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 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 firm’s approach to value creation with the use of internal talent operating partners who support the building out of managerial capacity in portfolio companies;
how they identify investment themes and source deals;
the threats and opportunities of AI;
the value of IP vs the operational ability to take market share;
and the firm’s plans to expand its VCT offering and complement it with limited partnership funds.
Paul Newsome is head of portfolio management at Unigestion, a Switzerland-based asset manager with a global private markets platform.
Paul has been at the firm for two decades, during which he has set up its private markets operation in North America, and has been instrumental in establishing its directs, co-investment and secondaries programmes.
In this discussion with Ross Butler of marketing services consultancy Linear B Group, Paul reveals the international growth story behind Unigestion’s expansion across private markets investment, how the asset manager makes effective investment-decisions (with reference to their proprietary AI tool), his reading of the prevailing market volatility and what it means for investors and the asset class, and his outlook for further industry growth.
If you want a crash course in private markets asset management at the turn of 2023, you are in the right place.
Alistair Lester is CEO of Aon’s M&A and transactions services business in EMEA. This is not the conversation you think. Aon has spent recent years building out its capabilities across the risk spectrum.
Alistair, you are the CEO of Aon’s M&A business in EMEA, but it’s not your first bout there. You started in the graduate scheme some 25 years ago, and in the mid 90s working for private equity clients. And I wanted to start by asking you to what extent has the insurance services industry over that quite long timeframe responded to the pace of change in the world and the risks that businesses and private equity firms face today?
Alistair Lester:
There’s been a huge amount of change of course, in the world. The insurance industry is not renowned for being particularly speedy in terms of pace of change, but actually there’s been a pretty significant amount of change within the insurance industry and particularly within the part of the insurance industry and the broader professional services aspects of our world that faces off to the M&A and private equity ecosystem. When I think back to being told that what we did for private equity firms was a niche part of our industry and a niche part of a firm that I previously worked for.
Alistair Lester:
I think we, as an industry, are really only just starting to embrace the scale of that relationship opportunity in the same way in the last three, four, five years, a couple of good examples of what’s really driven that Ross. If you go back two, three years, if I said to a PE firm, what do you think of Aon, Aon could do to help you? They might say, I know you, we talked to you on the limited partner side, you’ve got a big investment management arm of your business, and we talked to them about LP investments, or you are an LP in our fund or, or they might likely have said insurance due diligence. And they might’ve said something more recently, this warranty and indemnity insurance, or as we call it in the US, reps and warranties insurance product, which has genuinely exploded in the last four to five years in utilization in PE.
Alistair Lester:
And yes, we do all of those things, but what’s really exciting for us is our ability over the last few years as our industries evolve, and as Aon has evolved to bring multiple advisory capabilities, multiple advisory work streams to life on the one hand and multiple or an increased number of financially motivated insurance instruments to bear on the other hand and much more sophistication and science around how we really do develop, deliver value in the portfolio. So when you have that conversation now with clients who’ve been on that journey over the last three, four years, they would absolutely recognize our industry. And particularly our firm, I think, has been leading the charge in areas like cyber consulting, in intellectual property consulting and advisory and valuation, of course, in risk and assurance in the broad set of human capital from retirement benefits, but also talent reward and compensation aspects of deals.
Alistair Lester:
Then on the instrument side, looking at the adjacencies to warranty, and indemnity insurance like loan contingent risk insurance, be that tax insurance be that litigation insurance we’ve pioneered a product called judgment preservation insurance. We’ve pioneered the ability to wrap insurance around your intangible assets or intellectual property. You can potentially use those instruments as collateral, which enable you then to access different forms of financing. So really the big change has been this institutional-industrial realization there is an opportunity to marry up what has traditionally been seen as a relatively lazy, perhaps enormous pool of insurance capital with all the parts of the capital markets and bridge the two in a way that drives value into private equity deals, because as you and I both know, private equity are just so hungry for what they call new technology and new ideas, and that’s been a fantastic accelerator for what we do.
Ross Butler:
Why is AON providing the services that it is providing? What’s the journey from your insurance services capabilities to the services that you’ve currently just outlined?
Alistair Lester:
The world lives in a world of risk, and Aon as a firm is all about risk. We are a risk business. Insurance is an instrument that can help clients manage their risk. But what we don’t do is just deliver insurance products. We also deliver a range of advisory capabilities that help clients understand, identify and mitigate risk insurance instruments are just one part of the mitigation aspects of how you deal with risk. Every deal that any client does, they price risk into their deal, and they deal with risk in a deal in different ways. Maybe they priced chips. Price chips are a result of people identifying risks they’re not comfortable with. Maybe they seek contractual recourse against the seller against the counterparty, and maybe that contractual recourse is somehow secured through escrows. Maybe, as a buyer, if I identify risk in a deal, I defer an element of the consideration to see if that risk crystallizes, and if it does, I’ve protected myself because I’m not having to pay my deferred element of the consideration. All of those things are well-established approaches to dealing with risk in a deal. Those risks need to be identified for people to be able to understand them and then come up with solutions for them. So, the exciting point is we think those three buckets of price-chipping contractual recourse, and deferred consideration, they’re all perfectly valid ways of dealing with it, but none of them are actually optimal ways of dealing with risk in a transaction. By contrast, optimal approaches can include solving them through more insight into those issues, so you get more comfort with them. We can provide that in a range of ways across people, risk and cyber risk and intellectual property risk, et cetera, et cetera. But secondly, by introducing an insurance instrument, which can take that risk away in a far more attractive way and deal with those potential risks in a far more attractive way, potentially than price chipping or deferring, or getting contractual recourse against the counterparty.
Ross Butler:
And all of this kind of moves you further towards, I suppose, insurance being a purely defensive product. You’ve got a clear line of sight to enhancing returns through all of this.
