean, from sheer experience, point of view, you build so many networks, you build so much pattern recognition that, that clearly you can take with you, but, but you know, where people come and join you as an individual, is scary. But I think the fact that we talk with so passionately about the fact that it’s team-based and that everybody is equal if you will. And we start, we start with the junior people, sharing their ideas fast up into the senior, and there’s lots of frustration. Now, the private equity industry has grown up and many of these organizations have been quite large.

Mirja Lehmer-Brown (06:33):

That means lots of mid-level and junior, uh, uh, staff. If you’d be, look, people are frustrated with the same thing I was frustrated with. And if you see the people we were looking for, work Lilly, high-ability ambitious people, but then driven by the same values and principles of team, of responsibility of doing the right thing, are working hard clearly, but fact-based. And then also this continuous improvement mindset were also the senior people want to invest in the junior, learning by doing the type of job. You don’t read some books or become a good investor, but genuinely if you have as a mid-level and junior in a person genuinely feel that the senior person sit there for you, side-by-side they roll their sleeves up and want to transfer that knowledge to you. It’s a wonderful proposition. And hence it took a little while because it was not noon, you know, from a brand perspective on the equity side, but windows discussions, clearly lots of people that didn’t fit in.

Mirja Lehmer-Brown (07:42):

But there were a lot of people that were intrigued and were really looking for the same things. So now we’re a team of eight people and again, operating very much under those types of ideas and principles, you know, living, breathing that culture. And hence, that’s the most satisfying we are, did the strategies working and the performance coming through strongly now after three years, which again is interlinked. It helps the culture help the feeling of wanting to come to work. You know, the belonging of being there when it all works. But I think it’s driven very much by the cultural elements of it.

Ross Butler (08:23):

Yeah. Success definitely helps. Did I hear you say tha, junior people speak first?

Mirja Lehmer-Brown (08:29):

Yes. Around our, so our investment processes such, institutional three steps, that’s no different, but when we, um, you know, start in the team, so the first lab level, the one-pager, everybody is expected to readapt to a certain degree and we start with the most junior person. They need to share their views fast. And, everyone comes in many have banking background when they come in more of the mid-level, people when they joined, came from private equity, but none had really had that experience before. So when they joined the team meeting and were discussing ideas, they were not prepared. She was say, first time around the fact that they needed to express their views. First, second time around, they were very prepared. And why we’re doing this is it’s the same thing. As many things you can’t tell to children to avoid mistakes, they need to do it themselves in order to properly learn and invest in.

Mirja Lehmer-Brown (09:32):

There are so many different aspects in the pattern recognition. You know what you need to think about. And we obviously have strong protocols and processes to help along the way, but it’s really your judgment. Your thinking. If you listen to other people, you don’t really learn what is important. If you need to read about the company in a situation and you come up with your views, a unit of thought it through it’s your views. Um, and very often initially they are not filtered or the weightings are not, you know, where it should be, but it doesn’t matter because, for us, it doesn’t matter. It’s the only way to learn. So we look at a lot of things. We originate a lot of things. It’s part of our model, but we do be very, very disciplined. So we do very little, but the more we look at, the more we discuss, the more we learn and the more they learn in, changing, adjusting the way your thinking to become more balanced in their view and also go away from, is this used to good company and just come to a good company. It doesn’t necessarily become a good investment if you pay too much. So it’s just learning around companies is certainly important management teams and pricing and structure and part of value creation. And, and with that, quite quickly you can see the evolution in their thinking, their alignment with the filter, and how we assess where their, a situation is a good investment or not. And that’s also great to see

Ross Butler (11:03):

Tim said to me about, diversity, but from a very broad perspective, um, which is making sure that you’re not hiring in your own mold and making sure that, everyone, not just from the gender or racial perspective, but also in terms of, uh, the way people think and their economic backgrounds and all of that. But it can be in practical terms, it can just be very easy to, to, to instruct a recruitment agency to say, we want people from Harvard and Oxford and, you know, and suddenly you’re already going down that route. To what degree do you feel you’ve achieved some level of let’s call it intellectual diversity around the table so far.

Mirja Lehmer-Brown (11:37):

Yeah. And there are so many layers to it and we are eight people, but we are all different nationalities. And many of us have, not even two, I’m half Swedish, half German, and that’s only part, but, you know, it’s the language, it’s also the culture, the way you have been brought up, which then, the principles and values, because while do want, diversity in thinking for sure, diversity in pattern, you want a different type of pattern that recognition, but you still want the same values. You need to find a group, that, that those principals on why we are here needed to be the same, even if we are value-add from the pattern recognition in analyzing deals

Ross Butler (12:21):

Now in terms of your actual business, maybe could you set up for us, you know, your mandates, what, what you are investing in and where are your sources of funds?

Mirja Lehmer-Brown (12:30):

Yes. So we are, continue we’re backed by our Canadian as a British Columbia investment management corporation. And the strategy is the European mid-market. One of the things when I analyzed, uh, you know, setting up in 2018, because it was different when Haven was founded, they were very early into a new growing market that, the market of direct lending, private equities, quite mature. So one of the things that we did, I feel that the, in my view, the private equity industry has created silos very often. There’s a separate, product for primary funds or a second, separate silo bucket for co-investment or a sec, you know, secondaries have a different bucket. And I felt that for us doing mid-market, we don’t want any restraints. We want to be able to originate across the board and just focus on picking the right that the best opportunity is flexible across your mid-market.

Mirja Lehmer-Brown (13:30):

The larger funds, larger companies to a degree, you can say, I guess it’s less risk. So it’s a different style of investing and different returns, mid-market, or to generate, a premium return in comparison to the larger market. But if you look in the dig into the track record, people have all failed in doing that. And it’s been too much volatility. So when we set up, but we want to do, if we have one bucket allows us to, one year, maybe they’ll be more opportunities in, in co-investor as of late, this GP led, uh, secondary, a single secondary, which we do in Medan, several of them, but it’ll go, you know, one year or another year, it’s slightly different. If you only could do one type of investing, it’s very hard. And also very often the solutions we do, the fact that the same team can do a combination of investing that otherwise might fall in between the buckets is very powerful.

Ross Butler (14:31):

So in larger competitors, would there be a separate team for co-investment, or all your guys, do everything?

Mirja Lehmer-Brown (14:38):

All the guys, do everything to avoid things, falling off the cracks and allow for, for more opportunities and more discipline in what we do. And that’s been really helpful. And it’s already evolving, we’re now on our second program, and it’s gone from slightly more funds than you start out, also generate some of the co-invest opportunities to now coming out of the COVID where, this GP led market on the concentrated end, which has been around for a long time, but it’s really exploding. And that suits our skillset because we have built a team of stock pickers, very well. And we don’t, again, because we haven’t got a bucket. We don’t mind, it’s an asset opportunity. We don’t mind if you call it a secondary or a co-invest in what we do. And, also we find that the relationship, uh, from the primary side because the core thing with the GP led is also understanding why, why do they want to do this? And it’s the right thing for them and the acid, which if you have followed funds for 10 plus years, and they know the individuals in these funds, you will have a much stronger view on whether it’s the right thing to do. Not just numerically, but because we focus on both. So you gain that experience from primary funds investing is very helpful across the board. But particularly I would have said in the GPLS single secondary situation

Ross Butler (16:13):

When you’re setting up a new business like this, I guess the challenge is that you don’t have any existing relationships because the best managers will have long-standing relationships, although you were in the market yourself before.

