Tag: private chat

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.

Andros Payne talks to Ross Butler about the holy grail of private equity value creation: a systematic, quantitative approach to cultural and behavioural change. 

What makes businesses work well? Andros Payne is an engineer and entrepreneur who has spent two decades codifying and benchmarking the behaviours of senior and middle managers that are proven to drive growth and underpin cohesive and healthy cultures. 

His firm, Humatica, has worked with some of the leading private equity firms in applying the methodology to their portfolio companies. 

In this Fund Shack podcast, he explains how he has managed to make objective and transparent a conundrum that was long thought to be hopelessly subjective.

Reynir Indahl tells Ross Butler why he left the world of mainstream Nordic buyouts after the global financial crisis to pursue philanthropy and then on to re-imagine his role in investment. 

In 2016 he founded Summa Equity, which currently manages Europe’s largest Impact fund.

As explains, the difference between Impact funds and mainstream buyout funds is more philosophical than technical. In fact, he expects the term to have a finite life as all funds effectively becoming more Impact oriented. 

However, the firm requires a significant philanthropic sacrifice by its employees and Reynir has worked closely with his alma mater, Harvard, to develop a robust methodological approach to measuring the non-financial side of Summa’s investment activities. 

This episode of the Fund Shack private capital podcast deliver the kind of serious, senior insight that money can’t buy. So make sure you follow us, leave copious likes and please rate us on your podcast platform of choice.

What’s going on with private capital fundraising? To find out, Ross Butler of Linear B Group asks Warren Hibbert, founder of Asante Capital Group. 

After a splurge by institutional investors during 2021-2022, and a correction in public market valuations creating a ‘denominator effect’, fundraising sources have all but dried up – even for some big name private equity managers. 

There is a lot at stake, and while it’s difficult to ‘kill’ a GP, even one poorer vintage can put a manager on the sidelines for a decade. 

Warren explains what it all means for managers, when they should get on the road, and what to expect. 

Transcript:

[00:00:00] Ross: You’re listening to fund Shack. I’m Ross Butler and today I’m speaking with Warren Hibbert, founder and managing partner of Asante Capital Group. Warren manages global fundraisings for private capital managers, so he maintains relationships with institutional investors across Europe, North America, Middle east and Asia. In this episode, we discuss the difficult states of the private equity fundraising market in 2023, the outlook for the fourth quarter and for 2024, and some top tips for managers going on the road. Enjoy.

Warren, welcome to Fund Shack. We’re approaching the fourth quarter of 2023. I wanted to ask you what the market for private equity fundraising was looking like.

[00:00:42] Warren: I think it’s getting better.

Everything’s relative in this industry, and I’ll explain why I think it’s getting better, but it’s probably easiest to contextualize that in terms of what we’ve seen over the last three years.

So if we dial back to actually 1920, it was a very strange time. Obviously, you had COVID. You had a very poor, a relatively poor fundraising year in 2020.

[00:01:06] Ross: Yeah, there wasn’t much fundraising in 2020, but there wasn’t much capital deployment, I.

[00:01:09] Warren: Seem to remember well, in fact, if you go back to 2008, so if we really look at the broader perspective, the peak, which was back 2007 eight, was about 650,000,000,000 raised. That was eclipsed in 2014. And then you had a record in 2019, well north of a trillion, just under 1.3.

2020 was over a trillion. So it was a good fundraising year, relatively speaking. But it was a down year and it was a very funny time for a relatively brief period post which markets really just took off whilst everyone worked from home, invested from home, et cetera.

And I think it’s a case of no one really knew at that time which way was up. Markets were going crazy, everyone was working from home, you know the story, and we didn’t really know what the outcome would be. In fact, everybody in our industry were pleasantly surprised, regardless of what you were doing and what your role was at how things had gone crazy virtually, and everything was working and it was driving huge efficiencies, right? Yes, on the fundraising side, but across the spectrum, what you had with that was this huge leap in valuations in the market performance and valuations of tech stocks mainly. Tech stocks predominantly. And this is largely a tech story, really. And so what you had, so you had the very few large players who were in the right place, right time from a technology perspective, and the mega caps who were just there now, really asset managers being able to raise incredible amounts of capital off the back of amazing valuations and performance delivery, both in terms of realized and unrealized. And what happened in addition to that is the deployment pace picked up fantastically. And with that increased deployment pace, so the fundraising pace followed very quickly. And so what you had is, instead of funds, generally speaking, going out to market every two to three years, which is a pretty good pace, they were now coming out to market every nine to 14 months.

[00:03:24] Ross: So I am out of date because I was thinking it was. It was more like four to five years, they might go to a mid market manager. So they’re pretty much constantly on the road.

[00:03:33] Warren: It’s a perpetual exercise of fundraising.

[00:03:35] Ross: I mean, they’ve always said that, but now it really is.

[00:03:37] Warren: Right? It really is. It really is. Largely because you’ve always got a product in the market if you’re an asset.