Alistair Lester:
You’ve teed it up beautifully. So, we talk about what we do is securing investments and enhancing returns. That is our little strapline. We think with our advisory capabilities, we can give you much more insight into what you’re getting into. We think with some of the core traditional insurance solutions that are out there, very plain vanilla, traditional insurance solutions, you can secure that investment. But actually going to your point on enhancing returns, we think that we are able to deliver these structured insurance instruments across a wide range of areas, including structured credit and tax and litigation, et cetera, whereby spending a pound, a dollar or a Euro on that instrument you are realizing or recognizing multiples of that either in the enterprise value or somewhere in the capital structure of the transaction.
Alistair Lester:
That is a very different way to think about insurance, where for most of us, including people who live and breathe it, you know, renewing our car insurance or home insurance, or even our business insurance every year, what you’re really looking for is a way of reducing the cost of insurance, because you see it as a sunk cost. You don’t see it as a return generating instrument, whereas with a lot of what we’re doing, it’s spend a dollar or Euro pound on that instrument, and you will see a multiple of that somewhere in your enterprise value or capital structure.
Ross Butler:
It seems to me that risks over the, say, that 25 year period, have gone from being relatively tangible, relatively geographically, constrained to being much more intangible, much more distributed across the world, less physical and therefore just much more complex. And I suppose, as a result of that, harder to quantify and I guess where there’s complexity there is opportunity, which is why it’s logical for insurance providers to have expanded in this way. Is that a reasonable reading?
Alistair Lester:
I think that’s, that’s a very astute reading Ross. I think this is why Aon has diversified its capability set, for exactly those reasons, And if you double-click on intellectual property, as an example, and intangible assets, as an example, you only have to look at the huge rotation of the S&P500 over the last 40 years, which has gone from being, completely dominated by hard assets, tangible asset values, and companies who operated in those areas to companies, which are absolutely intangible asset rich and intellectual property based. And as a result, by the way, the insurance industry, some argue, has struggled to stay relevant as it could have done growth of global insurance premiums has lagged global GDP growth for that reason, because the insurance products are not as relevant as they need to be to what’s going on in the world traditionally. So, Aon made a move into intellectual property – and this is what Aon has done brilliantly – we have purchased capability and talent in adjacent areas to us. So, we bought a business, which was one of the leading intellectual property consulting businesses. And then what we’ve done is we have worked with that business to deploy that capability into a private equity context. We’ve worked with that business to build insurance instruments that can deal with intangible risk and intangible assets in a way that wasn’t previously being addressed. And we’ve gone one step further by helping to use both of those things, the insights and the capability we have on the advisory side, the risk modeling, the quants capability we have on the valuation side to then build product, which is enabling and opening the door to IP, rich companies, to access financing, using insurance as a collateral around their intellectual property in a way that’s never been possible before.
Alistair Lester:
So that’s an absolutely spot on. What Aon has done over the last five to ten years is it’s added inorganically areas of talent and capability, whether it’s in cyber, whether it’s in intellectual property, the talent world, we’ve added businesses and people who have bought different skill sets to our firm. Many of whom have had zero exposure to the insurance industry before. But actually by bringing these people into our industry, they are giving us perspectives on different emerging risks, which we’re able to support clients from an advisory point of view with, but also match those risks into the huge pool of insurance capital and start to build some new and evolved and developing insurance solutions that, that provide answers.
Ross Butler:
Tell me a little bit more about the, the IP services, in the specific context of venture capital and private equity. What type of business is it most useful for?
Alistair Lester:
So we think that one of the things we’re most excited about is we’ve always had a relatively limited story for the VC end of the private equity and financial sponsor community that is truly value added. We have an ability to identify, map and value the unique intellectual property, particularly the patents, but not just the patents, it can be data. It can be trade secrets, et cetera of individual companies. By doing so, we place a value on that, on that intellectual property, through a proprietary valuation methodology. We have the former head of intellectual property at Phillips in the Netherlands, global head of IP at Phillips. We have the former general accountants of general counsel for patents from Microsoft, right. People who honestly, if you ask them, ‘Would you ever, five years ago, can you ever see yourself working at Aon?’ They would have said, ‘absolutely not. Why would I?’ So we have some unbelievably deep talent in the IP space. I think we have more of the top 300 recognized global IP strategists working for Aon than there are at any other company in the world. And no one would know that right.
Alistair Lester:
We then spent a long time persuading the insurance industry of the efficacy of that valuation methodology, and there are many other parts of the capital market’s ecosystem, which rely on the underlying security of insurance to enable financing. We look in the aircraft, leasing space, residual value insurance on aircraft hall is, is a critical requirement for aircraft leasing. You know, finance use of aircraft leasing require certainty over what the, the aircraft may be worth at the end of the 10 year lease. And the way they’ve got that in the past is through residual value insurance that provides the underlying security, really what we’re doing and intellectual property is a similar thesis. We are valuing the intellectual property for a proprietary methodology. We then were demonstrating the efficacy of that valuation to the insurance market who are then wrapping an insurance policy around that value, not at a hundred cents on the dollar at a discount to the value, maybe 50 cents on the dollar by wrapping insurance security around what were previously intangible assets.
Alistair Lester:
You are turning them into tangible collateral. And what can you do with tangible collateral is you could raise finance against it. So, now we think we’re inventing or pioneering at least a new potential way for firms who are in the maybe series B series C stage to raise working capital and runway capital. Because up until today, the primary way for those firms to raise money has been to raise equity founders that owners don’t like raising equity, it’s diluted, it’s expensive, it’s painful all of those things and actually being able to, or they go and raise venture debt. And venture debt performs an essential service, but also it’s not, it’s got a lot of complexity to it. We think we have an instrument now, which can enable you to access pretty straightforward, not cheap, but pretty straightforward debt secured against an insurance wrapper, which is wrapping your intangible assets. And we think by doing that, we are potentially reinventing how you finance early stage companies. The British Business Bank wrote a paper probably two years ago saying why can’t banks recognize intangible assets more as collateral for financing? We think we are leading the answer to that question, which is- what can you do if you do it in this particular way?