Mirja lehmer-Brown (16:29):

Same thing, the principle of Hayfin, working with very experienced people. So, we hired Gonsalo Aras who co-led this, the private equity solutions team with me are very experienced from different some overlapping, but predominantly, uh, different parts of Europe and different types of relationships. So we bring that eminent relationship that you have as an individual is personal, it’s partially linked to the brand. It’s got its widows where you stand for, but moreover, when you’ve gone for, for, you know, over 10 years and, and quarterly knocked on the door on people to have a coffee, the Swedish way to have a coffee, that’s how you build trust that you take with you, because in the end now, in particular, there is so much capital the capital in it says, doesn’t matter. People want to choose an individual relationship that they feel they can work well.

Mirja lehmer-Brown (17:32):

It needs to be a high-quality type of capital, the quality of capital matters, but its excess. And then you go down to a more personal element. Is this an individual? I feel I can trust, is this, we can have a dialogue with somebody that is constructive and helpful to us. And that’s in the end to me why people choose, to work with somebody in a fundraise or in a co-investor opportunity or in this teepee lads, they’re really attractive opportunities. GPs have a choice. And the choice very often in who they select is just part capital and a lot about who you are and what you stand for and what type of relationship that you built.

Ross Butler (18:18):

Yeah, it’s a people business because you’re committing, you’re not just investing.

Mirja lehmer-Brown (18:24):

And I do think the nice thing, the additional benefit from setting up the entrepreneurial side, which originally I didn’t think of. So originally we’re more of the strategy being differentiated, the culture, being different shaded, and also the discipline. And I guess the credit focus from Hayfin to avoid the volatility in the mid-market. But the additional benefit is we are not entrepreneurs. The whole team, we call, is the founder team, every single one of my team, we are together. We are, the founders are our track record together. And we built this from scratch that also when we sit down very often, the mid-market, they’re also founders of their funds. So we can discuss the challenges of hiring people, motivating people, motivating the younger generation with certainly different to kind of the older generation systems, how that work or I see, but it becomes a different type it’s equal partner to partner. And we’ve gone through the trenches in a similar way, which also add to that, you know, the strength of that relationship.

Ross Butler (19:35):

Can I ask, what proportion are you roughly, in terms of, direct fund payments versus the more tactical approaches, co-investment and secondary and so on, and where, where would you like to be?

Mirja Lehmer-Brown (19:48):

You know, the core initially is the flexibility and the first program. So the first investment program was more than 55% funds and, you know, 45% asset opportunity because we don’t really split whether it’s co-invest or a GP-led opportunity. Out of COVID came an additional need for asset capital. It was too much, co-invest capital, but not always co-invest capital in the professional form. And, you know, out of it came, people want to work with a professional partner, a partner from the co-invest, not just in this indication, a partner that can be fast and have their own view, their own view of the asset that underwrite the asset themselves. They, you know, through COVID there were issues in co-invest and some, LP co-investors were worried about the performance and that created some friction in the relationship, the GP and LP so that, you know, the evolution of that was that the GP was happy or to work with somebody who did their own work.

Mirja lehmer-Brown (21:05):

So, you know, if we pick wrong, it’s not the GP’s fault, it’s our team’s fault that this, we would never blame a GP for offering us an opportunity. It’s our own process. And we would, you know, I don’t like blaming, but we will make mistakes, but we will be in ourselves. So that I think has been very, positive. So we’ve actually seen way more co-invest opportunities than I thought beyond the fund investments that we do. And then as I indicated, this deeply led market, this is full exploding. So the new program that we’ve started, or the second program we start,

Ross Butler (21:40):

Can I just ask you a question about, co-invest first, and then you can tell me about GP.

Mirja Lehmer-Brown (21:46):

I’m just going to say, so the proportion is 70%. So now 70% asset opportunities and 30% funds

Ross Butler (21:51):

I’m sorry, you still answering my question. 

Mirja Lehmer-Brown (21:54):

I was trying to 

Ross Butler (21:57):

It’s a different skill set, isn’t it? Assessing single asset opportunity versus, and so you’ve got a team of eight and they’re already looking at fund investment co-investments and these tactics, and, but they’re also looking at, company’s specific opportunities.

Mirja Lehmer-Brown (22:12):

So the co-invest, that’s why in the secondary market, it’s been a lot of this LP stake. So when an LP center sells to another LP, we don’t focus on that. That’s very different. It’s broad, diversified portfolios, it’s more cashflow pricing. So that’s not, it’s a very good market to be, but it’s not what we do, but where we have married every single one that we have hired, our focus on developing skills, in picking an asset, which is also aligned with, HayFinn is just from a credit perspective versus the equity perspective. In addition, my view has always been that if you are a good fund investor, that will help you as well to understand because when we select an asset, it’s not used to kind of do the numbers on whether that is a good investment. We very often need to understand why is that GP the best owner of that assets?

Mirja Lehmer-Brown (23:11):

Why would they be the good part of helping the value creation in that business? And that are more aspects that you focus on from a fund investment perspective. So certainly, you know, it’s certainly super value add even if the core skill to a degree is the fact that peeling the onion on the investment on an asset investment opportunity. That’s why, if you now go and look at very often the large secondary funds, they have predominantly priced cashflows because the market on the LP stakes side was so much bigger. They need to carefully think if they now, recycle their individuals to look at this more focused opportunities on the secondary side. One very often risk-return spectrum, very different from this portfolio, diversified cash flows. And as you rightly said, the skill set needed to do that is also very different.

Ross Butler (24:16):

So kind of from a philosophical perspective, your team feels almost more aligned with the GP mentality than perhaps the traditional institutional LP mentality. Would that be fair?

Mirja lehmer-Brown (24:28):

I think that’s a very good observation because we work very much like a GP. We source a lot of situations and we are very disciplined around the picking, and think much more like an act in that sense, much more like a GP.

Ross Butler (24:48):

What is it that attracts you? What would you look out for?

Mirja Lehmer-Brown (24:51):

That’s a very interesting question and actually linked, uh, the mid-market and pitfalls of the mid-market. Because if you look at the larger funds, CVC, or admin, it doesn’t tend to be people-dominated anymore. They have very strong processes. They have sector teams, they’ve got lots of operators around, they still need to be mindful about culture and how they drive organizations, but it’s a different type of diligence. In the mid-market, it’s much more, person and culture-dependent. When I started in 2006, the, um, the way people did fund investing back, that was much more numerical. You went through a track record and then, you know, from that track record, you looked at the processes and the track record. And I thought, oh, this must be good people in the future as well. And then I said, but how can that be?

Mirja Lehmer-Brown (25:47):

Because that investment will never come back. So the motivation of, and the process of choosing it and the skill set in the people align, those are the more important elements to review in order to access future performance. So in my own learning, coming from the sell side, it took some work, but I really felt that that lots of people went about it the wrong way, just focusing on numbers. So from that came a completely different type of filter, a hundred-point scoring system that, in addition to strategy and, processes and track record very much focused on the culture. Leadership, what are the motivators? Why are these people doing this. Organization? And the room in the ration linked to organization. Decision-making, functional team, dysfunctional, and those elements are much harder to assess, and to figure out, you need to look for them and you need to build that pattern recognition to see what works, what doesn’t work.

