With a deal drought across the global private equity industry, we talk to Chris Field of global law firm Dechert about what’s next for M&A and buyout deal flow for 2024. We discuss valuations and defensive deal structures as vendors and buyers find ways to come together.
Top quote: “I have never worked on an earn-out, ever, that has not resulted in some form of dispute.'”
In this Fund Shack podcast with Ross Butler, Chris reveals what it takes to make it as a top private equity lawyer.
Fund Shack Podcast Featuring Chris Field of Dechert
In this engaging episode of the Fund Shack podcast, 🎙️ Ross Butler interviews Chris Field, a partner at the global law firm Dechert, to discuss the current state of international private equity markets and the intricacies of private equity lawyering.
Highlights:
Market Sentiment and Interest Rates: Chris Field highlights the fluctuating sentiment in the private equity market, noting the anticipation of rate cuts and their potential impact on deal-making. He explains how interest rates have become the biggest challenge for private equity firms, affecting deal volume and value.
Deal Volume and Value: Despite a significant drop in deal volume and value over the past year, 2023 outperformed 2019 levels. Chris explains this apparent paradox, attributing it to the short-term memory of market participants and the exceptionally high activity levels in 2021 and early 2022.
Fundraising Trends: Chris discusses the bifurcation in the fundraising market, with capital being concentrated in large multi-strategy managers at the expense of smaller and newer funds. This trend is influencing the strategic decisions of private equity firms.
GP Stake Sales: A significant portion of private equity firms are considering selling stakes in their own businesses. Chris outlines various motivations behind these sales, including succession planning, liquidity injection, and bringing in external expertise to enhance the firm’s capabilities.
Valuation Gap and Deal Structures: The podcast explores the creative deal structures being employed to bridge the valuation gap between buyers and sellers. Chris highlights the increased use of deferred consideration mechanics, such as earnouts and vendor loan notes, to align the interests of both parties.
Regulatory Environment: Chris delves into the evolving regulatory landscape, focusing on antitrust scrutiny and foreign direct investment regulations. He explains how these factors are shaping deal-making strategies and the need for private equity firms to navigate complex regulatory requirements.
Private Equity Innovation: The discussion covers innovative liquidity solutions in the private equity space, including the rise of NAV facilities, collateralized fund obligations, and GP-led secondaries. These innovations are helping firms return liquidity to investors despite challenging market conditions.
Technological Impact: Chris touches on the role of technology in private equity transactions, particularly in the context of regulatory compliance and deal execution. He discusses the potential for AI and other technologies to streamline processes and improve efficiency.
Dechert’s Positioning: Chris outlines Dechert’s strategic positioning in the private equity market, emphasizing their global presence and expertise in complex transactions. He highlights the firm’s commitment to providing high-quality advisory services across various geographies and sectors.
Summary:
Chris Field provides a comprehensive overview of the current state of the private equity market, emphasizing the challenges posed by interest rates and the creative solutions being employed to navigate them. He discusses the evolving regulatory environment and the impact of technological advancements on deal-making. Dechert’s strategic positioning as a global leader in private equity advisory services is highlighted, showcasing their expertise in navigating complex transactions and regulatory landscapes.
Private equity is a great way of investing in uncertain, high growth environments. Strange then, that the African private equity industry is so small. In fact, Stephane Bacquaert of Adenia Partners argues that the Western, established private capital industry has systematically misunderstood the African opportunity, and in particular its risk profile.
In this Fund Shack podcast with Ross Butler, he talks about managing one of Africa’s largest control buyout funds, and the value that so many investors are missing out on.
Key Highlights:
Stephane’s Journey: Transitioned from strategy consulting to private equity in Africa, driven by personal connections and a desire to support African businesses. His initial venture failures led him to focus on supporting management teams through investment.
Investment Strategies: Emphasis on control buyouts and majority deals, which provide more influence over business outcomes. Investment decisions are driven by bottom-up analyses, focusing on companies with strong growth potential, robust management teams, and pricing power. Importance of being embedded locally to source and execute deals effectively, given the lack of structured deal flow and the necessity of relationship-based deal sourcing.
Market Dynamics: Africa’s high growth potential is driven by demographic trends, urbanization, and a burgeoning middle class. The continent’s economic fundamentals include rapid population growth, significant urban migration, and high GDP growth rates in several countries. These trends create opportunities in sectors such as consumer goods, retail, financial services, and infrastructure. Challenges include currency devaluation, regulatory complexities, and the need for infrastructure development.
Challenges and Opportunities: Navigating Africa’s complex regulatory landscape requires deep local knowledge and adaptability. Currency devaluation is a significant risk, necessitating investments in companies with strong local demand and pricing power. Building infrastructure is crucial, from establishing retail chains to upgrading production facilities.
Impact and ESG: Private equity investments in Africa have a profound impact on job creation and economic development. Adenia Partners focuses on improving ESG standards, such as transitioning companies to more sustainable practices and ensuring compliance with international environmental and social standards. Examples include the transformation of a retail chain in Kenya and the shift to water-based paints in East Africa. These efforts not only enhance business value but also attract international buyers and investors.
Fund Shack is a private equity podcast and global media channel for alternative investment professionals. Fund Shack is produced by Linear B Group. Contact: Katie Mitchell Email: katie@linearb.media Company: Linear B Group
Private equity fund managers are racing to find structures that will allow small private investors to invest with them. Meanwhile governments are introducing ELTFI and LTAF structures to encourage retailisation. Henry Freeman has been working at the nexus of public and private equity for two decades. And he has concerns.
Henry is founder of the Fund Society, an insight aggregator for investors, launching imminently. Sign up here for free and be among the first to benefit: https://thefundsociety.com/
An in-depth discussion with Henry Freeman, a seasoned investment manager and founder of the Fund Society. The conversation covers private equity’s accessibility to mass markets, the evolution of investment structures, and the launch of the Fund Society.
Key Highlights
Henry’s Journey: Henry Freeman has a diverse background in public and private investment markets, fintech entrepreneurship, and investment trust board membership. His career includes roles at Lloyds Private Bank, Foresight Partners, and Liberum, showcasing his extensive experience in managing and structuring investment funds.
Investment Strategies:
Semi-Liquid Structures: Emphasis on creating investment vehicles like LTIFs and ELTs that offer some liquidity while maintaining the benefits of private equity.
Commitment Focus: The critical role of commitment in private equity, arguing that commitment is a feature rather than a bug, essential for achieving the high returns associated with private equity investments.
Public-Private Hybrids: Development of funds that invest in listed private equity firms, providing liquidity and accessibility while capturing private equity’s growth potential.
Risk Management: Approaches to managing liquidity risk, including the potential for forced asset sales during market downturns and the implications for fund performance.
Market Dynamics:
Historical Discounts: Analysis of historical opportunities in listed private equity during the 2008 financial crisis and recent market conditions, highlighting significant discounts to net asset value (NAV) and the impact on investor returns.
Current Opportunities: Examination of current market conditions post-COVID, with a focus on identifying value in listed private equity and the potential for significant returns as market conditions stabilize.
Challenges and Opportunities:
Scalability Issues: Discussion on the scalability of closed-end fund structures versus open-ended vehicles, emphasizing the challenges and potential solutions for scaling private equity investments.
Mis-Selling Risks: Concerns about the risks of mis-selling private equity products to retail investors, particularly with open-ended structures that may not align with the traditional private equity investment model.
Technological Integration: The potential for leveraging technology, such as tokenization, to streamline the transfer and management of private equity interests, enhancing liquidity and accessibility.
Fund Society:
Platform Overview: Introduction to the Fund Society, an online hub for investment professionals, providing curated intelligence-based content, news aggregation, and thought leadership.
AI Integration: Use of AI and large language models to curate and prioritize content, ensuring relevance based on market trends and news events.
Community Building: Efforts to build a community of investment professionals, facilitating knowledge sharing and networking opportunities across asset classes.
Fund Shack is a private equity podcast and global media channel for alternative investment professionals. Fund Shack is produced by Linear B Group. Contact: Katie Mitchell Email: katie@linearb.media Company: Linear B Group
Daniel Zwirn is CEO of Arena Investors LP. In this episode of the Fund Shack private equity podcast, he talks to Ross Butler about the opportunities in private markets, and how to prosecute them in a way that truly aligns incentives with underlying investors.
Key higlights
Arena Investors’ Philosophy:
Historical Best Practices: Arena is inspired by successful financial models dating back to the 1600s, focusing on strategies from the Rothschilds, global grain traders, and Asian merchant houses.
Moral Hazard Prevention: Prioritizing structural advantages where Arena’s scarce resources (capital) are needed, reducing the risk of moral hazard.
Investment Strategies:
Cyclical and Opportunistic Investing: Identifying and exploiting cyclical opportunities across various sectors and geographies, avoiding overreliance on a single strategy.
Regulatory and Structural Arbitrage: Taking advantage of inefficiencies and regulatory differences across markets, providing a unique edge in capital deployment.
Market Dynamics and Opportunities:
Global Macroeconomic Trends: Analyzing the impact of QE, fiscal policies, and inflation on asset bubbles and market corrections, and strategically positioning investments accordingly.
Sector-Specific Strategies: Focused on distressed assets, special situations, and high-value sectors like real estate, structured finance, and commercial lending.
Operational Complexity:
Global Multi-Strategy Approach: Operating across North America, Europe, and Asia with a diversified portfolio including corporate, real estate, and structured finance.
Joint Ventures: Leveraging over 50 joint ventures worldwide for deep domain expertise, aligning interests, and maintaining variable cost efficiency.
Ethical and Social Responsibility:
Social Utility Investments: Focusing on investments that provide social benefits, such as healthcare and rehabilitation centers, while maintaining high returns.
Consistent Ethical Framework: Avoiding trends like greenwashing, with a focus on long-term ethical investment practices.
Daniel Zwirn highlights the importance of a disciplined, ethical approach to alternative investments, focusing on long-term value creation and strategic flexibility. His insights provide a comprehensive understanding of navigating private markets amidst evolving economic conditions.
Contact Information: About Fund Shack: Fund Shack is a private equity podcast and global media channel for alternative investment professionals. Fund Shack is produced by Linear B Group. Contact: Katie Mitchell Email: katie@linearb.media Company: Linear B Group
Hans Lovrek stumbled on Medieval Florentine documents that showed structures were being used to align interests in ventures with high information asymmetry that were uncannily similar to today’s limited partnerships.