Ross Butler:
I assume that larger businesses with large IP people folio, they’ve got other financing options.
Alistair Lester:
A hundred percent. That’s a great question. But, and yet, we also have clients who are approaching us and asking whether we can collateralize their IP portfolio for the purposes of satisfying pension trustees. Right. For example. So, you know, we need to provide collateral to our pension trustees. Maybe this is a product that we could use to satisfy our pension trustees over pension liabilities and future pension contributions. We’ve got financial institutions who are approaching us and asking whether this is a product that they could use to satisfy some regulatory capital requirements, right. So, you know, is this a product that could satisfy the banking regulators to a certain level that intellectual previously unrecognized intellectual property that they held in their business is now something they can collateralize and use to enhance their financing of, of whatever obligations they have. So it isn’t just the venture answer, but we’re seeing particular appetite and interest in the venture backed community in the early stage businesses area at the moment.
Ross Butler:
That’s a great example of allowing people to focus on the upside and enhance their returns. I don’t want to spend the whole time talking about COVID, but obviously it’s completely changed the nature of, and scale of risk. That touches on so many parts of business, so I’m thinking particularly like cyber, for example. I was speaking to a CEO the other day, he’s based in London, 90% of his employees are in India. Geographically remote. Can’t get out to them very easily. All of these risks seem to be not really thought of, just a couple of years ago.
Alistair Lester:
We launched our cyber- M&A private equity focused business, getting on for two years ago now. We did it for a couple of reasons. Outside of private equity and M&A, Aon had made an inorganic acquisition in a company called Strauss Frieberg, which was one of the leading global cyber risk consultancies that grew up in the US and again, I I’d imagine if you spoke to many of the people inside the original business, they had not had anything to do with the cyber insurance worlds. They were deep cyber risk consulting people. Then we built a client facing delivery of some of the capabilities within that business, and we did that by, we actually bought across people from the big four who were providing private equity, cyber due diligence, which was just emerging two or three years ago. We bought some of those people across. And the exciting thing is, we were able to persuade them of a couple of things, which I think we’ve proven out, which is one. We have the in-house technical cyber capability that we just bought this business with deep technical cyber risk capability. But two, we also have in our industry, a huge amount of data insight from cyber insurance. So we know what is happening in the cyber risk world, because cyber insurers are paying claims for our clients. So we know what’s, what’s creating those claims and we know how much is being paid for those claims and how those claims are being managed and how the risk of being mitigated to avoid them happening.
Alistair Lester:
Again, you put together deep cyber technical expertise with quant data, true deep, rich data over what is actually going on in the cyber world, which is causing financial loss. And you’ve got a unique skillset. So, our cyber team, actually very specific to private equity, have built something called Portfolio Scanner, a piece of proprietary tech, which blends in automated threat analysis with a quant model. We’ve done this for a number of PE firms. You can run it at relatively low cost, to come and run a six month cyber review across your portfolio. You can run it in very quick time, automatically across your entire portfolio, and it gives you a traffic light outfits of which firms in your portfolio need a closer, deeper dive from a cyber risk point of view.
Alistair Lester:
It’s no guarantee that there’s no problems in the ones that are green or amber, but it will tell you from an outside-in point of view, an unobtrusive outside-in points of view, where we think based on outside threat and industry sector knowledge and claims statistics from cyber insurance, you should be going to look Mr. GP to double-check that firm is doing what it should be around cyber risk. We actually ran that for a GP last year. And one of the firms that came out on the red of the traffic lights, we literally just reported to the sponsor. And just 10 days later, as we were going through the action plan, they had a ransomware attack. And that led into a huge recovery exercise. Again, no guarantee that if we ran that exercise six months earlier, the ransomware attack wouldn’t have happened, but certainly there would have been more awareness within that firm of the risks and, and hopefully some, some mitigating actions would have been taken.
New Speaker:
What’s really powerful areas that is all consulting work, but we’re delivering technical and rich data insight in an, in an automated manner, in a highly efficient manner, real time. We are launching and delivering within three to four weeks, not let’s run a long cyber risk consulting project, which takes many months because by the time the speed of the world’s changing so much that, you know, six, nine months’ time, it’s a different threat. It’s a different group of people. It’s a different type of ransomware, whatever it is, you know, you need to be keeping on top of this on a regular basis.
Alistair Lester:
So a lot of our PE funds now are actually running Portfolio Scanner on a regular basis, but at six months or 12 monthly, and they run it, it’s just a, it’s a health check across their portfolio. And it just helps them stay in touch with, with exactly what’s going on. And, you know, we were quite excited. We ran it for Cinven, which reported that in their ESG report.
Ross Butler:
That makes perfect sense to me, marrying the qualitative in the quantitative. I’ve long felt that you have the cyber professionals who are focused on best practice and process, but you’ve also got the kind of the unknown quantitative part, which is the elephant in the room. And you know, companies that pay ransoms, they don’t publicize it, of course. And one suspects that it is a much, much bigger problem than most people realize had they had to send a press release out and it was in the media. And so there’s something of a disconnect between the scale of the problem and what to do about it. And it sounds like you’re able to contextualize the problem and then find the solution, which feels to me like where I’d want to be.
Alistair Lester:
Yeah. Yeah. Look, I think just one thing I’d add is, is I’ve just talked about that in a portfolio context, which is critical. The other thing we’re learning is fascinating is our clients who go through that exercise, looking inside the portfolio, across the portfolio, they almost without fail, ensure they implement pre-investment cyber due diligence as a specific work stream going forward. A lot of firms haven’t been. Or they felt that their IT DD covers cyber. They’re close cousins, but they are distinctly different things. By the way, we’ve also got to make sure we’re okay as we’re going into new deals and this whole workstream of cyber due diligence, which we think where that evolving further into what we call digital and tech DD, where you’re looking at yes, the cyber risks.