Mirja Lehmer-Brown (27:08):

We are very focused on team-based. Very team-oriented, team-based decision-making teams, where also remuneration tends to be diversified if you will, rather than very strong founder-led businesses, because we think it is, reducing risk as one element. And the fact that back to what we said, that you haven’t got the dominating individual that shut challenge out, it could temporarily look good, but again, that’s a risk from our point of view. And very often when we go in meetings, the questioning is very much. So why are you here? What motivates you over and over again, with every person in the team to get the sense for what they’re saying, what they’re not saying, and, the general, yeah. To try to assess that culture again, because that we have found is a core KPI in assessing future performance.

Mirja lehmer-Brown (28:15):

You need to have local reference points, not their reference points. Very often, I say, that’s why it’s so fundamental to us to be local. Well, I’ll figure out I’ve gone to school with you. Uh, you know, in that referencing is there is a joined connection. We’ll have worked together. We will have gone to the same school, I’ll know someone that knows someone that will know your neighbor in order to that picture, that you tend to portray of you and your team, whether we feel that that’s transparent and true. So we do that first-time funds, which we do. We tend to do 50 reference calls, most of them off a list, and that you can only do if you have long-standing relationships on the ground that trust. And we’ll tell you because they know that your integrity is integral to who you are.

Mirja lehmer-Brown (29:11):

They will tell you how it is, and that is impossible to recreate if you’re far away and impossible to recreate in the mid-market because the regions are so different. Yes. So the portfolio is doing, doing well. Is it really well? Yes. And I think the third thing with this and discuss starting in 2018, setting it up, I thought we would have had a recession since 2016. So I was a bit afraid of 2018 as a starting point in setting up a new program. And so the third part of how we were doing it was to focus on a really resilient, resilient sector and resilient business model. And that was predominantly the timing, the 2018, and that belief in, within the investment period, there will be a correction. And from that, and LinkedIn to in Europe, you haven’t got as many sector funds as in comparison to the US but we believe in sector funds in that, again, it’s the pattern recognition.

Mirja Lehmer-Brown (30:15):

If you spend way more time in one sector, you can reuse your learnings much faster. And with that, the portfolio with them put into the ground in the first program is 70% healthcare and technology combined. And the rest is resilient service model. So clearly we had no idea about the health crisis, but we’re preparing for a correction. So with that sector waiting not only is our performance, the operational performance of the businesses doing exceptionally well, however, from being a high priced environment, the investment that we’ve done has rerated because now everybody wants to do healthcare and technology and resilient sustainable business model. So we have been fortunate not only to have an operationally well-performing portfolio but something that is also been rerated from a relations perspective.

Ross Butler (31:20):


Mirja Lehmer-Brown (31:21):

And a bit of luck is not bad.

Ross Butler (31:24):

What are the circumstances that you think are legitimate and would attract you to a GP led and what would turn you off?

Mirja Lehmer-Brown (31:32):

It’s evolved initially the, GP leads were for assets. Maybe they hadn’t gone that well and maybe needed a little bit. They still, so the GP believed in that asset, in the value creation of it, but it had taken longer. So that was a position, I mean, necessarily not a weakness, but it wasn’t a strength. And that has evolved what people now are focusing are really trophy assets, assets that are significant winners and with the pricing environment and additional competition, that are now out there, it’s really hard to find really good businesses. So if you have built a great relationship or maybe even changed and put them place a phenomenal management team in a very resilient business, but the underlying structure of a private equity fund is such that after a period of time, you need to liquidate it, you can argue. So why would I sell this to a larger fund for them to create more value?

Mirja Lehmer-Brown (32:41):

When I got hold of this company helped build this to better business, and my LPs can continue to be the beneficiaries of this good returned. So we think creativity is positive. It’s giving GPs more optionality in a market where it’s hard to find those assets. It’s not like every asset in a fund is of that exceptional quality that we are looking for, so that you de-risk it, from buying him to the next three to five years, you know, making a new plan and, and a feeling that this is a good thing to keep that business. I guess it’s linked to, if you look at the public markets, I don’t know the exact statistics, but a significant percentage of the increased market value or the value creation is actually linked to a very small group of companies. So again, the significant winners tend to be the one that continues to drive premium value creation. And those are the ones people tend to want to want to get hold on to. And with that, it needs to be high-quality process clearly, cause there can be conflict in that decision, but it also needs to be alignment. So you can’t just do it because you want to increase a UM you need to also align yourself also with your own, the GP capital, and behave as a buyer and a seller in that situation.

Ross Butler (34:21):

And do you normally, have to partner with other providers, or do you do the GP secondary on a solitary basis?

Mirja lehmer-Brown (34:28):

So depending on size, we tend to invest 20 to 15 million in an investment, either be the fund or a situation. So we have had a number of situations from these discussions going out, speaking to the GP community where we have been in a bilateral discussion to two LPs, if you will, into a situation. Cause we don’t want to be midority. We are minority investors if you will. An LP minority investors to then the largest situations where it’s more a larger group, you know, from five to 10 different investors into that asset.

Ross Butler (35:13):

And you said you’re seeing quite a few of these opportunities out there probably because things are becoming so polarized.

Mirja Lehmer-Brown (35:20):

Yes, it continued to go, we say, you know, let’s see right now it’s math, it’s the fastest-growing part of the second dairy market. No question. And there are a number of opportunities. So I think this will go on certainly for the next two to three years, but there’s always something else that happened. It could be one or two of them that maybe don’t perform that well, but you can also see a lot of people are hiring. A lot of different companies are hiring to address the growth in this market. So whilst it’s certainly going to grow for the next few years, I do believe some people are certainly banking on it growing for a long period of time ahead, but we don’t need it because we have other opportunities to, to invest in as far.

Ross Butler  (36:13):

In terms of how your team, your business, as it was sits within Hayfin, sits within the culture, but also the strategy and any kind of cross-fertilization of ideas and opportunities. How does that work?

Mirja lehmer-Brown  (36:29):

You know, initially again, more experienced people, more pattern recognition, and in different fields, that can be a value add. So just the fact that we know, GPs, where also from the credit side, they might lend into businesses is intelligence people, intelligence networks are always helpful, different angles based on different experiences. And that’s been very easy. It’s very easy because it’s easy to, to me, you need to be careful about some of the walls. So it’s, you don’t share detailed information, but quality of people or whether they got experienced or not in that type of field is something from the PE side that can be helpful. We came with much more of ESG processes because it started earlier on the equity side in Europe than on the credit side. So we work very closely together. You know, the PE team has been able to do ESG profiles of when the credit side work with P houses, we are involved from an ESG perspective from a profiling point of view, rather than they do the deal clearly kind of ESD analysis themselves.

Mirja lehmer-Brown (37:49):

So it’s very beneficial what we’ve now started to do. And that’s even more exciting, is we can make investments together back into what we’ve said instead of staying in silos. We have now two recent deals where we work together with the special opportunities side in creating a capital solutions for AGP into an investment where there’s a peak element and an equity element. And they are not that many of our competitors that actually can stitch together tailored solutions across credit and equity for a situation which, we are about to do our second now and I just expect that to continue. So that then start to, you know, even deeper working together across the teams and then the practice based on this team-based, culture in that, we are, we are super happy if we can work together and create solutions.

Ross Butler  (38:53):

So it’s an equity co-invest with a credit element attached to it, all from the same provider. And how does your decision-making process in terms of governance work and how does it align with the rest of Hayfin?