Through a method of historical institutionalism, Hans demonstrates how the same techniques have been used to solve similar problems, down the ages, and that today’s private equity industry is based on ideas that successful trading nations have used before.
This episodes was recorded in March 2019 and is released on podcast for the first time in December 2023.
Medieval Foundations of Modern Private Equity – Hans Lovrek on Fund Shack’s Private Equity Podcast
Hans Lovrek, Founder of Commenda Private Equity uncovers the historical foundations of modern private equity by analyzing medieval Florentine documents, revealing structures similar to today’s limited partnerships. His method of historical institutionalism demonstrates how successful trading nations historically addressed information asymmetry, influencing contemporary private equity practices.
Historical Parallels:
Medieval Commenda and Modern LPs: Lovrek discovered that medieval commenda contracts from the 6th to the 14th centuries share striking similarities with today’s limited partnerships (LPs), highlighting features like profit sharing, limited liability, and limited duration.
Structural Analysis:
Profit Sharing: Medieval contracts typically had a 25% profit share for the general partner (GP), akin to the 20% carried interest in modern private equity.
Limited Liability: Essential for allowing families and other investors to participate without risking their entire fortunes.
Duration: Projects were financed for specific ventures (e.g., sea voyages) with fixed terms, similar to the ten-year lifespan of modern funds.
Regulatory Influence:
Role of Regulation: Increased regulation in Venice facilitated the rise of commenda contracts by providing a framework that reduced moral hazard and ensured fairness, leading to a thriving venture investment environment.
Comparison to Modern Regulation: The historical necessity of regulation for venture success parallels modern regulatory practices, suggesting that a codified international structure could simplify private equity investments.
Due Diligence and Moral Hazard:
GP Clawback: Medieval practices included mechanisms to ensure GPs returned excess profits if investments later underperformed, a concept still relevant today.
Challenges of Information Asymmetry: Both medieval investors and modern LPs face similar challenges in monitoring GPs and ensuring aligned interests.
Contact Information: About Fund Shack: Fund Shack is a private equity podcast and global media channel for alternative investment professionals. Fund Shack is produced by Linear B Group. Contact: Katie Mitchell Email: katie@linearb.media Company: Linear B Group
Yaron Valler is a founder of venture capital firm Target Global. He is a successful entrepreneur and investor, and was part of the team at Intel that invented the Pentium Processor. In this episode of the Fund Shack podcast, he talks to Ross Butler about how AI will change ‘everything’, virtual reality, how government’s should direct innovation and risk capital, and much more.
AI and Innovation in Venture Capital – Yaron Valler on Fund Shack’s Private Equity Podcast
Yaron Valler, Founder of Target Global discusses the transformative potential of AI, its applications across industries, and the role of governments in directing innovation and risk capital. Drawing from his background, including developing the Pentium processor at Intel, Valler provides insights into how AI will revolutionize sectors like healthcare, finance, and agriculture, and emphasizes the importance of strategic government investment to foster technological advancement.
Key Highlights:
AI’s Transformative Potential:
Widespread Impact: AI will profoundly affect various industries, including healthcare, finance, agriculture, and manufacturing.
AI Applications: From medical diagnostics to real-time tax classification, AI promises significant advancements in efficiency and capability.
Pattern Recognition and Innovation: AI excels in pattern recognition and generating new content, revolutionizing tasks like email composition and medical image analysis.
Large Language Models (LLMs):
Valuation Challenges: Overvaluation of LLM infrastructure could lead to market crashes. It’s crucial to evaluate LLMs based on their real-world applications and market potential.
Decentralization Potential: While AI might centralize around major providers, localized LLMs could also proliferate, allowing more decentralized AI applications.
Government’s Role in Innovation:
Strategic Investment: Governments should strategically direct investments to address inefficiencies and foster tech proliferation, particularly in underserved regions.
Public-Private Partnerships: Examples like Germany’s public-private tech initiatives highlight the benefits of collaborative investment in fostering innovation and regional economic growth.
Investment Trends and Future Technologies:
Augmented Reality and Quantum Computing: Valler is excited about the potential of augmented reality in daily life and the revolutionary impact of quantum computing on various industries.
Geographic Focus: Target Global is exploring investments in regions like Africa and the Arab world, recognizing their potential for significant tech-driven growth.
Yaron Valler’s insights emphasize the vast potential of AI to transform industries and highlight the strategic role of government in fostering innovation through targeted investments. His experience underscores the importance of evaluating AI technologies based on their real-world applications and long-term market potential.
Contact Information: About Fund Shack: Fund Shack is a private equity podcast and global media channel for alternative investment professionals. Fund Shack is produced by Linear B Group. Contact: Katie Mitchell Email: katie@linearb.media Company: Linear B Group
Sanjay Panchal is a partner at Livingbridge, a leading international growth capital investor, where he specialises in healthcare. In this episode he speaks to Ross Butler about the opportunities for private equity investors across the healthcare sector.
Investing in Healthcare – Sanjay Panchal on Fund Shack’s Private Equity Podcast
Sanjay Panchal, Partner at Livingbridge discusses the dynamics and opportunities in the healthcare sector from an investor’s perspective. He explains how Livingbridge focuses on thematic investing, identifying long-term trends like aging populations and technology adoption. Sanjay emphasizes the importance of improving healthcare outcomes and the role of private equity in driving innovation and efficiency in the sector.
Key Highlights:
Healthcare Investing Approach:
Thematic Investing: Identifying key growth trends and focusing on businesses driving change in healthcare outcomes.
Mid-Market Focus: Investing in UK mid-market businesses and helping them scale, targeting areas with growth rates significantly above GDP.
Investment Philosophy:
Outcome-Driven: Partnering with businesses focused on improving healthcare outcomes, believing that commercial success follows quality care.
Employee Focus: Emphasizing the importance of recruiting and retaining skilled staff, crucial for sustainable healthcare businesses.
Service vs. Capital-Intensive Businesses:
Service Models: Primarily investing in service-oriented businesses, including technology services, rather than capital-intensive sectors like hospitals.
Examples: Investments include businesses like Helping Hands (home care services) and Nourish Care (digital record management for elderly care homes).
Changing Healthcare Trends:
Ten-Year Truths: Identifying long-term trends such as aging populations and shifts in care from hospitals to the community.
Technology Adoption: Significant focus on healthcare technology to improve service delivery and patient outcomes.
Life Sciences and Biotech:
Complex Drug Pipelines: Trends towards more specific, complex drug developments targeting smaller patient populations.
Outsourcing in Pharma: Increasing reliance on third-party providers for drug discovery, clinical trials, and commercialization.
Geographic and Sector Focus:
International Presence: Investments in various geographies, including the US and Australia, with a focus on scalable, specialized healthcare services.
Consumer Healthcare: Noting a shift towards greater consumer control and visibility over health, though the private pay sector still has growth potential.
Sanjay Panchal’s insights highlight Livingbridge’s strategic approach to healthcare investing, emphasizing thematic investing, improving healthcare outcomes, and leveraging technology. The firm focuses on scalable service models and recognizes the critical role of private equity in driving innovation and efficiency in the healthcare sector.
Contact Information: About Fund Shack: Fund Shack is a private equity podcast and global media channel for alternative investment professionals. Fund Shack is produced by Linear B Group.
Marcus Maier-Krug is partner and co-head of portfolio management at Arcmont. He has been working in private credit since before the global financial crisis.
In this episode, recorded in November 2023, we discuss what constitutes alpha in private credit, what it’s attractions are as an asset class, whether it can retain the market share it has taken from the traditional banking world, the different mindset and culture of private credit lenders vis a vis their borrowers, and much more…
Understanding Alpha in Private Credit with Marcus Maier-Krug
Marcus Maier-Krug, Partner and Co-Head of Portfolio Management at Arcmont discusses the evolving landscape of private credit, emphasizing its resilience and adaptability in volatile markets. He outlines the distinctive attributes of private credit, the sector’s growth, and how it competes with traditional banking. He also touches on Arcmont’s strategies and the broader market dynamics.
Key Highlights:
Private Credit Overview:
Bespoke Financing: Private credit offers tailored financing, often handled by a few funds, unlike syndicated bank loans.
Range of Products: Includes senior secured deals, unitranche, subordinated debt, and equity co-investments.
Market Dynamics:
Volatility and Adaptation: The last 10-12 months saw significant market volatility, impacting portfolios and origination.
New Opportunities: Liquid market substitution deals have emerged, offering new avenues for private credit.
Deal Size and Structure:
Upper Limits: Typically, private credit deals range up to €1.5 billion. Larger deals may require a combination of private credit and syndicated loans.
Global vs. Regional Differences: The US market sees more clubbed deals compared to Europe’s preference for smaller clubs or sole deals.
Deal Flow and Quality:
Declining Volumes, Higher Quality: Despite overall deal volumes dropping, the quality of deals has improved.
Less Competition: Struggles in fundraising and portfolio management for smaller players have reduced competition for larger funds like Arcmont.
Process and Terms:
Extended Timelines: Deal processes are longer, with more involvement from sponsors and management teams.
Due Diligence: Combines vendor information, buyer analysis, and independent verification to ensure deal legitimacy.
Current Market Environment:
Improved Terms: Higher interest rates and economic pressures have led to better pricing and more conservative financial structures.
Portfolio Management: Active management and restructuring are crucial to handle economic stresses.
Alpha in Private Credit:
Investment Mindset: Focus on managing downside risks and building strong relationships with borrowers.
Cultural Approach: Arcmont emphasizes a deep investment culture, involving the entire team in decision-making processes.
Attractiveness of Private Credit:
Inflation-Hedged: Floating rate investments provide protection against inflation.
Better Control: Private credit offers better documentation, covenants, and control over outcomes compared to liquid markets.
Future of Private Credit:
Growth Potential: The sector is expected to grow, with new opportunities arising from market dynamics.
Consolidation: Larger funds will likely continue to dominate, benefiting from economies of scale and deeper resources.
Marcus Maier-Krug highlights the strategic advantages of private credit, emphasizing its flexibility, better terms, and deeper market penetration. He underscores the importance of relationship-building and active portfolio management in achieving alpha.
Contact Information: About Fund Shack: Fund Shack is a private equity podcast and global media channel for alternative investment professionals. Fund Shack is produced by Linear B Group. Contact: Katie Mitchell Email: katie@linearb.media Company: Linear B Group
Alejandro Alcalde Rasch is a senior director in Advent International‘s portfolio support group. He joined Advent in 2010 having been chief transformation officer and head of supply at Gröhe AG and a partner in McKinsey’s chemicals practice.Â
In this Fund Shack podcast, Alejandro talks to Ross Butler about the genesis of Advent’s dedicated portfolio support group, how it has grown over time, what he looks for in value creation professionals, how the team works alongside deal executives and the importance of a value creation plan.