But going back to this period, which was really the 2020, 2021, you had these very large managers raising at a cadence that the market had never seen before. The flip switch that would have put that all to bed was the LPS going, look, we’re just out of capital.

But there was huge fear of missing out syndrome taking place, because those large tech stocks, tech stocks, tech GPS, if you take the top seven, their performance the beginning of 2021 back end of 20, was between four and nine times, net.

So you couldn’t. But you’re going to lose your spot. You had to re up.

[00:04:28] Ross: Were you talking global GPs who have a significant proportion in tech or something?

[00:04:31] Who are predominantly tech

[00:04:32] Warren: Yeah, predominantly tech.

[00:04:33] Ross: Okay. Who were all raising at the time in the sort of low teens to low 20s.

[00:04:37] Warren: Right.

Ross: So it’s not the redistribute distributions are increasing, it’s the fear of missing out that’s driving this.

[00:04:42] Warren: Correct. Allocate. Right, correct. During that period. Yeah. And there were distributions happening.

[00:04:45] Ross: Sure.

[00:04:45] Warren: But, yes, most of it was on paper in terms of the valuation uplift. So what you then had was these managers raising at an incredible cadence, LPS not being able to say no, and particularly the US state pension plan market, which is the largest pool of capital to privates, going, we’ve got to sort of double down. But effectively, we’re having to borrow allocation forward. So they’re committing future years allocation as.

[00:05:10] Ross: They’re eating into 2023.

[00:05:11] Warren: Exactly.

[00:05:12] Ross: Right.

[00:05:12] Warren: So what we saw in 21, and this was around October 21, and it was one specific USA pension we were speaking to at the time. They said, look, we think we’re done for 22.

And we sort of scratched our heads and said, well, hang on a second, you mean you’re done for 21? It’s October 21. No, we’re done for 22. They had effectively pre allocated all of their allocation to their respective managers, existing managers, to the end of 22, so over a year in advance. And that took everyone by surprise. But, whoa, what’s just happened here? Because no one had seen this forward committing, an extent to which it was.

[00:05:50] Ross: Happening, and it’s not a technical thing, it’s like a hype thing.

[00:05:53] Warren: Yeah, completely.

[00:05:54] Ross: My, I didn’t realize this.

[00:05:55] Warren: Okay. And so if you follow that through, and the same again happened in 22, where 23 was pretty much done back end of 22, as far as those managers were concerned, the LPS, what you then had is the correction with that. The LPS had really maxed out to the best extent possible, predominantly into tech, their allocations to the private markets. You had this drop off in public’s massive denominator effect. The distribution started to fall and it was the perfect storm.

And this was all leading into 23. So 22 was a down year, still a pretty good year if you take it in the context of the last decade.

But the first half of 23 actually was the epicenter. So LPs really sitting on their hands, having committed to their existing. Getting a new GP into your portfolio was almost impossible from an LP perspective. And again, I’m talking largely at the large end.

And so just a very difficult time, incredibly difficult fundraising time, because if you’re in our position, raising new capital into funds established or new first time funds, it was now impossible. And we’ll come to how we’ve managed to achieve what we’ve achieved. But it was very, very difficult. And in fact, we just completely put a line through first time funds for some time, which has been reflected in the market stats as well.

[00:07:25] Ross: Well, I have heard even very established brand name mid market managers been on the road for ages now and really surprised me because it’s like, okay, so maybe some of the big California state pension funds overallocated and got caught up in the hype, but we’re talking about global capital pools. You’d think that really good, well known managers that used to have a queue of people lining up, they’re on the road. Is that your experience as well? That there are some really good names still waiting?

[00:07:54] Warren: It’s a big reset for the market and it hasn’t quite played out entirely.

So the market, as you’ve heard and everyone’s heard many times before, invests by looking in the revenue mirror, as they say. So the performance of your 2017, 18, 19 funds is what’s relevant today. What’s happened in 20, 21, 23, it’s largely relevant. That’s money that’s being put into the ground, but you’ve sort of got a stay of execution. It’s really what have you delivered prior?

And everyone’s up against this new benchmark, which is the performance that was generated through 2020, 2021, through these incredibly periods of massive valuations. And there were significant distributions as well. So it wasn’t all on papeR. The VC market has had a very big correction, relatively speaking, not as big as the public’s, but there hasn’t been a significant adjustment on the buyout side in terms of valuations.

It’s just a very challenging time for many, because whilst you’ve been very consistent and generated net, 1.71.82, that doesn’t really stack up to this new paradigm. The new benchmarks that have been created, again, largely tech skewed. Hugely, hugely tech skewed in a way.

[00:09:15] Ross: But does that make sense?

Because the new benchmarks may just be Anomalous and this is one of the issues with the industry, is how do you decide who you’re going to re up with, commit to or in terms of new GPS or otherwise?

Warren: There is a multitude of different factors and performance is one of them.

Team is probably the most significant one. And then it’s a case of what’s the future play? Why is this going to be so interesting going forward?