Mirja Lehmer-Brown (39:08):

So we have our own investment committee. So, you know, the private equity investment committee contains about the senior members of our team and senior members of Hayfin and the special opportunities have a different investment committee clearly. There are some joint members and the learnings from one will apply to the other, but it’s also the focus. Again, the credit focus is different. The type of analysis is somewhat different, different from depending on what angle you come from. Yeah. And, something that was super beneficial was coming into this, COVID, working together was actually, we have a tremendous high yield and syndicated loans team, which are operating in the liquid markets. And with that, a higher degree of macro focus, that goes into their analysis. So coming into COVID, nobody, we’ve experienced the financial crisis, but not this a health crisis members, senior members from the whole firm working together, trying to figure out what is this, is it temporarily or is it something that we’re going to go into. A lot of people are going to die for a long time and it’s going to be a very different type of situation. So Gina Germano and her team had lots of phenomenon analysis that was very helpful in creating scenarios, right?

Mirja lehmer-Brown (40:44):

Where do we think we’re going scenario setting that was helpful for all of us. And as a group, as a house, we then come up with a scenario that we used as a base case and, every week or so we were assessing, is these the data points that are coming? Is this a valid scenario? And I think that allowed us also in 2020, where a lot of people, at least up until after the summer did not deploy that much. We were able guided by facts and scenarios and analysis working together. Our conclusion was that we can deploy. And we had a record year in 2020, across the board deploying in our different, product areas based on his intelligence and views of working together.

Ross Butler (41:36):

Did the private equity industry is a little bit slow at deploying during, during 2020, but, I mean, it’s a very difficult time because the economic situation has never looked more uncertain. I personally, I think, it still looks incredibly uncertain, and most private equity firms don’t have a chief economist. They don’t tend to even worry about the macro view in my experience so much, they take a view on people, but in a situation of radical uncertainty, perhaps they might need to take more of a view. I mean, I’d be, I’m sure it’s all trade secrets, but I’d be fascinated to know in general terms, what your outlook is with regards to the economic prospects of Europe.

Mirja Lehmer-Brown (42:18):

And I think you’re absolutely right. I think there are all sorts of elements that go into kind of the analysis of what you do. And I do think some of the larger houses definitely apply and have asset allocators based on more the macro, the research macro judgment helping in selecting the underlying businesses. And, you know, we are with that, you know, low growth, uh, for sure in general is something that we think will be here. We had the health crisis currently the aftermath of that is energy issues, supply chain issues, and still too much liquidity into the system. So whilst, you know, over the next little while is, seems like it’s still catch-up effects in a positive sense that are trending. There are certainly clouds out there that could lead them to volatility.

Mirja Lehmer-Brown (43:18):

So I think volatility, in general, is here to say, that’s why with the math typically trying to focus on thematic sectors, which have then growth. So megatrends that, that provide tailwinds. And that’s also LinkedIn. So initially when we said we’re focusing on healthcare and technology, it was more around the fact that we liked that pattern recognition. We liked the defensibility of it in preparation for a correction, but as we evolve and the content constantly need to reassess what we do, we’ve come to think because of the volatility and because in general, lower growth in Europe, if we focus on an aging population, if we focus on digitalization, those are longer-lasting trends that are structural, and we’ll continue to see growth, even if lot of other areas will temporarily go down in a volatility in order downwards adjusted scenario.

Ross Butler (44:24):

In terms of your, your own, section within Hayfin, what does the future hold in terms of growth? And do you have a growth strategy? Is it to just gradually increase your number of relationships or would you consider introducing, I’m not sure of the exact term for it, but the new sources of funds or even grow by acquisition of competitors.

Mirja Lehmer-Brown (44:47):

So, I think we were all growth-minded. So in order to continue to evolve, there needs to be some growth. And with that, we’re having a number of conversations with other similar parties, similar to BCI. So we will grow somewhat by adding, a more diversified investor base, but still though, and that’s very similar, across, Hayfin we do believe in being disciplined, you need to grow. That’s a positive for any organization also for the younger generation coming through. You need to show growth, but not for the sake of it. So disciplined growth. We still believe in ensuring that the right balance in how much you wanted the blot and that’s what’s leading us to the amount of capital we’ll take on. The strategy it’s scalable, particularly on a GP led or some of the co-invest we could have, instead of doing the 20 to 50 million, we could easily have invested a hundred million in several of those situations and the same goal with the fund, but not necessarily 500 million. So ask the market evolves, we will evolve with it, but we will stay on the discipline side because the discipline is also the guiding light that will allow us to act before.

Ross Butler (46:25):

Great. Well, the very best of luck with it, Mirja, it’s been really nice hearing about your startup story, I guess.

Mirja Lehmer-Brown (46:32):

Thank you very much for having me, my pleasure.

Ross Butler (46:36):

You’ve been listening to the Fund Shack podcast, make sure you subscribe and visit our website at fund-shack.com for many more video interviews. It’s the private capital channel for alternative investment professionals. Thanks for listening.

#20 Private equity demystified

Fund Shack
Fund Shack
#20 Private equity demystified

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Demystifying private equity on Fund Shack, with Oxford Said’s John Gilligan and the ICAEW Corporate Finance Faculty’s David Petrie

Private Equity Demystified is on the reading list of business schools from Boston to Singapore. It is now in its fourth edition, and in this podcast we speak with John Gilligan of Oxford Said and Visiting Professor at Imperial, who co-authored each editions alongside the late Mike Wright. We are also joined by David Petrie, Head of the Corporate Finance Faculty at the ICAEW, which has been a strong supporter of the initiative and, without whom, ‘the report would never have seen the light of day.’

We discuss the need to demystify, the outperformance debate, the power of M&A done well, and the need to adapt to a very uncertain future.

Ross Butler

David John, welcome to fund shack. I was wondering if we could begin by John giving us a little bit of an overview as to the provenance of private equity demystified, which is now in its fourth edition. And then we can get onto the process of demystification and talking about private equity in this brave new world that we’re in. So I believe that the first edition of private equity demystified in about 2008, which was at the very Dawn of a very different kind of crisis. John, take us through it.

John Gilligan

The backgrounds of this with a conversation over lunch, all good things happen over lunch. I was having lunch with Chris ward, who was the chairman of the Institute’s corporate finance faculty, the ICAEW. And at the time there was an investigation going on at the treasury select committee into the private equity industry. I was on gardening leave between leaving Deloitte and joining BDO. So I was one of the few people who was actually watching this live on tele because I was at home. Everybody else was obviously at work. So I said to Chris, have you seen the treasury select committee investigation? Cause it’s a little bit odd because the questions are very simplistic and the answers, therefore don’t make the industry look very show the answer in the best light. Shouldn’t somebody maybe write a note to somebody to just suggest how it basically works in principles so they could move on to the more interesting substance.

And what Chris said to me was, well, you’re not doing anything. Why don’t you do it? So I then phoned Mike Wright and Mike was my PhD supervisor at the time and said to Mike, well, you’re the leading academic in this field? Could you summarize all the academic stuff? And I had a sort of hidden agenda. I thought I’d get a free literature review for my PhD, but Mike saw through that one. So what happened was we did this and before we knew it, we went back to the ICAEW with Chris and said, well, we seem to have sort of written a bit of a book cause it got longer. And it just coincided with the ICAEW started to think about thought leadership and these sorts of things and such said, well, why don’t we just do it as a thought, a thought leadership piece and then the great, good fortune of life. We published it with a lot of help from people. And I said, it won’t be a huge amount of help from people actually. And then Harvard business school put it on their reading list and you thought, Oh, that’s handy. So that’s, that’s the background to it. And then once we were off the global financial crisis came along. We need to rewrite because the world changed dramatically. And we rewrote about every couple of years David and we’ve done it. So


A very kind of organic needs led process. David, why did you think that it was a project that was worth really kind of getting behind and supporting

David Petrie

Well, as John said, it, it, it had a very definite need at the time and you know, the, the BVCA does, does excellent work in this area. And it’s not to say, that, you know, they, they don’t constantly advocate the sector, but we, we felt that there was a little bit of a gap perhaps in the perception of politicians and policy makers really. You know, there is, there is this idea that if a particular professional body or a trade association comes to politicians and says, you know, well, you should be doing this because it’s in the national interest, they tend to say, well, w well, in the words of Mandy rice Davis, you know what you would say that wouldn’t you there is always this, this difficulty that they would tend to see them coming and say, well, of course you’ll pay to represent the, you are as it used to say, the voice of private equity and venture capital whereas the Institute of chartered accountants does as part of its Royal charter include the provision to act not only in the interests of the profession, but also in the wider public interest.