We had a client say to us not long ago, every deal is now a tech deal, right. So let’s look at the tech in that business and understand how risk-exposed it is. We just brought a guy in from Turner & Townsend, a well-respected property consultants. Again, not an insurance guy, he’s a risk consulting person, but he’s able now to deliver his risk advice in a much more informed and contextual way because of the data and the insights we can provide from inside the industry. And that’s why we’re bridging the advisory and the risk transfer together.
Ross Butler:
So just so I’ve got the lexicon straight, you’ve got it, diligence, which is like you, your internal systems, and processes, and making sure that they’re efficient and functioning. You’ve got cyber, which is like security and stopping attacks. And you’ve got digital and tech, which is
Alistair Lester:
It’s performance risk. We ran a deal for a PE fund who was buying a, a reasonably well-known real estate platform. Right. And actually what we helped them understand was how many of the hits on the platform were from bots and how many were genuinely from independent consumers, right. And that goes to value. You want to pay for the consumer. So it starts to become not just a risk issue, but also evaluation issue, which is exciting.
Ross Butler:
What about people risk? Do you do anything in that domain? Obviously there’s a link with, with cyber and behavioral behaviors.
Alistair Lester:
We do it very broadly. And I think traditionally again, when people thought, well, what would Aon do in the human capital space to help us? It would be, well, we’ll do some actuarial work on the pension plan, or we’ll do some look at life and medical insurance and make sure that we’re meeting employee benefit risk. But again, Aon bought a business not long ago called QT, now rebranded Aon Assessment Solutions, they are a bunch of psychiatrists and psychologists. We had an infrastructure client who was funds, who was buying a, a bus business. I mean, lots of infrastructure funds by bus businesses. I think EQT had just bought a big one in the US.
New Speaker:
Interesting little story: we were arranging motor insurance for the bus company and they have to have it. And one of the things that drives motor insurance is, is driver’s safety. The price of motor insurance is driven by how safely, how well do you train your drivers. We brought in our Aon assessment colleagues to create a framework for the type of personality that they wanted to hire and to maintain as bus drivers and to put it very crudely, you are looking for people who are less aggressive on the accelerator, on the gas pedal. There are characteristics which are going to lend you to be more heavy or less heavy on the gas pedal. So that had two incredible benefits.
Alistair Lester:
One: By doing that, and by demonstrating to the insurance company that they were hiring that sort of person that puts the risk in a better light, it enables Aon to secure a better price for the core old-fashioned motor insurance for the buses. But here’s the other thing you could also demonstrate: how the fuel consumption of the fleet would reduce and the environmental positive environmental impacts. And of course, the economic positive impact in terms of reduced gas fields and fuel bills for the bus fleet. You’re going to value in way more ways than just one, which is we can help you reduce your insurance premium. We could also help you reduce your operating costs through reduction of fuel consumption, and we can demonstrate that you’re thinking about that through an ESG lens in a world where those things are increasingly important. It’s a really good example of how we’ve gone from being an insurance broker to adding these other elements to a value.
Ross Butler:
And that comes from presumably the psychological profiling of the people
Alistair Lester:
Right. So when you go and hire now bus company, you need to hire people with these characteristics, which we have defined for you, and it’s now built into your, your recruitment processes.
Ross Butler:
There’s a huge change that’s, that’s happening in terms of the work environment. Are you’re doing some thinking on this area.
Alistair Lester:
So again, we have an enormous human capital practice who stretch right across, you know, governance, board consulting, compensation, talent, et cetera. And, and we have, we’re one of the firms we sponsored in various countries, something called the Work Travel convene. So we brought together in Australia, in the US and the UK in different countries, large employers. And we’ve done that over the last 12 months. And this isn’t, you know, the private equity and M&A world, but this is more broadly as Aon. And what we tried to do in the private equity community is then bring the conclusions and the insights that, that are being created from those sort of exercises into P funds into their portfolio. But the work travel convene is really trying to look in that crystal ball about where this is going, what are the implications for the workforce?
Alistair Lester:
One of our big areas of course, is terms and conditions of employment and benefit packages, and how do you construct compensation packages to reflect different working environments and all of those sorts of things. So a huge amount of work in progress on that. And I think a lot of clients are increasingly looking for help in that area, because as you say, there’s so much uncertainty.
Ross Butler:
Yeah. I think also private equity firms are increasingly focusing on people and talent and talent retention is their core asset. And you’ve got private equity firms hiring HR, internal HR people to just think about that within the portfolio.
Alistair Lester:
Again, one thing that people won’t know probably is Aon has two businesses, one called Radford, and one called McLagan. They are two leading compensation consulting and compensation data businesses. In fact, McLagan is probably recognized in the general partner and the, in the PE community as being the leading private equity compensation consultant in the world. We know we build many of the, many of the maps, many of the GP carry plans, they come through McLagan insight, but again, Aon in the past culturally McLagan would have been run as a very independent business, delivering his value to its clients in a, in a slightly isolated way.
Alistair Lester:
The way that the firm has been reorganized in the last few years is, is around what we call Aon United which is really about bringing the whole of the firms and the clients, and the fact that we have people who are delivering compensation and talent advice to a large number of PE funds, you then think about how can you maximize compensation particularly through carry of your general partner practitioners through the ever-increasing adoption of innovative solutions and innovative financing structures, right? So those things are linked as well. We can help you maximize returns in your portfolio companies, which then drive your compensation structure that we’ve helped you put in place by the way, through these ideas over here. So, these things are not all individually separate from each other. They are all intertwined.
Ross Butler:
I’ve got a couple of other COVID things on my list. Supply chains, which I assume is bread and butter for insurance services, but global supply chains, given international relations and protectionism, is, it’s not in a good place.