And I think there are many investors, many GPs out there, who have had to really sharpen their tools and go, okay, we need to up our game. So the performance has been generated fine, that’s an anomaly. And that’s certainly what they’re telling investors. And there’s a premium for consistency. So if we, the GP, have performed consistently through cycle, that gets us lots of points, and it does, but your performance needs to be north of two X net.

[00:10:13] Ross: When you say sharpen their tools, you’re talking about value creation and just.

[00:10:15] Warren: Yeah, how do we show that we’re really cutting edge? Because along with this technology hype and valuation has come technology itself, right? This huge creative of efficiencies and new means of driving value, new means of doing pretty much everything, and those taking advantage of it are at the forefront of technology. So the tech GPs have benefited massively because if they really have domain expertise, they’re going deeper and deeper every day, whereas the more generalist or others that are focused on multiple sectors have been content to just continue on doing what they’re doing with the brand above them that drives these raised funds every vintage, not sort of reflecting on whether their model is world class and relevant. Yeah. And I think relevance probably a bit extreme, but really, is it world class? And I think that’s what’s really interesting because we see it with groups. Groups we meet. So many very well known, have been around forever GPs who really haven’t got the perspective of how the market has moved and how it is moving. It’s a very real time thing.

[00:11:33] Ross: So this really is. It’s all about tech. But I mean, there are large managers who are generalists, but that can really go deeper, can tell their portfolio teams, everyone, invest in AI and see what comes of it or something like that. That must be the case that there are some. Sure, you don’t have to be a.

[00:11:49] Warren: Tech specialist, you don’t have to be a tech specialist, but you do need to reflect on your business model and try and figure out what is the best means of getting to the top of the league table effectively.

[00:12:01] Ross: You said earlier, I think performance is key, but actually team is potentially even more important. What do you mean by team?

[00:12:08] Warren: When an LP goes in to assess a GP, the performance is obviously very important, but performance to an extent can be manipulated, whether it’s valuations, IRR in particular. Right.

As I say, you can’t eat IRR, but that is how many LPs are immunerated today? The majority of them. So it is a huge driver and that can be manipulated to an extent. So what you’re effectively backing is the team who are going to be deploying your capital in the next blind pool that you’re providing for them for the next decade plus.

And you have to have absolute confidence and excitement and conviction that this team, as calibrated, can deliver that.

And so the numbers are really important, but if the team is not fit for purpose or you have question marks over it, it really doesn’t matter what the prior performance was. Yes, and that’s why it is so, so important, particularly where there’s team change or evolution, succession, et cetera.

[00:13:13] Ross: Presumably when you talk about team, then it’s about assessing the individuals, but it’s also assessing the cohesiveness of those individuals working together and the organizational structure and whether that’s credible and all of that.

[00:13:23] Warren: Correct. And the alignment. Can I quite easily figure out what this team is going to look like in the next decade?

It’s not next year or even the next fund, but it’s the next two funds.

[00:13:34] Ross: You mentioned the market’s bifurcated and always has been, but presumably that becomes ever more polarized, the tougher the conditions get. Are there people that can still go out and just raise at the snap of the fingers or not?

[00:13:47] Warren: Yes, there are, but it’s the very few. So roughly today, if you assume that a trillion just over is raised every year up here or down year, I think this year would be just over a trillion. Still, although it’s a down year, the top ten managers take roughly 30% of that. That’s the top ten. The top 10% take north of 80%. So it’s massive bifurcation. So we saw this really become a significant thing post 2008.

The bifurcation didn’t exist to the same extent prior to that. And in fact, we saw that day to day. So raising funds pre 2000 and eight’s correction, everyone raised. Everyone raised. If you were out of investment bank or you were out of a consultant and you decided, I’ve got this thing and I’m going to focus on this region doing this, even if it was generalist, you were always going to raise how quickly you’d raise question mark, whether it hit your hard cap question mark. But you’d get into business. Yeah, post 2008, that’s not the case.

And so there’s massive survivorship bias in all the numbers post that period, to a far greater extent than pre. And then post 2020, albeit not a financial crisis, you had the same. So it’s the sort of rush to safe harbor, which is the megacap asset managers in a way. And so they’ve been able to really get a leap on. They’ve also been way ahead of the curve in terms of applying technology and thinking about their business.

And that’s an all too obvious but very interesting way of looking at things. You’ve got these groups called GPS, general partners who go around buying up businesses to create a portfolio and driving huge value by creating better businesses, looking at all different elements of the stack and going, how do we make this much, much better, bigger, more global, whatever the case may be, very few put a mirror up and go, let’s have a look at our own firm. And that’s kind of what I’m talking about is there are many groups and there are many GPs out there with a fantastic value creation stack with great means of driving huge value that still aren’t looking at themselves.

The management company is something you sort of drag along whilst you’re investing in these businesses, but their businesses have become significant businesses and there’s a lot you can do with them and you really have to be ambitious and work out where are you going in the next 1020 years relative to your peers, because it is such a fast moving market.