And so the analysis that John and Mike did, has kept things up to date really with what’s been going on private equity industry. Certainly, certainly hasn’t stood still, but as John has also said, it has become a really very comprehensive text. And it’s useful for members of the corporate finance faculty and more broadly people hoping to enter the private equity sector as well as principals and investors in it. I think these days, because it is such a comprehensive piece of work you know, I think they probably started off attempting to write a relatively short book and found that actually what it is an extremely complicated and nuanced sector actually, and to understand it properly, it isn’t possible simply to set it out briefly though our levels of complexity that I think that even people working in the sector may not fully appreciate. And the fact that it is it’s sites over 200 academic references means that when we’re having discussions with policy makers in white hall and Westminster about the importance of private equity and its contribution to the economy and so on, you know, the evidence is irrefutable.

It is grounded in very solid research is, is not simply the view of a trade body. This is really solid stuff, but it also works very well for practitioners, for our, you know, younger chartered accountants who are wanting to make their fortune and private equity. This is a really good place to start in terms of how, what are the nuts and bolts of the business. So this is why business schools above it. And I’m sure John would be able to talk about this a lot more because it really genuinely is on the reading list of business schools from Harvard to Hong Kong. So it works at all sorts of different levels. It, but it busts myths on the sector and explains that it does add to economic value. And it also is candid about some of the criticisms leveled against it, but it also provides a very useful how to guide and that’s what we like. So you know, we, we are delighted to support it and to continue to do so, because it works for us at so many different levels.


I think that’s a really great summary. That is really the impression that I got reading it as well. David, just to look at the political side, I mean, it’s not an apolitical book, but it is incredibly balanced. And I think there’s a lot of academic work out there. Even that’s highly critical of private equity. And I think where, where things are known and the facts are put forward and when then where they’re not known, I actually think you’ve got a section John saying, you know, look, look at the evidence base. And often it’s not there for private equity.

John Gilligan

Well, one of the things we set out to do was not to be an advocate for any particular point of view, but to allow people to get to the point where they can ask the question and decide for themselves. So the whole idea of gathering together, the evidence was we only use evidence that is rigorously academic. So we don’t, for example, use pretty much any evidence produced by people who have an ax to grind one way or the other. So we wouldn’t use evidence from a trade body without commenting on it. So it’s all of the, all of the reference cited a peer reviewed. So the first point is we’ve done the exercise to get the data in one place. If you look in the appendix in appendix six, I think it is, it’s all there. It’s summarized in one paragraph. So you’d have to read the paper either, but there are paper references there.

If you want to read the paper. So if you want to dive into there, you can go there if you want. And the idea is to say, well, this is what we know, but here’s, here’s what we don’t know. And here’s the stuff that, where people have strong opinions where their opinions are based upon evidence. That’s. I mean, the evidence has been growing, but evidence is incomplete because one of the problems, I mean, it says it on the 10th, private, you know, it, I don’t think private is private because deliberately secretive. I never, I’ve never believed that. I think the private equity didn’t really care about communicating outside of its closed circle for a long time, because they never really thought about it. When we started, we made the point that private just means not quoted. It doesn’t mean secrets. It’s become, there’s become a public interest in it because it’s not so big and that’s legitimate. But back in the day, people say it’s secretive. It wasn’t secretive. They just hadn’t really thought about communicating with the people who didn’t to that point, how an interest. So we have, we’ve been through this process of unpeeling, the onion, where data has become available. People would come or interested. And a lot of the early academic research turned out to be wrong because the data was wrong. So a lot of it’s been rewritten. Some of it good, some of it bad.

Ross Butler

Yeah. I certainly didn’t get the feel that I’d be, I was being preached to, and to David’s point that it can appeal to many different constituencies. It really does feel like a manual. I feel like if you gave me a hundred million, I can at least go through the motions of managing a private equity fund. And every time I get stuck, I could just pick it up. Now there’s a, there’s a, there’s a lot of skill that goes into it, but you certainly kind of hit all the points in terms of, you know, from start to finish.

John Gilligan

The thing that we learned as we were writing, it was we started by, we were the first people to sort of sit down and try and write something that wasn’t either aimed at the management of the company during the buy-out or the investor in a fund. But we’re trying to just say, look, here’s the big picture. And here’s how it works. So it was more curiosity than, than anything else. And what became clear as we did each edition was this is an industry that is very intricate. It’s not complicated, but it’s very, very intricate.

And if you don’t understand the intricacies, you can’t draw the right conclusions. So the classic one is taxation of current interest. Taxation carried interests top of the agenda at the moment. Most people don’t understand a really important point about the taxation carried interest. The definition of carried interest in, the tax legislation is that amount of capital that is taxed as carry that amount of, of return. That’s taxed as capital in an LP agreement, carried interest is 20% of the return. They’re two different things because the return has interest fees and capital. So in the tax legislation, it’s defined as capital in the LP agreement. It’s 20% of all the profit. If you do the arithmetic and look at how much return comes from interest fees and capital, you’ll find it’s Ferris and fund to fund, obviously, but a lot of return comes from interest and fees.

That’s taxes, income. So a large proportion of carried interest is taxed as income already, but unless you know, that the definition and the tax legislation is different to the definition in the LP agreement, you’d never know that. And you have no idea how much time I spend talking to journalists explaining that the thing that’s certain in the tax legislation is different to the thing that’s written in the LP agreement. And it makes a difference what the tax rate is and has any journalists picked up on it and written it in front of genders. They’re interested in, and now we’ve, you know, there was an article in the Ft recently, and that point has now been been made, but it’s not try explaining that in a headline. And it’s not very exciting either, but it’s important.

David Petrie

Yeah, we certainly find it very useful when we’re talking to officials in the treasury and so on about fiscal policy and how that relates to government investment programs and the development of new funds and so on, which is what we’ve been quite busy attempting to assist within the faculty over the, certainly over the past nine to 12 months as the government has looked at other measures, which might increase the flow of funding into those bits of the, that are short of cash. And you know, there are all sorts of you know, in a crisis, all ideas are considered however, however, left field. And so sometimes it’s been quite helpful to us to be able to explain to people just how some of these things work, but in a context of an open meeting, you can’t necessarily do that. It’s actually quite handy to say, I’ll tell you what, I’ve got, something that I suggest you have a look at that just, you know, you can’t really say to people, you need to start with the basics, but if you are looking to do that, this is, this really is a very, very good place.