Alistair Lester:
That’s a critical factor. One of the most important parts of the insurance world, which is probably overlooked is two areas, but one is business interruption insurance. That’s come under the real spotlight as a result of COVID. I mean, let’s be honest and, and not necessarily the most positive spotlights, and we’ll see how that all plays out, hopefully positively for policy holders who have valid claims. People in our industry have been talking about supply chain risk for a long time. I think what COVID has done is accelerate that and now there really are needs for firms to really, truly understand their supply chain, but not just because of the, the revenue and the, and the financial risks, but also increasingly through an ESG lens as well, you know, modern slavery background checking, all of these sorts of things are really important in the supply chain.
Ross Butler:
I’ve written a couple of things down from your preamble, but I can’t quite read my writing. Judgment preservation insurance. Is that right? Yeah.
Alistair Lester:
So that’s a, that’s a new area we’ve developed over the last year or so. So we’ve invested heavily in, in our litigation risk group. So there again, there is a theory, a thesis that we would like clients to see litigation as a potential asset, rather than just something they unfortunately have to go through. If you’re bringing a claim against somebody and you believe you’re going to win. And more than that, perhaps you’ve won at the first quarter or the second court. We developed a product which will enable you to ensure as much of that judgment as you can. And in the event that it progresses to the next layer and you lose, then the insurance, it provides you that, that capital. And here’s the thing that that’s really exciting. So we just closed the deal for a client who had won a significant judgment against the large US firm. And we were able to secure several hundred million dollars of insurance, which by the way, it was not the total amount of the judgment award. It was a substantial tranche of it, but by no means a majority, we were able to secure some, several hundred million dollars in judgment preservation insurance, which very simply said in the event that this is overturned, you are going to be indemnified by the insurance company, and that’s nice to have, right. But here’s the really positive and interesting thing: that firm was then able to use the judgment preservation insurance to access third party financing. So the insurance became collateral to access financing. Litigation funding has become a big thing, right? Litigation financing has been around a long time. It’s absolutely got a place. It provides a very essential service. But we are introducing new ideas, which potentially are alternatives to that, arguably again at a lower cost of capital. And that’s super exciting. We’ve hired people in our firm from litigation, funders and litigators who understand that world. And what we’re really doing is using their knowledge and insight with our capability of building insurance, structured insurance instruments and structured products to, to redefine how, how clients can, can see, find value in those sort of situations and see them as assets.
Ross Butler:
In a private equity context, every moment counts, it’s the distraction, I would imagine more than anything, you don’t want it as a standing board item, when you’re trying to grow a business fast.
Alistair Lester:
This is exactly right. And certainly when you come into exit, right, what you do not want is uncertainty over litigation and exit. So we do a significant amount of wrapping up litigation like we do within the tax world. What insurance is very good at Ross is, is rapping, is bridging low probability, but high financial risk situations into certainty, right? And of course that costs money, which is the premium. But that’s what insurance can be very good at. And if you can, you can do that increasingly with tax. Some brilliant advisors around the world will tell clients, this should be fine. What you get from the big four, what you get from the lawyers is we’ve done this before. This should be fine. What you don’t know is whether someone on the other side of the deal table to you has the same view.
Alistair Lester:
Maybe they are a large conservative, strategic, maybe it’s the first time they’ve done a deal in that jurisdiction, whatever their motivations are for feeding the risk, the perception of the risk is different to your perception of a risk. And those are the sorts of things that can derail deals, right? They can get, they can, they, you know, they, they become distractions from actually, this is fundamentally a good business. We want to buy here, but we’re getting distracted by negotiating and arguing over whether we think this one piece of litigation is more or less likely to happen or more or less likely to cost this amount of money, right, and insurance can deal with those situations by giving you a well, we can sell you, it will cost you this to take this issue away. Now, all of that cost makes sense in the context of the data.
Alistair Lester:
It doesn’t, but at least it gives you something, a point of certainty, which you can get a resolution on and that’s becoming much more understood and that’s relevant in tax too. And you can push further by the way, without getting too off piece into further adjacencies around structured credit. So the same broad thesis Ross applies in receivables financing. So one of the things COVID has done is really drive a real increase in the amount of receivables financing that go on in the market. What many don’t appreciate is if you can wrap insurance around those receivables in an appropriate manner, you can de-risk that portfolio receivables. If you’re de-risking that portfolio of receivables, you can arguably lengthen the tenor and reduce the coupon on the financing terms you’ve got. So it’s the same thesis. And just in a slightly different situation.
Ross Butler:
So do you have a classic CEO 3 or 5 year vision for Aon in M&A?
Alistair Lester:
I do. We’re living in the middle of the hottest market we’ve seen in, in a long time. We’ll see how long that lasts. But I think, I still think we’re scratching the surface in terms of the value we can bring to our clients. If I’m really harsh on ourselves, we still are delivering one or two of our core traditional value propositions into a deal. And actually if we just paused and, and delved a little deeper into the deal or had the right conversation in the right way at the right time, there are multiple live opportunities that we have allowed our clients to leave value on the table because we haven’t been either able to identify or able to articulate how we could find a way to help them to, to find that value and bring that value off the table. So that’s really the key thing. I think we’ve grown enormously in the last three to four years. There is still huge white space for us, we think because there’s just, we’re very fortunate. We’ve got an incredible breadth of services and we’re backed up by this incredible ability to bring capital, to bear in a way which hasn’t happened before. And honestly, we’re scratching the surface.
Ross Butler:
Alistair, thanks so much for your thoughts and for coming on to Fund Shack.
Alistair Lester:
Listen, thank you so much for having us Ross. It’s been great.
This is a Fund Shack ‘private chat’ about the large opportunity set in the European private equity market, from buyouts through to venture capital, with a focus on growth strategies in all these markets.
Alternatively, you can listen to the filmed version here.