[00:16:33] Ross: So that matters when you’re actually raising a fund. LPs want to know that you’ve got a plan for your own money, because to some degree, I’ve got sympathy with the idea that let’s not focus, let’s not be too introspective, let’s just make money, let’s just create value in the portfolio companies, and let’s not worry too much about how things land internally.

[00:16:55] Warren: If you do that very successfully, and you usually find they go hand in hand, the introspection, and focus on your portfolio. But if you do that very, very successfully, those types of individuals and teams will be doing it on their own business inherently. That’s my view. And as a result, if you’re generating fantastic performance, so raising capital is fairly easy, and that’s the key element to growth, is primary capital raising. There’s a multitude of other things more on the secondary side that has been built in to augment that. But really, raising primary capital is the game.

Now, not everyone has a perfect vintage every time. From a performance perspective. There are some that are super consistent and very, very good, but we’re really getting to the top echelon 1%.

Everyone else is going to have a tough portfolio company and or even a tough vintage. And those can put you back on the sidelines for a decade plus, because it’s a very long term game. And whilst it’s very difficult to kill a GP who perhaps shouldn’t be around, it’s also very difficult for those GPs, particularly of even relative scale, to shift the direction of the tanker.

[00:18:10] Ross: So we’ve been talking about the extremes to some degree. We’ve been talking about the people that can raise really quickly, and we’ve been talking about the fact that not everyone will raise, actually, but the vast majority of people presumably are in the middle. They’re decent enough and they deserve to survive, but it’s a really tough market.

What should they be thinking?

Should they be conceding things? And are terms changing? And what’s happening in the mass middle?

[00:18:36] Warren: Terms aren’t changing massively. It’s always been a topic where, particularly through crisis, everyone switches to, well, the terms are now going to change.

Terms adjust relative to supply and demand, relative to each GP specifically. So there’s still GPS out there attracting premium terms through cycle.

Again, we’re talking back to the top 1%, everyone else, it evolves. So as you grow your Aum, as you get to a billion plus in terms of fund size, so you’re not getting 2% on your money anymore, but the 20% is rock solid. And then you now have continuation vehicles as well, upon which they’re earning economics.

And you can get quite creative on that front in terms of the degree of carry, in terms of ratcheting it.

[00:19:22] Ross: Up and down, because that’s newer, so they can play around with them.

[00:19:25] Warren: Exactly right. It’s less set in stone, but by and large you’re finding that GPs will continue to exist and raise capital. And even through crisis, they’re not conceding too much.

It’s more a question of how much can you raise? It really comes down to that you’re never going to go out and there isn’t a market clearing price per GPS, so you can’t go out and say, well, we’re not great or we’ve just had a rough ride. But inherently we think we’ve got a really good toolkit and we can drive value in the next vintage because we’ve learned from our mistakes, which all genuinely is pretty good. But the market will decide effectively how much you can raise, and that’s it. At set terms, you can’t sort of go, well, okay, we’re going to charge 5% carry and we’ll charge a few basis points of management fee and we’ll just suck it up for the next vintage because you won’t get anything at that point because the writing is on the wall.

[00:20:27] Ross: Cheeky question, but what kind of proportion difference does having a good placement agent make?

[00:20:33] Warren: Everything.

I think it depends on your scale. You take the host of child in Europe being EQT, who have one of the largest placement agents in the world, effectively in house.

They’ve got over 100 people focused on building out their AUM, and they do it very, very effectively.

You need a group focused on driving value in the area of capital raising at that scale, but ideally all the time. In the same way that you’d have a group focused on driving operational value within your portfolio companies, you need someone to be working on. How do you grow your business from an AUM perspective? And I think that’s something that many GPs haven’t quite got yet, which presumably.

[00:21:21] Ross: You need economies of scale in order.

[00:21:23] Warren: To you do in house or externally?

[00:21:26] Ross: Yes, one way or another.

[00:21:28] Warren: One way or another. One way or another, you need it.

And most importantly, it’s recognizing, and we can debate whether it’s 50 50, but I would certainly argue that 50% of your business is raising capital, at least 50%, whereas many believe that we’re out there to go do deals. We’re out there to go do deals, drive value and generate returns for our investors. And every couple of years, and amazingly, it shouldn’t be the case. But many still believe this, every couple of years, we’ll hit the light switch and raise more money. And those in that camp probably not going to raise again unless their performance has just been amazing. And if your performance is consistently fantastic, you raise yourself. That’s fine, that’s easy. And you probably need one IR person, really, just to make sure that everything’s running smoothly. But investors are marching to your steps, so that’s fairly straightforward. But again, it’s kind of irrelevant to discussion because there’s so few in that zone. So having a party, internal or external, who has a perspective and day to day, is watching what LPs are doing, particularly in today’s markets, where I still believe no one knows which way is up, is critical.

[00:22:40] Ross: Yeah.

Are there any differences between the North American fundraising market and Europe at the moment?