So I do use that to help people gather a sort of a background understanding of how some of these things really do work. And and, and it really is. It really is very effective from, from that perspective. And also, I think one of the other things that is particularly important about this latest edition is that John covers in some detail, not just some of the changes over the past two or three years in terms of the way that private equity funds have been well doing just that raising funds and structuring themselves and what this means for the broader economy in terms of systemic risk. So there are some important factors there that the government officials and the bank of England have been looking at, and we’ve had helped them use this addition to explain, but also more broader questions about, you know, how should public money be allocated to support businesses that might be struggling at the moment.

And again, that is touched on in the addendum to the text, which John wrote with Jim Strang after the original copy had gone to press. So there are a few, well, not a few, there were a lot of very important policy implications throughout the document, I think all throughout the publication, but we’ve certainly found it been very useful to support our work in determining policy, which then in turn leads to government intervention. So it’s it’s a useful underpin to actual fiscal policy when it’s working at its best. And I can say that there have been times when we have used it to to aid understanding and and it, and it’s proven very effective.

Ross Butler

I thought that the book was worth getting just for the penname that you wrote John with with Jim Strang, which is just a couple of pages, but I thought it was really interesting looking at how things are, you know, cause everything’s changed now. Right. But my impression from those pages was actually that I’d be relatively sanguine from the perspective of a private equity fund investor, but that perhaps some other constituents might feel some heat.

John Gilligan

Yeah. Jim Strang and I read that in April and it was the first thing that was first time we’ve ever tried to write anything with people when we couldn’t sit in a room together. So it was first time we did anything over zoom, which was the first word thing, but the private equity she’s been through a number of cycles. I mean, depending on how old you, I started in 1988, I lost track of how many crises I’ve done. This is obviously a longer and different one, but the industry has come through. Many of them and each time has gone in, there’s been this fear that the leveraging things will cause a problem. That’s essentially at the heart of what they, what the issue is. People concern that overleveraging things will amplify results that are bad and that will be bad. And we’ve argued for 13 years or whatever you were writing that because the funds haven’t been leveraged.

Now, there’s, there’s been changed in the fund structure, which means that’s creeping in. And we kind of said in 2007 that’ll happen. And it is a, but we don’t think at the moment is any evidence that that’s going to cause any kind of systemic risk. But the thing that is different is the structure of the banking market, which is radically different. And that’s, that’s the overflow from the last crisis. You know, the GFC changed the rules of banking to make the economics of leveraged finance different. There’s more catio on capital in banks now than they used to be against leveraged debt. And that allowed the debt funds to come into the market. So many of the debt funds in Europe essentially were the mezzanine funds. You started moving down the capital structure and then the us model came over here.

Those funds are leveraged and indeed some of those funds leverage each other and there’s as yet, that’s not yet been through the mill in Europe, it’s been through the men in the States. The concern is that some of the smaller funds, because these funds are actually relatively shorter, so privately funds 10 years. So if you’re going to have a crisis, every, every decade, you’ve got to probably hit war on average debt funds are shorter. So if you raised one in your first fund and you went into the crisis, you will have no ability to have no track record, to raise money for the next ones. So we have a, quite a fragile environment for some of the new entrance into that market over the last decade. And when we come out of that, of this crisis, which we will in the world will be better.

John Gilligan

It will be, it’ll be interesting who survives and who doesn’t, if you pitched yourself as a retail uni charge provider or a travel sector specialist, you know, the world got bad and there’s nothing you could done about it. It’s just, it’s just a caustic event. Conversely, if you’re a turnaround investor, maybe the world got more interesting. But the one thing we do know from each crisis, this is always been a good time for the equity investor writing checks. When the world has been bad, has been a good strategy over the years for the, for the GP. Interestingly for the LP, the evidence is that you can’t pick the time to invest because you don’t make the investment decision that the GP does. So when you can make an LP decision today, or your GP might not invest the money into three years, so you won’t miss this, this with this window,

Ross Butler

Which some could say is central to its inherent advantage because you can’t just flip flop and change your mind. You’re, you’re stuck in it through good and bad.

John Gilligan

That’s the reason it doesn’t spread risk is because you, you, you made your bet and you bet on it. Now the secondary markets and the ability to do leverage positions, changes out of bet and it’s eating away at the edges of it. The analogy that runs through my head is a bit like you know, when people used to snip the edge of coins in the 17th century, there comes a point when you’ve debased the coin. We’re not there yet, but that’s, that’s, that’s a sort of a similar analogy. We’re just chipping away at the model a bit, bit by bit. And the original model of you. And I set up something for 10 years at the end of 10 years, if I’ve made some money, you pay me 20% of it. And if we haven’t, you don’t, that models are now evolving very rapidly.

Yeah. And, and so the jury is out on the performance of debt bonds, but do either of you have a gut feeling with regards to the impact of debt funds on mainstream private equity. If we were to hit a situation where there was a lot of workouts and insolvencies and so on,

I mean, that’s organizationally, that’s the interesting thing about the smaller funds is they don’t have the internal organization to do that because they weren’t jumping around long enough and working things out is, is a labor intensive exercise. So then one of my, one of my colleagues I’ve been on the investment committee, a big issue, investor impact investor. One of my colleagues is of work is a partner of a workout fund. And what they do is they buy other people’s problems and solve them so that, you know, there are routes to, to solve these problems. But the original investor went to the benefit of that when you invest in. So there is a question as to are there enough people to know how to do this and all the in the right place, because they’re originally in the banks, the banks had workout departments. Now, maybe those people are all the people that are sitting in the, the debt funds now, because many of them would have left. But, you know, that’s the question

David Petrie

I think the other couple of other interesting things to say about that question, Ross as well. I mean, the first thing is that we’ve not really seen the level of insolvencies that we were anticipating, or indeed that many of us anticipated at the beginning of this back in back this time, last year, really all last March when we went into the first lockdown you know, the statistics are very, very clear. You know, the number of insolvencies is Cigna is, is less in Q4 of of last year than it was in 2019. So that’s, that’s the, that’s the first situation. I think many of these businesses are not that many of the difficulties for debt funds haven’t yet hit. As John has mentioned, you know, those private equity houses that have found themselves with businesses where they’re working, capital’s got stretched to such a level that there that businesses is unsustainable.

I suppose there’s no other sources of capital. Then they’ve, they’ve taken some fairly urgent action or some too desperate action in some cases. So there have been some high profile, private equity backed failures in the sort of within the sort of six months kind of horizon of the crisis biting. But they could, well, if some of those could well have been businesses that were already struggling for a variety of different reasons, I think what is also interesting is what you’ve seen or what we’ve seen more broadly with the actions that private equity took you know, over the past nine to 12 months. So the first thing that they did was look very carefully at their existing portfolio. Some businesses were doing well and others were clearly under a great deal of strain. So the things that private equities consistently argued that it does well is bring professional management into businesses.

So in, you know, ask providing an external perspective and looking at ways in which the business could be adjusted, working capital management could be improved yet further diff unfortunately difficult decisions could be taken in terms of reducing operating capacity and sadly reducing head counts. And so on the private equity funds took those. They, they move very quickly with their existing portfolio businesses, but then they also found that they had a lot of investee companies that were pretty much business as usual and alongside that they also changed their investment philosophy and private equity for, for many years is recognize that it can change the significantly changed the value of investee companies by building together similar companies as so-called buy and build approach. They recognized that this was a very, this was a, this was still a way you could do deals during lockdown. So John said they could, you know, you can, de-risk an investment because chances are what you already know the sector by definition with buy and bill, because you’ve got an investee company in it they’re already, so you’ve done your due diligence on the market and the dynamics of that, your content about that.