Transcript:
Ross Butler:
You’re listening to fund Shack. I’m Ross Butler. And today I’m speaking with Dan Aylott managing director and head of European private investments at Cambridge Associates, where he’s responsible for EMEA private equity and venture capital research. Dan works with clients to help them build, manage, and monitor their private market allocations. So he has fantastic insight into the industry and some unique perspectives on the market, which he was good enough to share with me. Enjoy!
Ross Butler:
Welcome to Fund Shack. You’ve been at Cambridge associates for a fair while now, but I believe you’ve just undertaken it a new role. Can you tell us a little bit about that?
Dan Aylott:
Yeah. Hi Ross. And I’m very happy to very actively speaking to you today. I’ve been at Cambridge just over nine years. I’ve been in the industry now for a whopping 20 years. I started with a private equity team in year 2000. I joined Cambridge nine years ago to work with clients on their private markets portfolios. So for the first sort of eight and a half years at Cambridge, that’s been my primary focus. And then last year, my role changed slightly. So I now I’m head of European private investments, which entails me having a mix of responsibilities.
Dan Aylott:
My primary responsibility going forward is to cover the European private equity and venture capital research function here, which means that, were tasked with finding best ideas and high conviction managers. But for our clients, I’ve brought some client relationships with me. I continue to work with some of our key clients at the firm. And yeah, excited by the change. Even when I was working predominantly with clients, I was often, doing manager due diligence and looking and scouring for ideas for, for those clients’ portfolios. So this is just a, really an extension to, to that role. But I’m excited. We’ve got a, a large opportunity set, I think, in, in European private equity and venture where we’re adding resources to the team so that we can we can cover all of those opportunities. And I’m very excited by what lies ahead.
Ross Butler:
What’s particularly exciting. You, what parts of the market do you really like the look over at the moment?
Dan Aylott:
I’m passionate about all parts of the market really, but I think for us at the moment, there’s a real desire and hunger to look for growth strategies, and that can be anything from very early stage venture through to growth, equity and buyouts that have a growth slant to them. We’ve long been talking about the benefits of growth and how growth is the predominant factor in achieving outsize returns in private markets portfolios. That’s where a lot of very interesting ideas are coming from right now. Certainly, in the venture space the ecosystem there has really been growing and expanding in Europe in particular, there’s always been a very sort of well-established U S venture market as everyone obviously knows.
Dan Aylott:
I think Europe has often been thought about as being in the shadows of the US and even potentially China and Asia to some extent, but I think recently we’ve seen some strong performance coming out of Europe and some the manager universe, if you like, sort of expanding in all directions with many interesting strategies for us to, to look at and to answer, consider for our clients.
Ross Butler:
Tell us a little bit about that if you would that. Can you quantify the, the growth of European venture in the last half a decade or so?
Dan Aylott:
In the last year alone, there was $20 billion raised by European VCs, but there was 40 billion invested in Europe. So that gives you a sense that the market is very attractive and is attracting investment from all over the world. In fact, and that’s really feeding into a very buoyant and a flourishing ecosystem. So it’s definitely an area of growth and, and definitely an area where we’re seeing lots of very interesting opportunities There’s always been well-established firms in, in the venture space in Europe for a long time. We’re seeing a lot of managers spinning out. Operators, people who’ve run or worked in senior positions in technology companies and have done very well made a lot of money, want to continue to invest in the space. Joining forces with investors to create new firms that I think are particularly interesting.
Ross Butler:
Then what underlies this growth? Was it just a question of time in the market, because for a long time, European venture capital it underperformed and it was, and it was subscale and perhaps to a degree, it is still subscale, but, but what underlies it’s, it’s, it’s recent growth?
Dan Aylott:
There’s a number of things that you might want to point to. When I started in the industry 20 years ago, roster the European venture landscape was really not on the map. I was joking with a colleague this morning about how, diligence used to be done. Data rooms came in the form of a, of, of envelopes packages in envelopes that were sent to you via the post. So that, that age has me somewhat, but the venture capital market obviously had been impacted by the.com crash. There were very few European venture firms last minute.com perhaps was, was the most famous impacted obviously when, when the crash happened. So really nowhere on the map where performance really wasn’t, wasn’t there either.
Dan Aylott:
And it takes a long time in venture for performance to come through. I think since the financial crisis, there’s several things that have happened. We’ve been in a very low-rate environment for a long time. So people have been seeking growth and seeking alpha from different areas of their portfolio. And I think that, venture and growth has been an area that has if that, that, that growth and that innovation that can’t be sort of captured anywhere else in, in portfolios. I also think it became a little bit uncalled to be a banker or or go into financial services after the last financial crisis. And there was an impetus perhaps, but for young people coming out of universities, strong tech universities to think about doing something different.
Dan Aylott:
So there’s a number of factors I think that has fed into it. And I think as, as we’ve seen performance improve in Europe and we have some statistics that show over recent horizons one year, three year, five year European venture growth has actually performed strongly versus the U S and Asia. And I think as that performance has started to come through its European venture has caught the attention if you like of investors. And from that, and the more capital that flows into the, into the industry, the more opportunities that it creates.
Ross Butler:
That’s all directionally very positive. But the venture managers that I speak still tend to complain about a relative lack of capital in Europe compared to their us counterparts. Would you, would you agree with that?
Dan Aylott:
I mean, I would. I don’t know how, what the best way of saying it… It is… Underserved relative to other markets. Something like10% of jobs in the US are currently within companies that are VC backed and the equivalent number in Europe is 1% that is still quite concentrated around markets like the UK and Europe. But what happens with LPs generally is that there’s a lag. So the PE investors see performance coming through and then think, well, okay, this looks interested. I’m now going to start committing capital to these types of strategies. And so that’s what I think we’re seeing here is that we were convinced Cambridge that European venture and growth is an interesting space for our clients to commit capital finding great ideas for them to do so. There’s some convincing to be done around European venture capital and growth for certain investors, because historically performance in Europe has been difficult.