[00:00:00] Ross Butler: You’re listening to fund Shack. I’m Ross Butler, and today I’m speaking with Alejandro Alcalde de Rasch, Senior Director in Advent International’s Portfolio Support Group. Alejandro joined Advent in 2010 and his job is to help improve the performance of portfolio companies. His previous roles include chief transformation officer and head of supply chain at Grua when it was a private equity backed company, and before that he was a partner at McKinsey. Today we’re going to get under the bonnet of private equity value creation. Alejandro, welcome Fund Shack. Can you just explain to us what the portfolio support group is? So what does portfolio support group mean?
[00:00:37] Alejandro Alcalde Rasch: Well, thank you very much for having me, Ross. And yeah, what’s portfolio support group? What’s our mission? Our mission is to support management in everything around the value creation programs that we want to get implemented in our portfolio companies. So we’re coming with a slightly different background than our colleagues from the deal team side. So typically we have a combination of consulting experience in the first place. So kind of learning the toolbox, what are the different tools in the toolbox that you have? And then ideally we’d like to see colleagues who have also been able to implement, to use those tools in practical life. So my background is kind of representative. So first at McKinsey, learning a lot about operations excellence and strategy consulting tools, but then also within grow, I was responsible for actually getting those tools into action. And so we like to see people who have this dual experience, and then our mission is to sit together with the management teams and to align on the value creation plan, set up the right governance to execute those value creation plans, and then support as we go along with the implementation of all the different programs.
[00:01:57] Ross Butler All right, so would it be fair to say that typically people in the portfolio support group would have more industry experience like in companies, than people in the deal investment sIde?
[00:02:08] Alejandro Alcalde Rasch: I would say so, although we have a lot of people that also have a background which is outside the finance, the pure investment banking world. But on the portfolio support group side, yes, we love to see people who have also gotten their hands dirty and who have practical management experience, because then it’s also easier to interact with the management teams. They probably recognize that there are commonalities between yourself and them, and it’s also for you, it’s probably easier if you have sat in the same chairs, if you have also been responsible for getting value creation plans implemented, because then you know what’s difficult, what’s not so difficult, and you know the challenges and you have probably a better understanding of the situation, the management teams will be in?
[00:02:59] Ross Butler: Oh yes, particularly not just working in a company, but working in a private equity backed company.
[00:03:03] Alejandro Alcalde Rasch: That certainly helps. It’s always good when I can introduce myself and say that, well, I’ve sat on the same side of the table as they are sitting right now.
[00:03:14] Ross Butler: So what might be helpful is maybe to go through the chronology of a deal from your perspective, because I think most of our listeners will be very familiar with the investments, of course, perspective. So I guess the simplistic way to think about your role is the deal guys come up with, they find a company they like, they do their due diligence, they buy it and they pass it over to you to improve it before exit. How does it actually work?
[00:03:38] Alejandro Alcalde Rasch: No, the reality looks slightly different. So first of all, it’s always good if we have the chance to get involved already before the deal is executed or done. So in the ideal world, I would be joining our colleagues during the due diligence phase. I would be also attending management presentations, expert meetings. It’s always good if you get to know management early on and they also have a chance to see you as part of the larger private equity company team.
So very important early on that you’re part of the definition of the value creation pLan, at least how we see it.
And then subsequently, once we’re in the lucky position that we won the deal, we’ve signed the deal. Then to use the time between signing and closing as much as possible and within the restrictions that the deal situation may provide to already work on. What are the next steps?
How are the first 6 months going to look like? What are the things that we would like to achieve and if there is a chance already to pre align these with the management team?
[00:04:53] Ross Butler: I’m just slightly intrigued around the dynamic between the investment professionals and the portfolio support group professionals, particularly at this point, because let’s say I’m an investment guy and I really want to do this deal, how do I view the portfolio support group person? How do I most effectively use them at that stage?
[00:05:12] Alejandro Alcalde Rasch: That’s a good question, because actually kind of tricky. We are probably the ones in the team who have, because of our background and our say, own management experience, consulting experience, we probably have a good sense for what is actually doable in a certain given time span. At the same time, our deal professionals at Advent, they are working within sectors, so they are also very knowledgeable about the sectors, probably have deeper sector experience than most of us because we tend to be generalists. We work across the entire portfolio and in many cases we are also working with them for the first time in a sector, potentially.
And then our role is to kind of look at the deal hypothesis from the point of view. How can management actually get this implemented? Are these the right levers? How is the sequencing of the levers looking like? What could be potential third parties to support with the implementation of things?
Are we having any perceived GPs in the management team that could become an obstacle for implementing things? What resources would we like to bring to play? And then together we’re working on the investment thesis. But obviously at the end of the day there is an investment committee that has to look at the deal from the different angles and together we’ll come up with a decision on what to do with the company. But we are really a supporting group. It is the deal captains who make the calls together with the investment committee.
[00:06:53] Ross Butler: I can imagine that must be hugely beneficial just from a kind of a grounding perspective to know what’s realistic. I’ve got that smart acronym in my mind, specific, measurable, but I think it’s attainable or something like that. If you get enthused about a deal, you can maybe run away with yourself. And to have someone to say, hang on, this is going to take a lot longer than you think could be quite helpful. Does that happen or am I not giving enough kudos to the investment guys?
[00:07:22] Alejandro Alcalde Rasch: I think you’re not giving enough kudos to the investment professionals because we have a quite experienced team who have done similar deals before and who have a very good assessment of what’s actually doable. And in many cases we would have already worked with these individuals before on a past deal. So we tend to be quite well aligned between ourselves. And then very rarely we have these situations where we would completely disagree on things. And then it’s ultimately also, it’s a kind of managerial decision to go for it or not go for it. And I can’t even recall a single deal where there would have been complete differing views on what’s actually doable. I think we have a lot of experience in working together.
For example, I’m spending a lot of time in the chemical sector and since 2011 2012 I’ve been working with one senior partner constantly on different chemical deals. And we know each other quite well. So we have a shared, shared experience. And I think over time we have learned on, okay, if someone says something, you learn what the specifics are that you should be listening to and where to focus on. I think experience matters a lot. I think in this.
[00:08:54] Ross Butler: Yeah, if you can develop some rapport with your investment professional partner. That’s got to be helpful.
[00:08:59] Alejandro Alcalde Rasch: And the same applies not just for the very senior guys. Because of this strong sector dedication, we have also people on the more junior levels that have repeatedly worked in the same sector with the same people. So we’re quite experienced team overall with a lot of sector experience, and that clearly helps.
[00:09:18] Ross Butler: How large is the portfolio support group?
[00:09:20] Alejandro Alcalde Rasch: We are more than 40 people globally. Within advent and Europe. We are twelve soon. 13.
[00:09:26] Ross Butler: Yeah. So that’s got to be one of the largest teams, I would imagine.
[00:09:29] Alejandro Alcalde Rasch: Well, we have built it up over the last 13 years. So basically on average one, one person per year. And I think it is very difficult to actually grow these teams faster than. Much faster than this. We have had a few years when we certainly had some step changes, but say on average one person per year. And that has worked well for us. We tend to have a team with high tenure. We had only one person leave our team in the last 13 years.
[00:10:04] Ross Butler: So how do you hire? So obviously you need the geographic component, but do you also look for not just specific, are you looking for specific skills, specific sector expertise, or is it more general business acumen?
[00:10:16] Alejandro Alcalde Rasch: We follow a model whereby the people in our group are generalists. So we’re not following a functional model. There is basically two archetypes of how you can do this. One is where people would follow a functional perspective. So you have one expert who does commercial excellence, one expert who does lean, one that is focused on procurement and so forth. But you could also follow a more generalist approach where you say that one person tries to cover the entire value creation plan. And we’re in this second camp, with few exceptions. So over the last three, four or five years, we have started to build up more functional expertise, particularly on the HR and digital side of things, where we have people who are working on multiple portfolio companies in parallel, and who are working alongside the generalists on a specific company. But our basic philosophy is that one portfolio support person should be able to handle two in some situation, three portfolio companies in parallel, but then cover the entire value creation plan. And then on an as needed basis we can pull in specialized resources. We call them operations advisors. They are not employees of Advent, but they work on an exclusive basis with us and support the management team on very specific programs. So it could be someone who has very deep it ERP experience, someone who has been a CPO in the past, who has very deep procurement expertise. And we bring these people in if there is a specific need in a portfolio company.
[00:12:09] Ross Butler: Can I just ask you about those operational advisors, they are not employees.
[00:12:15] Alejandro Alcalde Rasch: So we have a contractual framework agreement with them and we are on a case by case basis bringing them in. They are not running consulting projects within a company, so they are more mentoring, challenging, supporting the functional owners within the portfolio company.
[00:12:37] Ross Butler: So Advent has had this portfolio support group function for quite a while now. But you were one of the early movers. And people in recent years, say, people, your peers, private equity firms have been speaking a lot about this. They’ve been building out their own teams. You’re an early mover, you’ve come up with this model. To what extent have you been involved in kind of shaping it? I assume when you set up something new, it’s very difficult to get it right off the bat. Have you come up with the model that you’ve just described, or has it evolved?
[00:13:07] Alejandro Alcalde Rasch: When we started this in 2009, that was when we were in this recruiting process, when I was also considering that role, we had a senior partner at Advent who had done a lot of kind of due diligence, due diligencing what other private equity funds have been doing. And he had an initial idea of what portfolio support could be doing. And well, then I was the first hire in Europe.
And basically I just got a very simple framework which was, don’t screw up anything in the companies and be helpful, just be helpful. Start with little steps. First, support the management teams on smaller tasks. And then over time, probably in the first one, two years, we developed concept of chief transformation officer, how to define AVCP and how to break it down into initiatives, how to track all of this, finding the right ecosystem to support the management team. So preferred third parties with whom we would be working with. And then gradually over time, it just developed into what we have today.
So nothing was preconceived in the beginning, but it felt very natural, I think, over time. But it could have easily gone wrong if the first one or two assignments had gone sour. And probably we would have rethought a few things. But yeah, I think it has worked nicely for us. But that’s the way how advent is doing this with this generalist pool and then a number of functional experts in working across the entire portfolio, in the different sectors that we have for other private equity funds, they may follow a different model that can equally be successful.
[00:15:04] Ross Butler: So it’s been evolutionary.