And there’s a very good chance that the management team probably also know personally, you know, the other people within the target company, they met, they certainly know the customer base, the dynamics of it and so on. So that the private equity houses are able to use their existing resources, existing management teams, and so on to help them do due diligence, due diligence, investment targets. So we saw that developing as a way for getting transactions done.

John Gilligan

The great truth of private equity is cost of capital drives a lot of things. If that’s cheap, then, then transaction sizes rise and the are recalled giving a lecture 18 months or so ago with a colleague from Goldman Sachs he said, look, it’s a bit like being in, in the final of the French open, which still has you still have to win by two clear games in the French open, so you can keep playing till the end. So it could be 17 all, you know, the ends on the way, but you have no idea whether it’s going to be 1917 or 39 37, but it felt like that before we came into the crisis, because we were at the top of the market. And so when we submitted the book to the publishers, we actually said, again, we submit this nine we’re at the top of the market.

We had no idea virus was going to be the thing that disrupted it. I was completely surprised it was all obviously, but it’s still the case that we have this strange atmosphere across the capital markets where the cost of capital is distorted by quantitative easing and low interest rates means that the asset value inflates and when that’s unwound, the asset values will fall. We just don’t know if that’s going to unwind quickly or slowly or how that’s going to happen because nobody’s ever done it before. And the change of government in the state Springs to Janet Yellen back to the table. And she was in the process of slowly unwinding that towards the end of the Obama era has moved. Music has changed because the world’s changed. But that’s the kind of the, the big unspoken elephant in the room is what happens if interest rates rise significantly, because that goes back to the evidence-based, doesn’t it? Because the majority of the growth in this industry, I mean, it was a cottage industry before quantitative easing almost, and now it’s huge for many years.

So yeah, nobody knows. And I guess the, the other thing going back to David’s point is, yeah, there have been some sectors that have done phenomenally well, you know, software being the quintessential beneficiary of lockdowns. And then there are the sectors that I think David was alluding to where they’ve they’ve had problems, but those that are backed by investors with deep pockets, see it as a time to go hunting. And they may well emerge even stronger because they will dominate their sector, I guess, having rolled it all up. I mean, there, there is that. I mean, there’s the buy and bill thing is an interesting change. One of the questions that perplexed me since I started doing this all those years ago is all the academic evidence. We have suggests the M&A generally destroys value and all the academic stuff we’ve got about private equities, generally private equity at a gross level, outperforms markets, private is an M&A driven business.

That’s what we did. So how come the business that is focused on M&A and pretty much something else is outperforming the market when all M&A token taken around generally suggests that it’s quite distorted. And this is the kind of question that we wrestled with for years and years and years. It’s what we call the paradox of private equity is people do M&A and they make larger gains that larger returns than if they didn’t.

Ross Butler

David, that a controversial statement, I guess, from your perspective as a chief executive, the corporate finance faculty.

David Petrie

We tend to take a slightly different view in a rather more optimistic view to the value added by M&A than than, than perhaps Johnson indicated in the academic evidence. We always used to be entertained by a report that used to be published by one of the major accounting firms suggesting that M&A destroyed value. And we thought, why the hell are these guys publishing this? But of course, what they were publishing this fall was because they, the, they are, their argument ran of course, well, smart M and a with good due diligence and so on and all of these things. But of course, nobody goes into a transaction expecting it’s a fail. You know, so what, what has happened that has may have resulted in reduction in value, and the answer is things haven’t worked out the way you thought they would.

Yeah. So why is that? And these, these can be systemic issues. They can be political, you know, it’s all the usual, the usual analysis that John and his colleagues teach their students in business school. One of the areas in their pastoral analysis has changed beyond their imagination, original imagination. If there’s something fundamentally wrong with the target, then even some of the largest examples illustrate that it is possible typically to take legal action against the the sellers. Americans are making a very unfair to Americans by the way, for any Americans watching, but in the unit in the U S I should say, I should preface my remarks by saying that the use of warranty and indemnity insurance is become much more widespread than it ever was 10 or 15 years ago. And also the propensity to claim against those policies, which is where my well, I’ve dragged my Americans into it.

You know, the, there is evidence that suggests that American acquirers are more inclined to claim against WNI policies than perhaps it’s typically the case in Europe. And that, again, I think is a function of the way that those transactions are done again on the basis of completion accounts rather than the lock box mechanism, which is you know custom and practice in the UK, but it’s not to say that these things, you know, won’t won’t change. And but I think, I think there are lots of probably lots of factors actually, which might contribute to things, not working in quite the way that people expect, but it’s not something that we tend to like to talk about. And a few years ago Vince cable had had a good look at this and commissioned a piece of piece of research.

Looking at the value that M&A did actually add to the markets and that particular research illustrated that the impact was, was relatively neutral. But in the corporate finance faculty, we give an award every year to the public company that has added most to shareholder value through the use of M&A activity. And this year we did an analysis to look at past winners of these awards, because of course, as many people know, a lot of companies fear the curse of the award. As soon as you get given an award values collapsed, and something goes horribly wrong. This is not the case, actually, in, in eight out of 10 of the businesses that we gave an award to. And given that they were all public companies, if you’d invested in the stock of each of those businesses, you’d have, you’d have generated a return. That was significantly ahead of any average industry and most tracker funds, because these businesses were making very judicious use of M&A and very effective use of M&A to add to shareholder value.

John Gilligan

Yeah. what, what, what may am I kind of pick to weigh out over the decade was trying to answer this question, how come this thing is happening? And we think on the conclusion of the book in a sentence is we think it’s about process. We think it’s the fact that private equity firms are good at doing this stuff because they do it in a fixed process. So there are other, like, there’s this idea that great deals get done over a napkin, sitting in a bar over a bottle of wine between two entrepreneurs. Those are the ones that probably go wrong, because if you do a process and you have a process that you do every time, what you do is you select out the failures quite, quite efficiently. You know, there, there are waves that can swamp you like this tsunami of, of, of the virus.

But if you select it are all the things that you could have selected out reasonably, then you avoid the losses when you avoid the losses, that makes a big difference to where you’re going. And we think, but we haven’t yet been able to demonstrate, cause we haven’t figured out. We never quite figured out how to do it. In fact, I’m doing some work at the moment that I called Tim Galpin, Oxford on this is what is defining the success of private equity is two things. One is the, on the way in, there’s a process that not only buys as well, but implements the purchase process. Post-Completion well, so the a hundred day plan thing. So due diligence turns into action. And secondly, the focus on exit makes people do it quickly, because if there’s one thing to say, I’m going to change the strategy of this business over the next decade.

And there’s another saying, I’m going to have to do it in the next three years, three to five years, and you can just work quicker. And we think those two things are at the heart of, or probably our conjecture is that those are at the heart of why this works. That sounds plausible to me, but could you not kind of zoom out a little bit further and say, well, the processes, the function of the structure of the LP structure, it’s not just the LP strip to think about the different surfaces. Imagine I sort of business GE some years ago, and they’re really good acquirers. They have an internal process, but it’s all internal. So it’s an internal process. And their level of knowledge in that process is limited by the number of transactions they do, which is a lot or used to be a lot when they were very inquisitive.