[00:22:46] Warren: Sure have been for a long, long time, simply because the largest pool of capital, privates, is in the US and will be for some time to come. It’s moving slowly only because the US is a very mature market. And so the element that is the largest, which is the US state pension plan market, is sort of tapping out at its maximum allocation to private equity. So that’ll continue to move ahead, but the growth is getting to the point where it’s going to be ceded to other groups, sovereign wealth, other large pensions, less so Europe and more Asia, and to the extent, the Middle East. So that’s quite interesting.

But you’re finding that really, the US has been such a strong market and the predominance of capital has been so favored towards North America, that in tandem with the fact that it’s the oldest, so they’ve learnt more, it’s a far more developed market. The returns have been better.

Getting in your car and driving down the road to your investor is very easy. And from the investor’s perspective, investing in your backyard, from a currency perspective, et cetera, has been pretty easy. So it’s been self fulfilling to a large extent, and has remained that way for a while. It’s been more a question from that market question for the US market as to how they diversify and whether they even need to.

And for quite a period post 2008, there was a retrenching back to, let’s just do it in our backyard.

Then only in 20, 16, 17 did we start to see them really going, we need to rebalance into Europe. Not 50 50, but we need to put more into Europe.

And that pulled back again post 2020, but is now starting off. It’s kicking off again. But Europe is a market where there have always been many questions around. To what extent do you need to be in Europe if you’re getting the returns and the diversity in terms of type of manager in our backyard in North America, predominantly the US.

And the only other real question was, okay, so how exposed do we want to be to Asia? Because Asia is moving really quickly. China is super interesting and we’ve got to be there until they can’t be there. And so that is a change now that we’re seeing where that may actually favor Europe.

[00:25:10] Ross: Right.

[00:25:11] Warren: Because that capital will shift across.

[00:25:13] Ross: So the domestic pools of capital, what kind of proportion, in terms of European GPs looking to raise money?

North America, obviously hugely important, but there are domestic sources of are.

[00:25:25] Warren: But the European market is a much smaller market. But yes, and just as a general rule, your local investors are going to be the ones that know you best, know you personally as a GP, because you dine at the same restaurants, whatever the case may be. And you always see that natural affinities, where, in fact, if your local pensions are not invested in you, investors outside your region start to go, well, how good are you?

[00:25:51] Ross: Yes, proximity matters, doesn’t it? And then there’s the kind of cultural things. And the topic of ESG feeds into this to some degree, because that’s become kind of a polarized issue in the US itself, but also between North America and Europe. And Europe is very much pro and not all of North America is. And so a topic like mean, that’s a delicate one to tread through.

[00:26:16] Warren: Is it? It’s a complicated one because it’s a question, I think, in many minds, as to what extent it’s window dressing versus genuine impact. And there’s ESG, but there’s impact, and there’s a ton of ways to describe what GPs are trying to do. Many with the right intent, some with a question of trying to attract capital from those LPs that are just focused on impact or ESG. And when you distill it, the reality is investors that are focused on impact and ESG is a significant proportion of investors. It doesn’t mean they’re impact and ESG investors. It doesn’t mean if you label your product ESG that you’re immediately going to raise capital from those investors.

Investors are still looking for the same simple things, strong team, great track record, and if you’re doing the right things for the society and the world, which most the best GPs are anyway. They’ve just rebranded as ESG and impact. Fantastic. You tick the boxes and you raise money, but not the other way around.

[00:27:21] Ross: Yeah. So maybe the lesson there is not to get too obsessed with the labeling and actually just do the.

[00:27:27] Warren: Do it properly. It’s one of those things. The understatement works if you do it well. And we’ve actually had this with a GP recently where we’ve had investors go, actually, we’re going to put you in our impact bucket. But they’re not an impact GP.

But the reporting is phenomenal and they really care about it and they do a lot of it, but that wasn’t the reason they got into business.

[00:27:49] Ross: We’ve relatively recently seen the rise of private credit funds as well. How’s that affecting, let’s say, the overall balance of the opportunity set if you’re a fundraising as a private markets manager, is that eating up some of the private equity allocation?

[00:28:04] Warren: No. So separate, separately separate in many instances, separate teams on the LP side reviewing the propositions.

A lot of that capital has come out of the fixed income buckets and that entire market has come to be what it is today, which is this juggernaut post 2008 as well. So you had the global financial crisis happen. Investors were desperate for yield for just some degree of cash back because it was pretty barren, it was just desert. Were you ever going to get your capital back, regardless of what strategy you were investing in?

And on top of that, very obviously, the banks were in a tough position, to say the least. So this credit fund market came to be and has grown incredibly since. But a significant portion of that has come out of the allocation to fixed income. What’s going to be interesting going forward, and it’s here to stay, there’s no question the banks are going to be in, are going to have ups and downs at infinitum, in my view, but they certainly have a bit of a tough time now, and that’ll happen through crisis, because we push the limits in the industry all the time and the credit funds are better able and aligned to fix things versus try and take the keys, which actually makes it a bit of a smoother landing when you do go through the downs and more attractive to GPs and more attractive to GPs and they’re able to take more risk, et cetera, they understand the assets better. Their approach is from the inside, as opposed to from a sort of banking perspective, where you’re just a line item of thousands.