Yeah, that’s interesting, because advent is known for getting this right, for doing it well, I would say, generally speaking in the market, because there is certainly a theoretical tension between an outfit that historically has just been all about doing deals. I’m not talking about advent, but private equity in general about doing deals and then bringing in this extra component. And so the way you describe it, that you’ve kind of grown organically, that’s probably a good way of doing it.
[00:15:36] Alejandro Alcalde Rasch: Yeah, I think at least I would think that it only goes this way. It has to be an evolution, not a revolution. I don’t think it makes. If you have something that is already working nicely and if you have strong sector, dedicated deal teams, then you’re looking at, okay, what is a complementary capability that would support the management teams and also the advent colleagues in trying to make this deal even more successful. And that is this transformation value creation capability that we can bring to play. I think what’s also important is to have a general attitude that the management is at the center of the value creation and that we are only there to support the management team in being successful in what they are doing. And once you have this basic understanding, then you look at, okay, what can help management be successful? And you think about, okay, it’s about the governance, it’s how you set up these plans, how you check whether we are on the right track. That’s one element. The second element is of course a content element. So commercial excellence, for example, it may be the first or second time that a portfolio company is going through this. But for us at Advent, it may have been the fifth, 10th, 15th case where we’re doing this. So it’s also bringing past experience into play. And then it could be that there is someone, for example, on a functional level that needs support, needs a mentor, he or she is probably doing the first carve out. There is a lot of experience needed in how you carve out an IT system, how you set up your own ERP and so forth. And then if you have a network of people that you can bring in who have done this before, but who don’t want to do it themselves, but rather support someone in being successful doing it. I think then you have the different elements that are required to make this deal hopefully successful besides all the other macro things that need to work out.
[00:17:43] Ross Butler: I would imagine then that soft skills are going to be quite important because if the management are leading the charge on this, it’s kind of easy for private equity to go in and we’re in charge and we’re changing management if it doesn’t work out. But if you’ve got to partner with people, they’ve got to trust you and to some degree like you, I guess.
[00:17:59] Alejandro Alcalde Rasch: Yeah, well this is, I think the whole trick, because on paper, everything sounds relatively straightforward. You think, okay, we’re bringing the best of two worlds and bring them to play and we share our. But the reality is much more complicated, actually, and every deal is different.
I’m working a lot in chemicals, so chemicals has been during my consulting time, has been my deep spike, and it’s now also at Advent. We have a tremendous flow of chemical deals in the last years, and so I’m repetitively working in that space. But if I look back to the different deals we have done there and that we’re still involved with, all these companies are different, even if they are working in the same subsector. You notice that the management teams have totally different approaches and they need a totally different way of handling and interacting. So we have very independent management teams that do not like and rely on external advice so much because they have a doing mentality where they rely a lot on their own teams. And then we have other teams who have maybe a different background, different heritage. They come from parent companies that were used to using a lot of external advice and also rely on them. And so the value creation plans tend to be completely different, not necessarily in terms of the levers, but in the way how they are implemented. And so is also the approach that you need to have visa vis the management teams. I think the most important thing is that you need to establish a trust based relationship, no matter how the setup is in the company.
And you also need to spend a lot of time with the management teams, ideally on site, not just with the C suite, but also with N minus one, N minus two, N minus three, to really understand what the opportunities are within the company. So I tend to work a lot on the governance level, but then also do a lot of deeper dives when I would be working with the individual project teams to understand what’s going on.
[00:20:20] Ross Butler: When I was thinking of questions to ask you, I kept thinking, well, the only answer to that is it depends because it’s all so context specific. So I thought, well, we need to raise it up. And I did think that one of the uniting factors would be that people have just got to trust you and get on with you.
What’s the spectrum of engagement that you would have with a portfolio company? So from this company is doing really well, very light touch through to actually things are going a little bit wrong. We need to get involved. Can you give us a.
[00:20:51] Alejandro Alcalde Rasch: As you said, it depends.
I think there is one thing which has to do with how long we are now working together with a portfolio company. So in the beginning, certainly after the closing phase, it’s probably the most intense time because everything is new. Very often we have carved out situations. There is a lot of stuff that just needs to be done in the first month.
If it’s not a carve out, it’s probably the first time that the management team is exposed to private equity owners. So they may not have the experience in working with us. And so there is a lot of time that you spend on talking through, okay, how should we set up the VCP? What are the right levers to address? How should we sequence them? Do we have the right resources in play? So in the beginning, say the first year, actually it’s quite intense. It can be two, three days a week. And then over time, when things get more mature, when everything is a little bit more settled, your interactions will be a little bit more punctual. So maybe it’s a day a week, then there is a second one, which has to do with, okay, in which situation is the company?
Certainly if there is a bigger acquisition, then there are more hands on deck required in order to integrate that company. So there could be another spike later. As you mentioned, if the company is going through more turbulent times, I don’t know, there is a need maybe to look into the cost base. Then you would also probably go deeper and spend more time. It really depends. In an ideal situation, you have everything kind of going smoothly and then you just focus on a few interactions per week. But yeah, it all varies very much. There are times like the current situation, particularly in the chemical space, where a lot of hands are required on deck. So it’s certainly intense times. If you have seen this before, you know how to handle this and you know, what’s the best way of supporting the management teams.
[00:23:06] Ross Butler: If I may just jump back to a couple of specific value levers, as they’re called. You mentioned that. So you’re mainly generalist, but you are starting to hire a couple of more specialist people. And you said digital and HR. I can kind of imagine why you’d need specific digital people. It’s technical and specific and so on. But HR as well. That strikes me as slightly more of a generalist competency.
[00:23:25] Alejandro Alcalde Rasch: I think it’s all about people in the end. Yeah, we say the management team is at the center of the Value creation plans, and the management team is a broader definition. It’s not just the CEO CFO CIO, but there’s also a management development agenda. Underneath. You want to have people in the right people in the right positions underneath, you want to understand whether the organization itself is developing more muscle in terms of people development, bonus systems, retainment ESG agenda is also quite an important element.
So the requirements are just increasing. The war for talent is real, so handling search firms is also not trivial. You need to know who are the right partners for which types of positions. And so we thought that it would be a very good investment into building up this institutional muscle on the recruitment side, but also in the management development side.
I think two years ago we started in Europe, what we call the Advent Leadership Academy, where we have a little mini MBA type of program where we bring in talent from the different portfolio companies together, go with them through academic classes, but also give them a better understanding of what private equity is all about, and where we want to identify talented professionals early on and give them exposure to colleagues from other portfolio companies. So that’s another example for a program that has been initiated by our HR leadership team.
[00:25:15] Ross Butler: So from speaking with various people in the industry, I’ve kind of noticed a general trend away from if there’s a problem, we’ll just change. We’re just bringing different people towards kind of nurturing or trying to improve or support and mentor existing managers.
[00:25:35] Alejandro Alcalde Rasch: I think every change in the management team is always a disruption. So if the basic hypothesis is in an ideal case, we have already a successful management team, or we support the management team in kind of developing additional muscle, exchanging people is probably the last resort, at least from my point of view, that you should consider. So I’m always proud if we have a management team that doesn’t change over time and that together with us is successful in implementing the value creation plans. Actually there is sometimes a tendency to personalize issues that are probably not personal issues in reality. So you have a problem, a challenge in the commercial space and then because of lack of other, say, other reasons that you identified for this not being successful, you think, well, that has to do with the chief sales officer, and then I exchange the chief sales officer and everything will be good again. I think sometimes too easy to go into that solution.
So I think there may be situations where it’s unavoidable that you need to, need to make a change, but that should be the last resort.
[00:26:59] Ross Butler: I think it’s a very blunt instrument, isn’t it?
It indicates that you have an action diagram maybe needed.
[00:27:06] Alejandro Alcalde Rasch: There may be situations where a company has fundamentally changed because it’s a business that started with a size X and then three years later it’s three X because of acquisitions, mergers, and then people may not have the experience of managing a larger organization, or there is a fundamental change in the industry. It’s consolidating. It’s moving away from, I don’t know, a top line driven game to a more cost focused game. And then you may require a different set of leaders. This can happen, sure, but it should be from my point of view, I don’t feel good if we have to.
[00:27:47] Ross Butler: Change someone, what about bringing in third parties? So presumably there are situations where you diagnose this specific need. What’s your criteria for bringing them in and what do you look for?
[00:27:59] Alejandro Alcalde Rasch: I think it’s important to first sit down with management and step back into, before we talk about third parties, is to look into, okay, what is the challenge? What do we want to accomplish? What is required in order to accomplish this? And then the first question is, do we have the right resources on board already today in order to deliver this? Then you sit down with management and try to identify who would be the right third parties to support us for this specific challenge. And then we bring in some third party resources that we know from our past that have been successful, but also management may have had already very good experience with somebody else. And then we typically start a beauty contest, whatever you call it, RFP process, and then try to identify who are the right partners for this specific situation. So it’s not that we come in and say, no, you have to do this project with consultancy XYZ because we always do it like this. I think that’s not a recipe for success because you want to have management accountable and in the driver’s seat. So they should be ultimately the ones who make the decision in the end.
[00:29:16] Ross Butler: Right.
[00:29:17] Alejandro Alcalde Rasch: Obviously, we would be trying to influence that. Yeah, we would certainly object if we don’t think it’s the right third party. But very often you have two or three choices, and then it’s also very often not the name of the third party advisor. So the company behind, but it’s the individuals.
These organizations have become so big.
[00:29:39] Ross Butler: Yes.
[00:29:39] Alejandro Alcalde Rasch: And I think also there is the, or should I say the standard deviation, has become bigger of what you actually get. And so ideally, you work with someone who is already trusted by management, whom you trust, too, and you like to see people that you have seen in the past already and who have delivered impact.
[00:30:02] Ross Butler: I guess from a private equity firm’s perspective, that flexibility allows you to see more people in action. You’ll get a greater breadth of understanding.
[00:30:10] Alejandro Alcalde Rasch: Absolutely. I mean, I come from one consultancy, and I always thought that what we were doing was the best thing that could ever happen in a specific space.
But then when you see what all the others have to offer, then you realize that you only knew so little in the past. Yes, and that the space out there is just huge. But it’s also tricky to navigate in that space. You need to find the right ones for this specific situation. And one firm that may have worked nicely in one situation may not be the right one in another situation. Just because the context is different, the management team is different, the style of management may be different. So you need to be quite flexible and adaptable to it.