Now imagine that your, I don’t know, pick a fund, doesn’t matter. Most of those funds externalize the process. Private equity is a big user of the services provided by people like Amelia and other people know we did a lot more transactions than anybody else did. So we learned more. So the, you know, the big four accounting firms and GT and BDO below them do more transactions per year than any private equity fund in the world by orders of magnitude. So funnily enough, the people who have come across the problems tend to be in those footsteps. Some of them ended up moving into private equity. So one of the conjectures is that by externalizing a large proportion of that process to people that you work with consistently, you’ll get the benefits of their learnings. And therefore you avoid mistakes. You would have made had you not used external advisors, corporates use of external advice less, and therefore they’re more likely to fall for their own beliefs as it were. They don’t have an external check mechanism in the same way. So when we were conjecturing that, you know, you hear a lot about passion and vision, all these sorts of things in business schools, and my colleagues do all this, but maybe here competence is what we’re talking about. You know, being very competent, a process might make a hell of a big difference.

David Petrie

Yeah, yeah. I was just going to say that that certainly the view expressed of course by very many of the members of the corporate finance faculty who are themselves advisors and they do, as John says, they do, they do see the same things day in, day out. And you know, again even some of the larger or mid market houses, I guess in the UK might do 10, 15, 20 deals a year, but they’re certainly not seeing exactly the same thing in quite the same way. And the increasing specialism within the advisory firms as well, again, increases that level of expertise and that ability to be able to say you know, this, what this, this could be, this could prove to be one of those unforeseen difficulties that I was talking about a little time ago. They’re not really unforeseen they’re they’re things they’re factors in investment risk that people just might look at differently and be proud.

And to actually take a, perhaps an artificially optimistic view about at the time, because it happens to fit with company strategy. And I think that to, to sit alongside John’s analysis or perhaps to, to, to add to it or to add facto, no doubt they’re considering is that I think in private equity, they’re set up to monitor changes and KPIs within a business extremely closely and where things are going wrong. They will tend to know potentially anyway, not this is generalizing, but perhaps quicker than they might within a private company or public company, perhaps they will know sooner that something’s going wrong. And, and also perhaps they will be more inclined to take action sooner. You know, one of the facts and perhaps John I I’m worried that I don’t now have academic evidence to support this, but there is a lot of anecdotal evidence amongst the advisory community to suggest that private equity managers change management teams

There’s, there’s evidence of that. There’s, there is evidence that private actually changes management board, anybody else? Absolutely here.

John Gilligan

Yeah. And they’re doing that in order to, they are proactive managers, they will step in and intervene. And there’s not necessarily perhaps the giving an investment, the benefit of the doubt, if we could call it that, that you might get in you know, a, a public company transaction where it might be, well, we don’t quite know why this isn’t working, how much of what we’ve bought is, is now integrated within the much larger organization. And therefore it’s less easy to assess exactly how much value that it’s actually added to the, to the, to the whole. Whereas if you’ve got the thing running discreetly, it’s much easier to to assess its performance. So there’s a whole series of different factors that are at work here and academic support and analysis of these things does allow for directors to challenge some of these, these concepts, these ideas that, you know, we know that we need to be careful with M and a, because, you know, we’re concerned it doesn’t necessarily add value. And how can we change our processes, try and minimize risk, taking it back to private equity demystified. That’s where, you know, some of the principles in private equity may not think about some of this stuff quite that way all the time, but having, going back to the text and say, yeah, actually that’s an interesting trend. We need to have a bit of a think about that. It’s really great

Ross Butler

And he’s coming on again soon to talk about his new book on, on governance, which, sorry,

John Gilligan

I was reading Simon Witney’s new book on Governance last night, a friend, and there’s a point that he makes in that book, which is far more scholarly than I am, and often a lot, lot smarter than I am. But the point he makes is, is that if you stand back from this and look at the simple decisions you make as a shareholder shareholders in public companies have the option to sell. So the private equity shareholder has to have the option to fire because they don’t have the option to sell. And so the reason you change the management is because you don’t have the option to bail out. And that’s, that’s the sort of the contract you enter into. You have this simple idea of if I don’t like you I’ll sell and that we know that will be affected, the market will make the price of the asset fall because of that, you can’t do that in the private equity world, or couldn’t historically get this bit of secondary trading. You can do it on now. So you have to have the option to fire because what else can you do now? There isn’t a third option. And that’s, that’s again, one of these things that David was saying, I mean, it changes the game. If you can’t sell, you got to do something else.

Ross Butler

Yeah. There’s an interesting interplay between the advantages of the governance model and the advantages of the process that you outlined as well. And obviously they’re interlinked, but they are separate as well. Yeah.

John Gilligan.

Yeah. I mean the governance thing sort of comes from the process. And so there’s a process on the way in which is a bit I know. Well, cause you know, I was an M and a person and then there’s a process once you’re in, which is, which is kind of embedded in the, in the governance piece. And the thing that strikes you when you deal with a private equity fund year on year on year, is how consistent that process is a cost of pay.

Ross Butler

I’d really like to try and bring you two together on the point because I think it can be done listening to you both. And so let me try you on something, which is that the academics may have discovered that MNA may on average destroy value, but the average does not necessarily dictate the overall benefits of an activity. And David’s prize is highlighting people that have hits upon a successful formula and are accruing knowledge along the way. And your description of private equity does the same thing. And so while the average may destroy value the activity as a whole may be a creative

John Gilligan

That’s absolutely. Right. Right. So the, the whole, one of the biggest problems that the conversation about private equity has generally is the average is a coastal over the place. So the average return on compared to the average return on a market, is that a meaningful thing? And the answer is, well, not really, it’s not meaningful for a number of reasons. One, nobody buys the average. When you put leverage into things, you make the dispersion of the distribution bigger because you amplify everything. So th th this constant question of does private equity outperform the market. I sort of got to the point where I don’t think the question makes any sense anymore because there’s now leveraging funds. So I, as an investor in the fund, first of all, investors don’t get the same deal. If I put a hundred million pounds to a fund, I get a different deal.

And if I put 1 million pounds at the same site, secondly, there’s leveraging funds that comes in and out. So depending upon when I’m in that fund, if I’m trading in the secondary market, my returns would be different to yours if you stayed in across the whole piece. So even within one fund, the LPs are getting different returns. So what does the average mean? No idea. And then there’s this, this, this whole question of what does it, what’s the average of what if you’re doing turnaround investments in France and I’m doing buy and builds in Spain? Are we doing anything similar? I don’t know my organization, it looked very similar when we draw an organization chart. I mean, might all be in my book and, you know, we might put them down as a private equity fund, but is it really sensible to compare us?

Because the strategy is really the question. The real question is an investor is what do you say you’re going to do? Did you do it and give him the risks I took? Did I get a return for it? And comparing, I know every always picks on KKR. So I was picking know some large buyout fund CBC, God fed. Doesn’t worry about it too. LDC or inflection, or I don’t know somebody else, is that a sensible thing to do know? It’s a bit like comparing the performance of somebody in Chelsea football club to somebody in Harlequins rugby club. They’re both playing a sport with a ball on a field, but they’re not trying to do the same thing.

Ross Butler

Have you come across the American intelligence definition, the difference between a puzzle and a mystery, which helped probably mangle, but puzzles. Basically they have an answer, at least in theory, they can be sold computationally and mysteries don’t have a single answer. And even when you have all knowledge, it’s still unclear what it is. And so it strikes me that private equity demystified as a title is peculiarly appropriate. And obviously it’s very much needed as well. So it’s been a great pleasure speaking with you both. And I really commend the book. It’s it, it’s actually a good read as well. Thank you.

John Gilligan

And also, so that everybody buys it, I don’t make any money out of it. We give all the money to the big issue where I’m a trustee of the charity. So if people want to give money to charity and also learn about, about private equity, as I said in the post on LinkedIn, it’s not bandaid, but it does a bit.