Dan Aylott:
The exit environment has been a little more challenging, and that’s being addressed. I think in some ways, here in here in Europe, there are changes to the regulations around listings, for example, that might make it easier for technology companies to go public. But that’s just one example, but there are, there are changing in a positive direction in Europe. And so, I think it’s just a matter of time for people to continue for investors to continue to see that positive momentum coming through. And I think that the capital will continue to flow into it. Abut I think it’s today, or you’re right. I think there’s still, more to go for. I think the overhang of capital in Europe is much less than it is in Europe. sorry, then it is in the U S apologies. Yeah. so, there’s some interesting dynamics in, in Europe that were, that we’re keeping our eyes on.
Ross Butler:
I’ve heard one hypothesis, which is that in fact, if more capital accrues to European venture and growth capital, you might see returns increase relatively counter-intuitively because of that sub scale element to the industry. Is that something that you would agree with, or do you think that the more capital that flows in will, will eventually kind of push returns down?
Dan Aylott:
Yeah, it’s an interesting thought. I mean, the fundraising market at the moment is really, really frothy. And boy, there’s lots of capital being raised everywhere, not just in Europe. I think the general perception is that the more, that more capital that gets raised, the more likely it is that returns will tail off. So it depends, I think you still have to keep disciplined. I think the key is for the managers that raise the capital that are successful at raising the capital stick to their strategies and, and remain disciplined in, in the areas that they’re good at and the areas that they can, they can produce, the attractive returns for their clients. And I think if managers can do that then, then, then returns will still be maintained. I think, as I’ve said, I think the, the universe of opportunities continues to grow for some of the reasons we mentioned earlier, more entrepreneurs, more, data scientists coming out of, of universities, more, more M&A from corporates looking to improve and acquire additive technologies.
Dan Aylott:
So as the universe continues to expand, I think that there is enough opportunity for more, more firms, more managers, more funds to be raised, but there probably will come an inflection point, right. Where, where potentially there becomes too much money and the overhang becomes too great. The managers either become ill, disciplined, or valuations get so high that it can then impact returns. And that’s always the concern and something that we’re focused on a lot,
Ross Butler:
But we’re not, we’re not close to that point though. Would you say….
Dan Aylott:
I don’t think we are in Europe yet. No, absolutely. I think there’s probably quite a way to go. We still like to see our managers remain disciplined, as it relates to fund size and strategy. But there does seem to be, an increasing opportunity set. And back to that stat, I mentioned earlier about 20 billion raised by European VCs, 40 billion invested, that tells you that even managers outside of Europe are looking at Europe as a potentially fertile place to invest. And I think that will continue and we’re seeing more and more, for example, U S firms setting up offices in Europe that haven’t previously had boots on the ground here. And so I do think there’s a way to go on that.
Ross Butler:
So if I’m a European venture manager or growth manager, it’s a good time to hit the road and start fundraising, but I’ve got to be disciplined. I’ve got to stick to my knitting as they used to say to what degree do I have latitude with regards to kind of think about different fund structures or sub sectors. Do you think there’s, there’s investor appetite to see firms explore those kinds of innovations?
Dan Aylott:
Yes I think so Ross. We are seeing, in terms of funds raised, ‘opportunities’ funds or, or ‘overage’ funds so that they can continue to back the winners in their portfolio. And this has been a phenomenon that we’ve seen for a few years now and that can work really well. Managers want to continue to invest with their best companies and if they can select the winners in their portfolio, then the benefits to their investors are all great. And obviously, investors must be comfortable for the longer hold periods that that entails. But we’ve seen, we’ve seen a lot of that happening in terms of fundraising and that’s one way for managers to expand their offering if you, like.
Dan Aylott:
I think the other side is that increasingly we’ve been seeing specialization across the, across the market and this applies to the buyout space. It applies to growth, and also it applies to venture where we’re seeing managers really sort of focus on what they understand what they know best. And it might be areas of things like FinTech. It might be AI, it might be SAS or consumer. And, and we’re seeing an increasing level of specialization with, with some firms. This can, this can be interesting. It allows LPs and investors to really kind of construct their own portfolios in the way that they want to, if they have a, a belief, for example, that FinTech is where the greatest opportunities are going to be. They can add some FinTech opportunities, maybe some crypto, that’s another area where managers are really specializing. And so we’re seeing an increasing amount of that. Again, we still like to see managers remain disciplined, raise the right amount of capital to prosecute that strategy. And that’s always the key consideration for us, but we’re definitely seeing more of that in the venture space and frankly, elsewhere in private markets. There’ this theory that as, as a market evolves there becomes more specialization and more deeper domain expertise within the managers.
Ross Butler:
And is that a firm or fund or both phenomenon? So, I’m thinking if I’m a generalist venture capital manager, is it the right strategy to start raising very siloed funds,
Dan Aylott:
Different strategies, work for different managers, right? There are definitely, there are definitely examples where people have been successful at doing just that as you described. So, they raise different vehicles within, under the same firm umbrella and have dedicated teams prosecuting on those strategies. They raise a, a one fund, one pool of capital, and they have teams within their firm that specialize in certain areas, but ultimately investors get a diversified portfolio across those, across those themes. And then the other thing is the other way of doing it is to be a single strategy firm with a very clear specialization in what you’re doing, whether that’s crypto, whether it’s digital health or, whatever the sub strategy is. And so there’s different ways to play at Ross. And there will be different ways it will work for different firms. I don’t think there’s a one size fits all answer to that really.