[00:30:53] Ross Butler: So the value creation plan, it sounds like the key document is kind of like your North Star. As you travel through this process, you kind of write it, I suppose, at the start of the investment. How often in practical terms, do you actually, or you, the management team, refer to it and refine it and adapt it as it goes along? Or are you just up and running by that point?
[00:31:14] Alejandro Alcalde Rasch: Well, it starts basically with the deal thesis, which is obviously driven by the deal team. The deal team is looking into different investment opportunities. And for every investment opportunity, there’s always the question, what do you want to achieve with this company? What are the value creation levers and so forth? And then when you get done involved during due diligence phase, you bring in your own input, your own experience from your past portfolio company situations. And then this evolves to a point where this becomes part of the final investment thesis memorandum, right? But then latest after signing, you also want to look at, okay, what is management’s view? So you take your investment thesis, you combine it with the management plan. Already during the due diligence, the management will have presented a five year plan to you with some value creation ideas. And then you try to blend the two.
In many cases, you will find that the things are complementary, that you had an idea in one particular function and management had something else in another function, then they are additive. Sometimes you find that their level of aspiration was maybe lower than what you thought could be doable. And then you need to align it with management. You sit down, basically you go through, okay, this is what we learned during due diligence.
Let’s now talk about what we learned in the due diligence, what your plans are. And then we try to combine the two things. And then we have kind of a starting value creation plan. It’s kind of the things that we would be doing in the first two years or so. Obviously there are sometimes longer term things that we need to initiate. Like if it’s a roll up in a certain sector, you need to already think very early on, okay, what are the different acquisition opportunities? And they may or may not work out, but say on the more homemade things that you can do internally, it’s difficult to think more than two years on.
And after two years, it makes sense to just sit back and rethink what is kind of VCP 2.0 and kind of what are the things that we should add. It’s very rare that an initial deal hypothesis is still valid five years later. I mean, the core elements will still be valid, but the way how we get there may be different. So it changes over time. And if you’re in turbulent times, like in the last years, where you have to cope with supply chain disruptions, you have to cope with energy crisis, you have to be very flexible.
[00:34:07] Ross Butler: Because I was thinking, say you’ve got a three year plan, but you can’t exit exactly when you want because the timing has to be right and so on.
[00:34:14] Alejandro Alcalde Rasch: Yeah, timing. Timing is one thing, but also the industry such can go through different cycle, cycle phases of a cycle. So in chemicals, for example, a longer period of challenging times, let’s put it this way, right than it used to be a few years back.
[00:34:33] Ross Butler: What’s causing that, out of interest? I don’t know about the chemicals energy.
[00:34:36] Alejandro Alcalde Rasch: It’s disruptions in the supply chain.
It’s plants that are being taken out by suppliers, by competitors. So there is a quite radical change. I think you see similar things in the pharmaceutical industry. We had a terrible 2022, very challenging because of supply chain disruptions. Products that are coming from China, from India, precursors into pharmaceutical products that have gone through turbulent times. And then 23 is a totally different year. You see that all these things that didn’t work so well in 22 all of a sudden are coming into place again, and that you go back from seizing up smaller growth rate into a much higher growth rate just the following year. So you need to be adaptable with your value creation plans.
[00:35:31] Ross Butler: Now that we’ve seen those risks being borne out, are you more alert to them on the way into a company? You’re like, this company is too dependent on elongated supply chains. Or have things just opened up more? And that was a one off.
[00:35:45] Alejandro Alcalde Rasch: People have become more critical of what risks you are willing to undertake with a portfolio. You have learned from your past experience. It’s like every child, once you put your hand on the hot stove. On the hot stove, yeah. You will probably be more careful next time. And the same thing is here. So if you realize that there could be supply chain disruptions. Just because you are dependent on single source suppliers, you will focus more on, okay, what is dual sourcing, what is the lead time for a certain product? I think this kind of collective experience is important that you have that, and that’s also why it’s so important to have a team that has experience in what they do. Like I’m now 13 years in my role.
Many of my colleagues are 5678 years, ten years in the same role. So they have already gone through a number of challenging economical situations. So you learn from these things. If you’re in a world where everything has gone just into one direction, and all of a sudden you have to look into more challenging time, it’s the first time for you, and then you do not have that experience.
And having this experience doesn’t only show you, okay, what should I be doing in a specific situation? But it also tells you that, hey, I’ve gone through this already in the past, it’s going to be better a few months from now, potentially, and you just feel a little bit more relaxed about these things. You know, things can go sour, but you also see that things can actually also turn around pretty quickly.
[00:37:27] Ross Butler: So in practical terms, that means you’re not as likely to overreact to downturns.
[00:37:32] Alejandro Alcalde Rasch: Because it’s always difficult, particularly in supply chain. So the tendency that you overreact, you have too little stock, then you overbuy, then once you’re not able to supply your customers and six months later, you have an oversupply of raw materials and work in progress materials, and then your inventories will go up big time, and then you have another challenge.
These experiences, I think, matter a lot, and I think that’s why it’s also important to keep an experienced team and not to have too many changes.
You need to have stability in your portfolio support groups.
[00:38:16] Ross Butler: So there’s an inverse relationship between the general trading environment and your learning rate.
[00:38:21] Alejandro Alcalde Rasch: But you can also learn from good times.
[00:38:23] Ross Butler: Yeah, better that way. Buy and build has become, for quite a while, an increasingly important part of the upside in a private equity play.
That strikes me as kind of an investment side skill set. To what degree do the portfolio support group get involved in that?
[00:38:41] Alejandro Alcalde Rasch: Buy and build? It’s a lot about the capability of a company to be able to integrate the business that you have bought. It varies a little bit by sector, but if I look at the more industrial space where you have physical goods that you’re touching, you need to be able to integrate that company into your sales and operations planning process. You need to be able to integrate them into your ERP landscape. So there is a lot of institutional knowledge that you need to build up in order to be able to integrate those businesses quickly, because very often your buy and build will be also based on synergies that you can capture from these companies. And then it’s important that you can actually realize those synergies and that requires that you integrate them.
There are certainly areas in the tech space that work differently. I can only speak of, say, the industrial part. So it’s very important that you develop this capability as a company to be able to take a company, take your own processes and put those processes into that company that you acquired, the whole GNA space, sales and operations planning, production planning and so forth. That is something where I think where we can play an important role to be able to integrate those companies quicker.
[00:40:08] Ross Butler: Are those skills diffused across a company, generally speaking, or would you try and create a unit for integration and transformation within the portfolio company, or a bit of both?
[00:40:18] Alejandro Alcalde Rasch: We have some companies that have a more constant flow of stream of acquisitions, that have developed an M A team that has these strong deal capabilities, but who also have developed the capability to integrate those companies. So yes, wherever meaningful, you should have that as a dedicated team within the organization.
But it depends very much on the portfolio company and the value creation plan.
How important are Bolton acquisitions in order to deliver the entire VCP?
[00:40:59] Ross Butler: So it depends.
[00:41:01] Alejandro Alcalde Rasch: Yeah, it depends. Again, there is no silver bullet, unfortunately. So I’ve always tried to. Okay, what are the things that I have learned in this one company, and can I apply them one to one in the next one? It very rarely works.
[00:41:14] Ross Butler: Well, at least that means your job can’t be taken over by AI.
[00:41:18] Alejandro Alcalde Rasch: I don’t think so.
But AI is indeed, it’s one of the big disruptors, I think, that we’re currently seeing. So how can we optimize GNA processes using AI, which processes, sorry, GNA so general, and admin processes, so back office processes. It is a little bit of a mantra that has been constantly preached, but there is something, it is disruptive, I think I’ve also had to learn it over the last few months that you can completely change processes by applying AI in an intelligent way. It’s interactions with your suppliers, where you have an AI engine that is looking at data and even writing memos that you would send to your suppliers in an automatic fashion that you couldn’t just handle in the past. So it’s a lot of examples like this. So it’s something we need to seriously look into and we are looking into it.
[00:42:21] Speaker A: And presumably there’s quite a lot of scope for knowledge sharing as well for something that’s so emergent and generally applicable.
[00:42:27] Alejandro Alcalde Rasch: Yeah, that’s also why we have built up this digital muscle in the last 24 months, because that is something that is not sector specific. It’s a capability that you can easily transfer from one portfolio company to the next one, and where you also need to have enough knowledge, a lot of knowledge to be able to navigate in this ecosystem that is developing of different development firms, software companies and so forth. And that is nothing where I would feel very comfortable with navigating in. Yeah, so you need someone who really knows this stuff.
[00:43:02] Ross Butler: So as we move through the lifecycle of a deal and we get towards exit, generally speaking, would the portfolio support group have less and less to do with the deal because you’ve almost finished your.
[00:43:14] Alejandro Alcalde Rasch: Normally, I said we’re having twelve people in Europe, so we need to be careful as to where do we spend our time on. So we always want to be short on supply so that actually we don’t never come into a situation where we don’t know what to do with our time.
So we’re typically not supporting all of our portfolio companies because there may be some who are either from the beginning, they do not require a lot of handholding because the investment thesis is quite clear. Management teams knows their stuff and it’s relatively straightforward, still needs to be done, of course, but there may be other situations where the heavy lifting in the VCP has already been done and so we’re at a later stage and then it’s all about exit preparation. And then there are situations where we need to also prepare the company for exit, just spending more time on them, working on an additional new wave of VCP activities. It’s the exception, but it happens that we are also involved until we exit the company. But it’s few situations. I think the heavy lifting is the first one, two, three years.
[00:44:27] Ross Butler: But how do you feel when you say goodbye to a portfolio company, having worked with a bunch of people so.
[00:44:31] Alejandro Alcalde Rasch: Closely for you hope all the best for them, for the future that they continue to be successful. Hopefully we have made a great exit for ourselves, but hopefully, I always hope that it’s also a great investment for the next owner. Obviously I want to see that the management team continues, continues to develop and it’s not like you sell it and then you forget about it, you’re still interested. And also there are some sectors where you meet again, not necessarily because it becomes another deal like a second acquisition. But it could be that you may work with this company as a supplier or as a customer.
[00:45:17] Ross Butler: Right.
[00:45:17] Alejandro Alcalde Rasch: So if you’re in an industrial space, in chemicals, for example, it can happen that your pass portfolio company may become a supplier of a critical raw material three, four years down the road. So the better your relationship to them, the easier it may become to work with them again. Or it could be that individuals, you meet them again in a different role in a different company. So it’s not like fire and forget, it’s quite the opposite.