That said, what is going to be interesting is the extent to which that capital starts to flow back to fixed income now that you have a pretty attractive yield coming through and how that starts to now compete with fixed income, which was zero. Therefore, of course, you moved it across and that’s massive. I mean, the fixed income market is larger than the public equity markets. The fixed income market is so large, it’s circa 130,000,000,000,000 that a very small proportion was shifted across into privates. It’s not all going to shift back. Sort of. No one’s really noticed, is my view.

[00:30:26] Ross: Yeah. It might just be worth keeping your hand in as a large institutional investor into the private credit market, just completely.

What’s your view on private credit? Because in terms of we got a rising rate environment and let’s say it plateaus here, or slightly higher, does it grow over the medium term in that environment, or does it require a low interest rate environment to become, to grow in the way that private equity has grown in the last decade?

[00:30:53] Warren: I don’t think it’s going to grow to the same extent it has over the last decade plus because it’s really gone from zero to hero quite quickly because your competitor was your competition, being largely the fixed income bond market, was at basis points, and you could deliver net sort of six to early teens, even on the senior secured side. So that’s very, very interesting. But you had no competition. You now effectively have competition for capital. And that, I think, is going to mean that they’ve got to fight a bit harder. But you’re also going to have this and you really have that. This bifurcation is going to become even more extreme. So it’s going to be those that are quasi banks who can really provide any financial solution for you.

[00:31:45] Ross: And what’s your kind of medium term outlook on the private equity fundraising market as a whole? You started by saying, by being kind of cautiously optimistic.

[00:31:58] Warren: Back to that discussion around where the market is and why 2022 and 23 are going to be tough fundraising years. Our view is 24 will look a bit like 22, and so we’re potentially back to a steady fundraising environment in 25. That’s our view anyway.

But the epicenter was the first half of this year and you can see the sentiment marginally improving, which is why I emphasized relative, it’s marginally improving. Investors are starting to get a little bit excited about what is to come in 24, where we haven’t seen that for quite some time now, which is great, and there’s capital out there. As I said, if you look at the fundraising statistics year on year, we’re in a period that’s way up on where it was a decade ago. You’re having up and down years for sure, but it’s still in the trillion plus, and I don’t see it changing dramatically. It’s just where that’s going.

Everyone sort of thinks on it as a very big market, which it is, and there’s plenty of capital out there if you’re, if you’re raising roughly a trillion two every year.

But if that’s only going to a handful of managers, for the most part, how do I, as one of those marginal managers, raise money? That’s, that’s the big thing. And that comes back to your point, around some very established groups who will raise, but are going to miss their targets, in some cases dramatically. They will continue on, but that’s going to be the story to watch is to what extent do they walk away and go, okay, well, we’re still around, we’ve raised money, we might not be able to do as many deals. It might be a slightly more concentrated portfolio stroke. We may take advantage of a lot more co invest. Not a bad thing for LPs to deploy into our assets and build up again. But what do we need to change such that that never happens again?

If you go on as well, it was just a tough environment.

When we raise our next fund in 26, everything will be fine again. You’re in trouble.

[00:34:03] Ross: Yeah. What’s your top tip? In the heat of the moment, you’ve got a fund to raise your top tip to a GP. What’s the common mistake that you’d watch out for something like that?

[00:34:12] Warren: Yeah, there’s one. So we have a diligence questionnaire where GPS always list out their common most or their key lessons learned. And the most common lesson learned is we didn’t replace management quick enough. Every GP’s got that lesson learned. If you would apply that to fundraising, it’s. We went out too early.

So that’s my piece of advice, is if you’re going to, before you plan to go out, you need to have a pretty good sense on what your fundraising is going to look like before you launch. You’ve got to have a very good sense on at least 50% of your capital that you want to raise and when that’s going to come and from whom before you launch.

And as you mentioned earlier, it is a perpetual exercise. So you’re always fundraising, even if you’ve only got one product, you should be speaking to your investors and spending a lot of time with them such that you can get the answers from them around. Are you there to support me and for how much? WheN I launch the next fund, that’s your existing investors, then you’ve got to do the same for new.

You should have a far greater degree of certainty around your existings, obviously, than your new. But I say obviously, actually not in today’s environment. So many investors, certainly through the last two vintages, have switched out of existing managers into new, or have had the problem of not being able to re up with all their existings simply because they didn’t have the allocation and the capital. So it’s been tough and you’ve got to have that perspective, which means you really need to make sure that you’ve actually mined the markets in your pre marketing exercise very, very carefully. Right.

[00:35:50] Ross: The readiness is all?

[00:35:51] Warren: Yeah.

[00:35:51] Ross: How long have you been doing this?

[00:35:53] Warren: Roughly 20 years.

[00:35:55] Ross: Right. And you set up your firm?

[00:35:58] Warren: Yes.