[00:45:47] Ross Butler: Yeah. So private equity is essentially, it’s an iterative game. And I think that’s what people who do not understand or are not involved in private equity. The general public perception of private equity can be very critical. We get it sometimes in our comments section. Yeah, some private equity people are nice, but mainly they just buy, leverage and sell. But what that misses is the integrated nature of business and also the fact that you’re not just doing one deal and then you’re done. Your reputation spreads across time and across deals and across sectors.
[00:46:20] Alejandro Alcalde Rasch: First of all, very practical things. You can only make a successful exit if that company has a brilliant future ahead, because otherwise, who would be buying that company?
I’m coming from Germany. So we had what we call the locusts debate a few years back, before 25 ish, where even the government was stating at some point that, yeah, private equity will come in and, like, locusts, will fall over the companies and they would leave nothing left behind. It’s a complete misperception of what we’re trying to do. We’re trying to create industry leaders and long term industry leaders and companies that are successful also for the next shareholder. Otherwise no one would be paying the premiums that we hope to get for those businesses. And then your reputation matters a lot in Germany. If you’re perceived as someone who treats the management teams and the employees badly, you will have a very hard time in getting your next deal.
So I think it’s quite important that you’re supporting, you’re creating great enterprises and you treat the companies fairly in that process, that you help them become stronger and that also the public perception is as such. But you’re always only as good as your last deal, actually.
[00:47:55] Ross Butler: Right? Like Hollywood.
[00:47:56] Alejandro Alcalde Rasch: Yeah, it is like that. So the memory is also sometimes a bit short.
[00:48:03] Ross Butler: So you’ve done more than a dozen deals. Do you look back generally and think, this is a very worthwhile enterprise, created value and, yes, absolutely. Good for the world?
[00:48:12] Alejandro Alcalde Rasch: Absolutely. No, definitely. I mean, otherwise I wouldn’t feel happy with what I’m doing. First of all, I enjoy every day of this professional life because it’s so, or should I say it’s so diverse in terms of topics you have to deal with. That’s interesting. But then you’re also proud if you exit a company and you see it being successful a few years later.
[00:48:37] Ross Butler: Well, that’s a great point to close, but I actually have a bit of a cheeky question. Okay, so I was speaking to a chief investment officer the other day and we were talking about private equity firms themselves and how well run they are. And I made the observation that, well, you go in and support portfolio companies and make them better. So why isn’t it just standard procedure to always be introspective as well? And he made the valid point. He says, yes, but portfolio companies don’t do it to themselves. It’s actually quite difficult to make yourself better. It’s easier to make someone else better. Now you slightly separated from the main part of Advent’s investment side, and you’re always looking at how to improve companies. So just from your perspective, in terms of how private equity firms are run in general, perhaps, do you ever think that could be done better?
[00:49:27] Alejandro Alcalde Rasch: I’m sure we see this every week. There are things where we could think, okay, why are we doing it this way? Why aren’t we automating the way we are gathering information from the companies?
There is a lot of things, but I think we have a long history already. I think we were founded 1984 and since then the Advent has gone through tremendous growth, but also I think a lot of institutional learning. So I think we are very conscious about our own internal processes, how we develop people and so forth. And there is always things that you can do better. But I think the general direction has been very clear from at least since I am there. And I think yes, we can improve things, but we should not be trying to make an internal portfolio support group program just on ourselves. We have a number of things on the ESG side. We have done quite a lot. I think we have invested a lot of time and effort into becoming more diverse as an organization. I think we have done a lot of progress. We have made a lot of progress in the last years. So there’s always things where you can get better. So complacency is probably the biggest enemy of ourselves. And as long as we are critical with ourselves, as long as we try to improve things, I think it will go well.
[00:50:56] Ross Butler: Alejandro, thanks so much for sparing your time for Fund Shack. It’s been a pleasure speaking with you.
[00:51:00] Alejandro Alcalde Rasch: Well, thank you very much for inviting me.
Harvard professor Josh Lerner explains the risks and requirements of public intervention in establishing a thriving venture capital and entrepreneurial ecosystem.
Professor Lerner tells Ross Butler that seeding a venture capital industry is a difficult and slow process – it’s not just the case of emulating Silicon Valley. With reference to his classic work, ‘Boulevard of Broken Dreams‘, Ross Butler asks for Josh’s key recommendations, and in particular whether increasing the supply of venture capital or the demand for it, is the more sensible route for policymakers.
With reference to the US, Japan, Australia, the EU and Great Britain, this wide-ranging conversation looks at where policymakers are going right – and wrong – when trying to promote entrepreneurial risk taking and institutional venture capital.
We close with a look at the importance of ethics when working at the cutting edge of scientific innovation.
[00:00:00] Ross Butler: You’re listening to Fund Shack. I’m Ross Butler and today I’m speaking with Josh Lerner professor of investment banking at Harvard. Professor Lerner teaches venture capital and private equity one of Harvard’s biggest elective courses. His research focuses on private capital and he has many published papers and books on the subject including The Money of Innovation, Patent Capital, the Commingled Code and Boulevard of Broken Dreams. He also founded and run as the not for profit Private Capital Research Institute. In this episode, among other things we will look at how to nurture a thriving entrepreneurial and venture capital ecosystem.
Professor. Welcome to Fund Shack. Just after the great financial crisis you published a book called Boulevard of Broken Dreams which I read at the time and it’s one of the more poetic titles, I’d say in the pantheon of venture capital literature. So well done on that. And in it you made a very nuanced argument, I thought for the necessity of state intervention of public sector support to at least kind of seed and nurture venture capital ecosystems in their formative years and decades. But you also equally, I think, put as much emphasis on the pitfalls and of not getting it wrong and hence the title of the book, I guess. So I’d like to look at both of those angles. I mean, I guess I’d start by saying do you still believe that state support is necessary? And if so, kind of why do you think that is?
[00:01:25] Josh Lerner: First of all, thanks so much for the chance to be here and it’s great to get a chance to talk about these really important issues. I think that the answer is yes. That the nature of venture ecosystems which in some sense are even more compelling today than was the case 15 years ago. Given the kind of growth we’ve seen in both new technologies like artificial intelligence but as well as just simply the creation of wealth associated with these new ventures with jobs and the like, that this is a tough process. We’d like to say it’s just a matter of sprinkling a little pixie dust and it takes care of itself. But it seems it’s a really slow process of trying to get a lot of things coming together and in a way there’s an instinct to look at Silicon Valley and say wow, that’s great. I can just clone this and carry it over and just get the right looking buildings, a fancy university, a few fancy professors and everything will take care of itself from there. And I think everything we’ve seen about creating these kinds of clusters suggests that it’s a much longer and much harder process than that where we have to get a bunch of things coming together.
Were we trying to put a label on it? We might say, increasing returns.
[00:02:57] Ross Butler: Right.
[00:02:57] Josh Lerner: That it’s really hard to be the first entrepreneur in a city in a category by the time there’s 100 people buzzing around doing stuff in that area, it’s much easier. But that process from going to one to 100 of really getting the plane off the runway is where the challenge really lies.
[00:03:15] Ross Butler: But do we not need to distinguish between kind of general entrepreneurialism and business creation and scale up and all of that stuff? And then a formal institutional venture capital can presumably, you can have a thriving innovation ecosystem without necessarily a venture capital ecosystem. Is that true?
[00:03:34] Josh Lerner: Absolutely. And certainly we can think about the history of much of Europe as saying that when we look at many of the really critical technologies, everything from Internet to biotech, european academics and researchers were right at the front lines. In many cases, they were there first. The challenge that I think is pretty well documented for much of Europe has been really that translation of the innovation of the researchers with great ideas into businesses and ultimately into prosperity. And it’s really that translational thing of going from the innovation to the ecosystem, all the stuff that goes with it, where the intermediaries play a critical role.
[00:04:28] Ross Butler: And you make the case for state intervention primarily, I think, by looking at historical case studies, silicon Valley being an important one. People tend to think of Silicon Valley as the cutting edge of free markets. But as you explained, it’s not that at all. And in fact, I think to a large degree, in the early years, it looked like the kind of the R D wing of the US. Military. And to some degree, it’s still very closely related to that. But I guess the difficulty is the very limited number of case studies there are with regards to successful venture ecosystems. And so my question really is, and you are very nuanced in the book about this but what’s your kind of confidence level that let’s say in the next 20 or 30 years there won’t spring up a vibrant venture ecosystem in an economy that currently doesn’t have one, where there was no proactive state support or intervention?
[00:05:28] Josh Lerner: Great question. So I think one observation I’d make is that when you look around the globe today, it seems like every corner you look at, governments are doing policies to do stuff right. Certainly you look at things as diverse as Australia and the Emirates and Brazil, and you see very active policies to try to nurture high potential entrepreneurs and the intermediaries that help make them succeed. I should say that’s more than venture capital, right, that we’ve seen, particularly in the last decade or so, a lot of interest in trying to boost angel investors as well. And I think there’s often a sense that the angels will will wander where the venture capitalists fear to tread, right? In terms of I mean, in a way, when you look at many angels, they’re bright, sophisticated, successful people, but they also are doing this not just simply to maximize their bottom line, right? They’re getting some real enjoyment out of working with entrepreneurs, trying to in many cases try to boost the economic development in their place and they can really play that bridge role in the early stages. So we are seeing a very significant uptick in terms of the kinds of interventions that are there. We recently completed a project where we just looked up to the time of COVID and tried to identify all the programs we could find around the globe that were aimed at boosting entrepreneurial finance or the intermediaries that provide that capital. And our compilation came up with somewhere in the order of 900 such programs in the last couple of decades. Pretty much everywhere in the planet you look except for a few corners of Africa and the like did you look.
[00:07:31] Ross Butler: At how many of them had been successful or in your own subjective view, where has this been done?
[00:07:37] Josh Lerner: Know, I think you came in at the beginning saying it’s a little qualitative.
[00:07:41] Ross Butler: Right.
[00:07:42] Josh Lerner: And I agree with it know? Certainly when I feel when I’m asked, for instance, to give advice to a government or just give a talk, I always say a lot of what we’re doing here is not at the when we try to write an article, submit an article to the Journal of Finance, everything has to be at the 95% level of confidence right. With two stars and all the regressions. And they really like it when it’s 99% confidence. Right. Here we’re definitely in the realm where if we feel we’re 70% confident, we feel really happy that this is more often right than wrong. So there certainly is not real certainty on many of these things. But at the same time, when you look at data, you do see that some of the messages that I and others have been pushing that first of all, government intervention can make a positive difference at least in the right places at the right times. And secondly, that the provision of matching fund shack trying to get a signal from the market as to where the money should go is really important. Those two things are very much corroborated in the large sample studies as well.
[00:09:00] Ross Butler: Right, so I was going to ask you what are your key recommendations? Sorry, could you elaborate on those? So did you say you got to identify the need effectively? Was that your second point?
[00:09:11] Josh Lerner: Right, so I think certainly one of the challenges that public programs have faced has been this sense of saying let’s just go and do whatever the flavor of the moment is, right? That when you think about it, most politicians and most senior administrators are no doubt well intentioned but they’re not deep students of economics and economic development and even if you are a deep student in it, predicting what the future is is really hard right? So in a way to come in and say what so often happens is people look around at what other places are doing and just simply emulate what’s going on.
One example, of course, is biotech. I think an example I’ve used many times over the years is a paper by my friend Marianne Fieldman, where she documented that in the United States at the time she was looking, 49 out of the 50 states had programs encouraging biotech ventures, which were sort of predicated on the proposition that their state had some unique competitive advantage in biotechnology.
And the only one which didn’t was the Alaska, which had one where the former governor and former vice presidential candidate Sarah Palin abolished it on the grounds that it made no sense for Alaska in one of her few moments of really good public policy.
Right. When we look at that, you say that’s absurd.
[00:10:56] Speaker B: Because no doubt there are a number of places where having a biotech cluster makes sense, but 49 out of 50 is unlikely to be there. And we’ve seen the same thing play out with clean tech and various other various other things as well.
[00:11:12] Josh Lerner: And when you ask the question of what’s right, it often is hard to say sitting in the ivory tower. But once you actually see it work in practice, it actually makes sense. So I remember one of the Australian states had put a big effort in terms of encouraging research in terms of life sciences. They had built all these fancy labs and he had a bunch of professors they had hired for big sums to come over and set up these facilities. But they were very frustrated because they were not getting the spin outs that were there. The spinouts that were coming out of those labs were either going to Sydney if they were good, and if they were really good, they were going to San Diego or San Francisco. And meanwhile, when you looked at saying, what are the startups that are doing really well and getting a lot of financing and market traction, it was things like using drones for low water agriculture software for the mining industry and stuff like that. In other words, companies that had some real rationale for being located there because of customer demand and being able to do really cutting edge applications. Right. And it’s hard to sit in the ivory tower and figure that out in advance, even if afterwards you say, AHA, that makes a lot of sense. And in a way that really sort of speaks to the power of market signals. In other words, saying, let’s see who’s sort of able to get traction there and then help those people get to the next level, rather than the more technocratic idea of saying, here’s our plan, and we say the answer is x. Right.
[00:13:12] Ross Butler: So the local dynamics is critical, but it’s very difficult even for politicians in that locality to know what they really are in advance. The lesson, therefore, presumably, is don’t be too specific with regards to your intervention and where you want the money to go and what you want it to specifically achieve. Is that fair enough?
[00:13:31] Josh Lerner: Absolutely. Right.
We just have thousands of examples of not just politicians who get it wrong, but even people who get it wrong about their own discoveries. We have across the way here the first programmable computer that was developed at Harvard during World War II. And there’s a famous quote from the professor who invented that like ten years later. They said, is this computer going to be useful for doing things like helping department stores send out bills? And he was like, if this computer, which we did to do calculations for developing the atom bomb differential equations ends up being useful for department stores, I’ll regard that as the biggest miracle in the history of humanity.
[00:14:21] Josh Lerner: So even there, the dude who had actually put this thing together, conceptualized this and put this thing together, couldn’t see around the next bend as to how It technology was really going to evolve. So in some sense to say to a public figure, oh, you figure out how all this sort of really complex stuff is going to bake out is.
[00:14:49] Ross Butler: That’s really the miracle of Silicon Valley, isn’t it? Because you made the point in your book and as I mentioned earlier, it’s very much one way or another, the military has either been a customer or a funder of ventures, but in another economy, that’s kind of where it would have begun and ended. But with Silicon Valley’s genius is to take whatever it is, global positioning systems and allow everyone to find their way, right? Yeah, go, absolutely.
[00:15:18] Josh Lerner: In a way that sort of serendipity or basically having just a ton of really bright people who aren’t afraid to fail and aren’t being punished for failing, being able to sort of play around in the sandbox and say, what is the next step that could be done with this? Fully cognizant of the fact that most of these ideas aren’t going to work out. But if one gets that right combination, it can be enormously powerful.
[00:15:50] Ross Butler: But I still come back to the point that it’s like there’s only one Silicon Valley and that’s true even in America. Like, if there were three or four Silicon Valleys, then maybe it would make sense for other countries to say we need one of these, but there’s one. It looks like a real anomaly. Maybe I’m being too cynical. Maybe there are other clusters that are smaller there and I don’t know, but from a layman’s perspective, it does look like a know, you’ve got America global power, you’ve got Silicon Valley, one cluster, end of story, and everything else is just miles behind. Is that unfair? I hope so.
[00:16:25] Josh Lerner: I think the answer is it is unfair. Right. If you looked at a chart of just a pie chart of venture capital and its allocation over the years exactly. If we took the snapshot as of 2001, and looked at it, basically the US. Would represent 85% of the pie. And once you added in the slices for UK, a little bit of France, Japan, Australia, Canada, right. You were basically at the mid 90s in terms of accounting for the accounting for the pie. And the whole rest of the world was just a tiny little sliver. Right. Today, when we look at it, or at least in 2022, what you see is the US. Is still the biggest piece. It’s probably 40 something percent in terms of the pie. But we’ve got any number of other slices of pie which are very significant. Obviously, China, the red slice, being quite big. But today India is representing close to 10% of the venture capital investment around the world. And we see significant clusters in a lot of other places as well, with a lot of the growth having taken place. Not so much in the again, when you look at relative growth because overall pie has grown, but the growth in the slice of the pie being most dramatic in the developing world in various places. So I think the view that this is just a game about the US. Or just a game that’s about Silicon Valley is mean. Certainly there’s still this sense of when you go within a particular country, when you go to Sweden and look around, right. The vast majority of the action is going to be in Stockholm.
[00:18:26] Josh Lerner: It’s still a game where there’s just a lot of what US nerds would call agglomeration effects, and we might just call lumpiness or stickiness, where people all want to be together with want to be together with each other. But when you look at the aggregate trend, it has really been to go from just one big lump to a series of lumps around the globe. Yeah.
[00:18:54] Ross Butler: Okay, well, that’s good news. So there is progress, and I’m being too cynical, and I’m glad to hear it.
So you could probably tell that I’ve recently reread your book because another point that you made, and you put this so brilliantly, and I hadn’t thought of it this way. It’s very simple. You basically say there’s a couple of ways that you can support venture capital. One is to create an environment whereby it thrives, and another is to increase the availability of capital, the equity gap type thing. And one, the former increases the demand for venture capital, as you say, and the latter increases the supply.
Which would you say is the most effective?
[00:19:31] Josh Lerner: Well, I think it’s certainly the case that you can’t have the one without the other. And in particular, I think there’s this sort of natural instinct that is, regardless of the political system, regardless of the culture or the religion, we see this natural inclination of political leaders to want to hand out big checks to people. Right. It’s just somehow, as a leader, that’s what gives you the warm and fuzzies in terms of saying I’m doing my job, I’m going to get lots of happiness and recognition for having done this. And one thing we can say with a lot of certainty is just that strategy of pill mill distributing funds without having done the hard work of setting the table, of making an environment that’s conducive to entrepreneurship is very unlikely to be successful. And yet we’ve seen this again and again. I think that there are any number of classic experiences along these lines. Probably with the Japanese being the most famous of policymakers who were bound and determined to create high potential venture VC ecosystem and said let’s just skip all the other stuff and go directly into dumping money into the entrepreneurial ecosystem. And as long as they were shoveling money into the system, there were people there willing to take it. But as soon as they had to because of financial pressures scale back the spigot, the venture industry just disappeared.
[00:21:18] Josh Lerner: And in a way it was an artificial industry that was being propped up by the public funds. And you say why was that? Are Japanese people not entrepreneurial? Are they not smart? Are they very smart? And certainly you walk around downtown Tokyo and you see big signs saying Toyota and stuff like that and these were real entrepreneurs who created companies out of nothing and created tremendous wealth from it. But that being said, for much of the period the government was trying to do this boosting of the venture sector. It was an environment which was really stacked against the entrepreneurs. First of all, of course the labor market. You could quit your job at Mitsubishi, but once you quit there was no way back in, right? Which really raised the barriers to going and starting something. You were definitely burning your bridges behind you. The tax laws, the labor laws, a 1001 other things were sort of rigged in a way that really made it unfriendly to be an entrepreneur and where it was a real struggle as a result. And I think again, why didn’t the government address that? Well, a lot of that was really hard, right? We know that anytime you sort of have regulatory or policy reform there’s lots of vested interests yelling and pushing in a bunch of different ways. In some sense it’s a lot easier to say we’re just going to go hand out funds. But I think that really has to be the first step.
[00:23:00] Ross Butler: Do you have a view on what’s going on in Europe and the EU’s initiatives to support venture capital?
[00:23:06] Josh Lerner: There’s certainly been a lot of money handed out by European Investment Fund and others and certainly there’s been some significant changes, positive changes in terms of some of the table setting kind of stuff, right. So if you think about a couple of decades ago in a place like not just Italy, but even Switzerland, you had this sort of extremely unforgiving regime in terms of treatment of failure. Right? As I understand it, the extreme form of that was not only were as an entrepreneur, if you were an officer of a company which failed, were you banned from being an officer of another company, but even as a board member you basically were hexed from doing that, right? Which of course, no doubt if you were sitting at the Swiss Business School and some student came to you saying will you be on the board of my startup?
Your answer would be no.
So, you know, there’s certainly been some positive changes in terms of some of these areas. And certainly you look at many corners of Europe. We talked about Stockholm already, right, where you do see a lot of this sort of virtuous cycle. And I think we could put London in the same category, where you do see just much more development of an entrepreneurial culture and process. I think on the other side you could certainly ask an impolite question which is given the massive investment of public funds, has the return on investment been as high as it ought to have been? And I think there my answer would probably be no. And if I was to highlight one issue or one problem, it seems like in many cases they’re starting off with a big lump of butter and then spreading it super thinly over I don’t know what the number is now 28 or 27 pieces of toast. And even on each piece of toast they want to put some money up in northern Lapland and some money out in the extreme western end of a country and so forth, right?