[00:35:58] Ross How’s that?

[00:35:59] Warren: 13 years ago. Fantastic.

Really good. It’s never a straight line, like most things in life, but ours has been a pretty extreme curve through the last 13.

It’s just a lot of fun, and that sounds fairly fluffy. But the most important thing to us, as we keep on saying, is the culture of the firm. And if you’re having fun, that’s everything, because everything comes with that. If you’ve got a team that are motivated, aligned and having fun, it’s like having a boat with four big engines.

And a lot of the good things come from that. It’s become more challenging as we’ve grown, obviously, as it does, particularly when everyone’s not under one roof.

So we’ve got five offices around the world, 74 people, and it’s maintaining a singular culture and that drive, passion and energy, that is something we spend a lot of time on every day doing.

[00:37:02] Ross: Sounds like a good culture and philosophy.
Well, thanks for coming on the show, Orange. Lovely speaking with you.

[00:37:06] Warren: Thanks for having me. Lots of fun.

Fund Shack is produced by Linear B Group, a full service media, design and editorial production company, focused on financial services.

In this Fund Shack private equity podcast, Ross Butler of Linear B Group speaks with Douglas Hansen-Luke, founder of Future Planet Capital.

Douglas explains how the firm runs a portfolio of mandates for purpose-oriented institutional investors across the world. He defines Impact, and explains how to measure it, as well as how to assess and manage the risks of unintended consequences (negative impact). 

Future Planet Capital also has exceptional links to the world’s leading universities and Douglas gives the inside scoop on the ins and outs of harnessing the very best ideas for commercialisation. Most famously, the firm backed the Oxford Vaccitech T-cell Covid vaccine directly from the university to lab, and saw it list on the Nasdaq stock market in 2021. 

Other investments include Roslin Technologies, a fake meat business from the university that brought you Dolly the Sheep, Tokamak Energy, a fusion business feeding into a future low carbon energy grid and Tropic Biosciences, a cutting edge gene editing company.

Douglas has also been on the frontline of efforts to allow UK pension funds to invest in private equity and venture capital, and he explains why the latest ‘Mansion House reforms’ make sense for pensioners and for Britain. 

???? If you are interested in impact investing, you may also want to check out Travers Smith’s Alternative & Sustainability Insights Briefing. Check out the latest edition, looking at the rewards and risks around collaboration between companies in order to achieve sustainability goals: https://www.traverssmith.com/knowledge/alternative-and-sustainability-insights/

David Larsen has been at the forefront of alternative assets valuation policy for several decades. He is managing director at Kroll, which was acquired by Duff & Phelps in 2018, and advises many of the largest alternatives institutions on private equity transactions and valuations policy. He has been vice-chair of IPEV – the International Private Equity and Valuations Board; and he is a member of the International Valuations Standards Council (IVSC). 

In this podcast with Ross Butler of Linear B Group, David explains how managers should approach valuation in times of high volatility, providing a strong defence of why fair value is in the best interests of both managers, investors and the wider alternatives market, and insider’s view into the latest accounting standards changes and their implications for private equity valuations. 

In this episode of the Fund Shack private equity podcast, we look at the core concept of fair value, which David Larsen defines as the amount one would receive in an orderly transaction. He emphasized the significance of market participant assumptions and elucidated the challenges of applying fair value to illiquid assets, a prevalent scenario in alternative investments. Throughout our conversation, the pivotal role of valuation professionals in accurately assessing fair value and the role of transparency in aiding investors to make well-informed decisions remained at the forefront.

We explore the role of fair value in the context of economic downturns, such as recessions or depressions. David Larsen illuminated the crucial aspect of transparency that fair value accounting brings to the table, helping to mitigate asset allocation imbalances. We also tackled the misconception that fair value was the root cause of the 2008 financial crisis, clarifying that fair value rules are designed for orderly transactions, not fire-sale pricing.

In the latter part of our engaging conversation, we delved into recent developments in fair value accounting, particularly a noteworthy change introduced by the Financial Accounting Standards Board (FASB). This change disregards contractual restrictions on equity securities when determining fair value, a decision that sparked skepticism from David Larsen. He laid out the unintended consequences and complexities this alteration introduces, especially for limited partners who report under US accounting principles.

Overall, this episode of the Fund Shack podcast offers a comprehensive exploration of fair value accounting’s profound implications for the private equity, venture capital and alternative investment landscape. It illuminates the challenges and intricacies involved in valuing assets transparently and accurately, providing valuable insights for professionals navigating this dynamic and critical field.

Jonathan Blake is head of international funds strategy at Herbert Smith Freehills. 

In the 1980s, Jonathan was responsible for devising the very first limited partnerships for venture capital and private equity in the UK and Europe, and was responsible for convincing the British government that these closed-ended funds were a legitimate structure and valuable business for the economy. 

He is also responsible for four decades of carried interest being taxed as capital gains. 

This podcast with Linear B Group‘s Ross Butler is the untold story of the birth of European private equity by the lawyer who was at the table and holding the pen when it all began. 

In this Fund Shack private equity podcast, Jonathan recounts his journey, which began in the early ’80s when he joined a startup firm called SJ Berwin. 

His career took a turn when he was tasked with understanding and structuring a venture capital fund. At the time, limited partnerships were relatively unknown in this context, but Jonathan, with the guidance of influential colleagues, successfully navigated the complexities to create a tax-efficient structure for venture capital investment.

The conversation touches on the evolution of private equity and venture capital, highlighting how limited partnerships, initially an untested concept, became the standard structure in Europe. 

The podcast sheds light on the challenges faced in persuading tax authorities and shaping regulations to accommodate this new industry. 

Jonathan’s contributions played a crucial role in laying the foundation for what is now a thriving private capital market.

Today, Jonathan continues his work at Herbert Smith Free Hills, advocating for private capital and helping the firm adapt to the evolving landscape of unquoted companies and private markets, emphasizing the benefits of this approach over traditional publicly listed companies.

Subscribe now: Apple Podcasts | Spotify

Trevor Hope is Chief Investment Officer of Gresham House Ventures, the growth capital arm of one of the UK’s oldest companies. 

In recent years, the firm has been growing rapidly, consolidating the market for Venture Capital Trusts, tax-break vehicles for individual investors to access growth business in the UK.

The so-called perma-crisis of political and economic volatility witnessed in the UK, and beyond, has made the business of raising and investing long-term funds is even more uncertain than usual. 

To help private markets practitioners navigate these choppy waters, we spoke with David Gauke, Damien Crossley and Shailen Patel from Macfarlanes. 

David Gauke is one of the most senior former politicians to be working in private markets today. He was responsible for the UK’s tax system as Exchequer Secretary to the Treasury and then Financial Secretary to the Treasury, followed by Chief Secretary to the Treasury, Secretary of State for Work and Pensions, and Lord Chancellor. He is now head of public policy at Macfarlanes. 

Damien Crossley is head of tax and reward at Macfarlanes, where he advises fund managers on fund formation, remuneration and investment structuring.

Shailen Patel is head of the firm’s corporate advisory, focusing on financial, strategic and regulatory matters for asset managers and private markets. 

The trio are ideally placed to appraise the market context for private capital participants in 2023.

In this Fund Shack private equity podcast, we discuss the industry’s inclination towards retaining ownership of assets rather than opting for sales. This transformation is observed as a conceptual move, with ramifications extending from the listed market into the private sector. 

The discussion looks at the dynamics of asset management consolidation, succession planning, and the considerations faced by founders of asset management businesses. The industry is undergoing substantial changes, mirroring historical shifts in the financial sector.

The conversation also touches on the evolving sources of capital in the fundraising landscape, including diversification beyond established financial centres. However, the stability of regulatory regimes, especially in the UK, remains paramount in attracting and retaining investment.

We touch on Environmental, Social, and Governance (ESG) factors, which must be adapted to local preferences and nuances, making fundraising strategies more complex.

Laura Dillon leads Waterland Private Equity‘s Dublin office, which she established in 2020. Laura has had a varied career both in private equity and business. She has worked at several private equity firms, including Apax Partners and Riverside, and set up a distribution business with her family that was sold to a corporate acquirer. 

In this podcast, with Ross Butler of Linear B Group, she talks about her career to-date, the opportunities in the Irish private equity market, and her experience of working within Waterland’s international mid-market investment operation. 

Her career has been marked by a series of transitions and success stories within the private equity sector. 

The opportunity to lead Waterland’s Irish office came unexpectedly when the firm announced its plan to open an Irish branch. Laura initially dismissed the idea but reconsidered when approached by a headhunter who recognized her potential. Waterland’s reputation for being entrepreneurial and its track record of impressive returns were key factors that drew her to the firm. Laura’s unique connection to Dutch culture through her passion for sailing with a Dutch team also gave her valuable insights into Waterland’s transparent and egalitarian culture.

Upon returning to Ireland, Laura took on the challenge of building Waterland’s Irish office from scratch. Despite facing personal and external challenges, such as a skiing injury and the onset of COVID, she successfully managed to establish and grow the office. Waterland’s focus on partnering with business owners and entrepreneurs to accelerate company growth resonated with Laura’s vision. She also discusses how Waterland employs a buy-and-build strategy to support companies in fragmented markets, expanding internationally through acquisitions.

In terms of the Irish private equity landscape, Laura emphasized that the market has evolved over the years, with an increasing number of domestic and international firms showing interest in Irish companies. 

Waterland’s unique position as an international private equity firm with an on-the-ground presence in Ireland allows it to collaborate closely with Irish businesses seeking to expand globally. Laura also highlighted Ireland’s favorable tax environment and its attractiveness to multinational companies as factors contributing to its appeal as a business hub. 

She expressed optimism about Waterland’s growing pipeline and its potential to further enhance the Irish private equity ecosystem while maintaining collaborative relationships with other local firms.