Even at a country level, rather than putting one pat, there’s this tendency to want to spread it out extremely broadly and in some sense that’s appealing, right? It’s sort of fair. That why let one place get all the goodies and other places not get the goodies, right? And in particular, you might argue the need for economic development is probably way higher up in northern Lapland than it is in Stockholm, where people are pretty prosperous and happy. But it ends up being really counterproductive because once you get that 1000th of a millimeter layer of butter spread all across the board, you can’t taste it and it doesn’t have any kind of real positive effect.
[00:26:21] Ross Butler: Right.
[00:26:21] Josh Lerner: It basically ends up ignoring the lumpy nature of this process. And I think that’s to some extent cut against the efficiency with which money has been spent.
[00:26:35] Ross Butler: So just as an aside, back in 2010 I was working actually at the European Private Equity and Venture Capital Association, which is now called Invest Europe. At the time we put out a venture capital white paper so we all read your book and we had a chap on to comment from the EIF called Thomas Mayer. And so the conclusion that Thomas and we came to was kind of precisely what you just said. And the solution that one of the solutions we put forward in the White paper was it was mainly focused on what you’re saying, increasing the conditions to increase the demand for venture capital, but also to try and take the source of public funds one step removed from the EIF. So you create a kind of a fund of funds and that allows the market to allocate to pick the winners rather than it was still online if anyone’s interested in reading it, but that was where we got to. But obviously Europe’s difficult because it is.
[00:27:27] Josh Lerner: Intensely political, obviously, but certainly I’m very sympathetic with this notion of saying to put as much distance between the politicians on the one hand and the entrepreneurs on the other is, I think, a great guiding principle. You know, when you think about some of the efforts that have been successful, albeit at a sort of smaller scale, so you can think about something like New Zealand Venture Investment Fund. They tried to create a body to take the public funds and allocate. It where they put a real moat around it to influence the process of somebody from Parliament calling up and saying my brother is trying to launch a fund and can you talk to him? And all that kind of shenanigans that we know is all too often the part and parcel of the process. I mean, this is not a popular message pretty much anywhere in the globe. I remember once testifying before some Senate committee and some very distinguished and reputable senator from somewhat far corner of the Wild West said this is just a sign that you’re a Harvard elitist who just wants you kind of people on the coast to do really better and don’t care about us. And with that kind of framing, you knew the conversation was not going to go terribly well.
[00:28:48] Ross Butler: Well, good for you for putting out unpopular messages because someone’s got to do it.
Have you been following so I’m currently in London, just had something called the Mansion House reforms where our government has encouraged British pension funds to allocate significantly from a very, very low base anyway to private capital in general. And obviously the press release focuses on venture capital. Have you any thoughts on that kind of corralling of local institutional investment vehicles into the sector?
[00:29:18] Josh Lerner: I must admit I’ve got a fair degree of caution there and again, you can say this is simply anecdote, but we have had a number of experiences in the past. I think one of the great case studies was that of the experience in Australia in the early 2000s where there was a real effort on the part of the government that was in charge then to strong arm the super funds. Basically the pension funds, which are massive due to the mandatory savings that they have in Australia to put money into local venture funds. And again, it was well intentioned in terms of what they were trying to do, but it was a situation where the industry itself was extremely young in many cases. Not that the people running the funds were not that good and where certainly it couldn’t accommodate the kinds of funds that the super funds were being asked to put into it. And the results were bad in the short run, which is to say a lot of money got put into these nascent venture funds which weren’t able to wisely invest it and ended up with basically a lot of money being wasted. But the real consequences were in not just the few years afterwards but really the decades afterwards. It just created this extremely bad taste in the mouth of the super funds around doing venture type investments, particularly locally. And they were like maybe we’ll give a little money to Carlisle or KKR but we’re certainly not going to put any money into any aussie bloke who shows up here talking about doing venture capital here.
[00:31:08] Josh Lerner: And it became counterproductive right? In the sense that they were so negative on this that it almost became an active aversion to doing venture investing and unwillingness to say the market is very different today than it was 15 years ago. That’s sort of gradually changing but it really had an unintended consequence and a very long hangover associated with it.
And I worry a little bit that I think it’s often very tempting on the part of policymakers to look around and say here’s a big pot of money, let me just solve my problem by reaching into it and using it over here. But I think that without really making sure that there’s an attractive set of ventures out there, it can be pretty problematic.
[00:32:04] Ross Butler: It’s not just tempting for the politicians, it’s also, I think, tempting for the industry itself, of which I kind of count myself as part. And with these Mansion House reforms people have been going around giving each other high fives. There’s this massive rush of capital coming into the industry. That’s got to be good news. I’m a big believer in the power of private equity. But I’m asking you this line of questioning because, of course, there is another side to it which is a little bit more concerning, which is maybe long term this is a risk. And that the press release that the government put out put some really was very specific about how it was going to improve the performance of British pension funds. Governments can say that kind of thing, private sector institutions can’t. But it’s certainly I think it is a bit of a concern. But you can understand that the industry is all for it because they can’t change the wider environment. One thing they can do is change that. They can lobby very narrowly for more funds for themselves. And so there aren’t that many people kind of sitting on the sidelines calling for kind of the bigger picture and a little bit of caution.
[00:33:10] Josh Lerner: Certainly this is a chicken. And egg problem and anything that can sort of shortcut that conundrum is obviously appealing. But I think one ends up being keenly sensitive after looking at enough cases to this sort of law of unintended consequences and how things that seem appealing end up can come back to bite one.
[00:33:33] Ross Butler: What about patents? I see you’ve done quite a lot of extensive work on the importance of patent regimes in order to spur innovation. What’s the situation there in the US and elsewhere?
[00:33:46] Josh Lerner: The good news with patents is that they really do allow one as an entrepreneur, or even a proto entrepreneur, to get protection for one’s idea and be able to use that protection to more confidently go and approach corporates for strategic alliances, potential investors and the like. And there was a very intriguing paper by some academics here in the States as well as in Sweden, where they looked at entrepreneurs who got slightly bigger, broader patents and slightly narrower ones, but where it was really much more a function of which patent examiner was doing the review of the patent more than anything else. And what they showed is that those entrepreneurs or those proto entrepreneurs who got the broader patents ended up being more successful subsequently, really, again suggesting that patents can be a really positive thing for entrepreneurship, given just how challenging the position you are starting off is.
On the other hand, and sadly, there always is another hand, right? We’ve also seen some real abuses in the US system, right? And this has been much we’re at the extreme end here, but the sort of patent gamesmanship of people basically often self styled entrepreneurs, but who are basically doing nothing besides litigating patents. And if you’re an entrepreneur trying to build a real company and you get a letter from one of these persons, it basically is framed as give me $50,000 or I’m going to sue you. Right? And in most cases, picking up the phone and calling a fancy patent attorney, the first click on the taxi is basically $50,000, right? So they’ve configured it in a way that it’s often considerably cheaper to just give them the money and have them go away rather than fight this thing. But the consequence is, of course, that it becomes a self perpetuating kind of thing, almost an innovation tax. So there really is both this bright side and this dark side. There and again was American public policy. A little bit more together, we would have figured out ways to try to accent the positive and downplay the negative.
[00:36:24] Ross Butler: So there’s no easy answer with regards to kind of IP law. And there’s nowhere in the world that you think are particularly kind of a good case model.
[00:36:32] Josh Lerner: I think Europe is better, if only because I think the quality of the examination system I think one of the big issues here is that not only are patent examiners not paid very much, but they’re under tremendous pressure in terms of quotas to get throughput in terms of this. So even if you get a patent, you sort of think it’s wrong or problematic, so forth. You’ve got your boss looking at your computer output and saying you’re not moving fast enough here, right? Even if ultimately that patent ends up doing hundreds of millions or billions of dollars of distortions to the economy, you’re under your pressure to do your 8 hours in that patent and go on to the next one and the next one and the next one. So it’s certainly a system that is ripe for a little bit of improvement.
[00:37:24] Ross Butler: So I noticed from your bio that you graduated from Yale and you looked at physics and the history of technology and the reason I bring that up is that, well, I’ve been thinking rather a lot recently about the scientific endeavor for good and for bad. And there’s the new movie out, isn’t there? The Robert Oppenheimer movie, which I haven’t actually seen. There was this phrase, not so common now, but a few years ago in Silicon Valley about move fast and break things and it’s know, just innovate, innovate, innovate and something good will come of it. And I just wonder if you’ve got any views on that and on the scientific endeavor and its dangers and our ability to, I don’t know, apply I’m a venture capital to apply kind of an ethical caution to innovation.
[00:38:15] Josh Lerner: It’s a great question. I teach a class for undergraduates over in the engineering school and certainly I’m surrounded by youthful founders who are not spending deep amounts of time contemplating the implications of what they’re doing, right? But I think when we sort of step back and say how do people get into trouble? Right? In particular, when we look at many of the boneheaded moves made by some of the most successful entrepreneurs, at least in our country, you say, how is it they were so blind and not thinking through the broader picture? And a lot of it is because a they probably just studied technology and we’re like, we’re not going to bother with those sort of soft kind of classes where these painful, complicated questions that can’t be resolved with a few equations lurk, right? And B they’re under whether self inflicted or inflicted by the outside pressures. They’re under so much time pressure that they’re never stopping to sort of step back and think what is this? What can go wrong? And so forth. And in some sense, clearly you’re never going to have a situation where you have entrepreneurial venture as a think tank where everyone’s spending months and years contemplating every ethical application of these things, right? There’s always going to be an element of experimenting just simply because by the time you know the answer, the opportunity is too late. But at the same time I think that it’s absolutely essential to have some of that awareness and this willingness to question baked into the entrepreneurial system. And I think those who have neglected know in many cases it’s ended up coming back to haunt them at some later point.
[00:40:27] Ross Butler: I heard this really scary story about I think it was in Princeton and there was an experiment going on with regards to gene editing, and I think it was CRISPR technology. And it was only by accident that one of the students came in over the weekend and realized that it was turning everything to slime. And the professor was reported as saying that if it had leaked out, it may have ended terrestrial life on Earth, all green life. And it’s like, oh, well, that sounds dangerous.
So great. Look, professor, thanks so much for sparing your thoughts and maybe you come to London next year and we’ll kind of pick up where we left off because there’s lots more to talk about.
[00:41:07] Josh Lerner: Absolutely. I’m really looking forward to act two. Thank you so much for the invitation to talk about all this stuff.