Ross Butler:
Does Europe have any particular sub sector advantage advantages in either of those kind of very broad spaces? I mean, you mentioned a couple already FinTech and
Dan Aylott:
Yeah, it’s interesting. I, and I think these, these sub strategies are still emerging, really Ross. I think we’re watching closely areas like FinTech, and I think the fragmented European sort of financial services markets are helpful to that. And the, the different currencies in, in Europe can be helpful to spawn interesting opportunities across FinTech. So that’s one area. I think Europe is a leader in yeah, environment, environmental issues. And so climate tech could be an area that Europe excels at. And, and there are some, some managers that we’ve seen that are focused on, on those types of strategies, agritech, climate tech energy, that kind of thing. But yes, I think there are certain areas that that Europe has a unique kind of positioning for areas such as, SAS and enterprise of enterprise software, SAS digital health, I think are probably a little more global in their, in their sort of their reach if you like, or applicability. So I think we’re seeing as much innovation there in Europe as perhaps we have in the U S although probably, a few years behind in terms of the development of the market, as we’ve talked about already. So
Ross Butler:
In the UK versus the rest of Europe, because obviously the UK is still in Europe given the events of the last year, rather than put Brexit on the back burner. But, but how are things looking from a vendor perspective there,
Dan Aylott:
That’s a good question because Brexit, like you say, we’ve been talking about Brexit now for, for, for more than four years, right? It’s well, when you’re coming up for five years and I think when then the referendum result happened I talk about this as well in the context of bias, but I think just the uncertainty around Brexit was the key thing. Now that we have some certainty, I think people can adapt and they can, adjust their, their, their business models to deal with, the additional admin that’s related to Brexit. I think the key thing we were concerned about were, was talent and movement of talent. So I think we still got a way to go really Ross before we can answer that. And no one has a crystal ball. I, what I would say is that particularly in the venture space in Europe, there have been, hubs that have, have, have grown up in Europe, places like Berlin cities in central and Eastern Europe in the Nordics, there are the French ecosystem is flourishing for venture.
Dan Aylott:
And so I think, I think venture capital really i, a pan European phenomenon, although, as I mentioned, earlier in terms of venture backed employment predominantly, it still resides within the UK as a, as a percentage of the overall market. But I think perhaps what we’ll see is a more even distribution of that across Europe.
Ross Butler:
Can we talk a little bit about the exit market you’ve already touched on the fact that there’ve been some easing with regards to IPO restrictions, what’s your general view on gone on, on the exit world?
Dan Aylott:
I mean, I, I don’t know if the regular, I haven’t seen the regulations around listing. I think we’re still being debated, but I think it’s been recognized that in Europe there needs to be an easier path to listing companies, venture backed companies. And so that is, that is I think, still under review. I don’t, I haven’t seen the results of that of that review yet. But as I said earlier, I think large corporates have become more acquisitive. So there’s probably more opportunity for M and a, and there’s also the U S market. So European companies can still can still go to the U S for, for their access. I think it’s still something that’s improving. And for example, there’s been some very successful life sciences exits the, they don’t necessarily hit the Heights of some of the U S listings that we’ve seen, but that they are happening and, and producing some very attractive returns for investors. And I think that that will continue to be an improving picture as time goes on and will help again adding to the to the attractiveness of the European market.
Ross Butler:
I guess one of the things that the venture industry has struggled with is, is a lack of natural institutional investors that are venture capital minded. But I assume that that’s something also that will develop and, and grow over time as investors gain experience in the asset class.
Dan Aylott:
I think so Ross, yeah. And it comes down to risk really, and the perception of risk. Right. And we work with clients of all shapes and sizes, right? With all different types of programs. We’ve, we’ve Cambridge, Cambridge associates. We have been advocates for venture for many decades and our clients have done extremely well from their venture allocations. And so, I think, I think overall, we have an easier time of convincing clients of the benefit of venture, but look, it’s a, it’s a re it’s a riskier asset class when you look at the loss ratios, for example, in funds they’re still very high. So that doesn’t mean that, as I’ve said, performance has continued to improve in Europe and has been, for mthe right managers in the U S have been extremely strong.
Dan Aylott:
And the point there is that the winners, far outweigh the losses, right? You, you need to pick funds who can find those breakout deals that are going to produce the returns that investors are looking for. But I think there’s still this perception that venture overall is a riskier part of the market. And so, I do think that as a, as I mentioned earlier, as the returns continue to solidify and be strong more and more investors will take note more and more investors will take a closer look at venture and find us a place for it, an allocation for it in their portfolios. Particularly as the traditional. And, if you look back at the buyout opportunity in Europe, the early two thousands, there was a lot of low hanging fruit, white space returns were very strong. People could generate great returns. Second decade returns have moderated. It’s been harder to differentiate yourself. The market has become more efficient. And I think as those parts of LPs portfolios start to see that there’ll be looking for other ways to generate outsized returns
Ross Butler:
That you also cover private, private equity buy outs, but from a growth perspective. So what, what are you seeing there are there? I mean, it’s easy to call yourself a growth-oriented buyout specialists, but how do you determine that that’s actually the case?
Dan Aylott:
Growth is a strong determinant of returns. And so, when we’re looking at managers, we’re looking at, what type of businesses they’re buying what are the growth rates in those business in terms of, of revenue and, and how are they helping to maintain and even grow that revenue over there, over their whole periods? That’s not to say that we, we don’t look at any managers with a different strategy. But I think increasingly over time, we’ve seen that just, buying, buying companies, applying a bit of leverage, making a few operational changes to increase margins. Doesn’t really, doesn’t really cut it in terms of achieving the sorts of returns that investors would, should, should expect from this asset class. And you really need to have an element of growth. Now that growth can be, it can be a quiet, it can be organic, there’s different ways of, of looking for growth in buyouts. But that’s what we’re focused on. We’re always looking to see where that growth is coming from. And I think, as I said, it’s an important determinant of returns.
Ross Butler:
We’ve also seen buyout firms move into the venture space as well, which I suppose with some buyout firms has a cultural effect, because there was once a very clear division between the VC and buyouts for a long time, and perhaps that’s not so clear anymore.
Dan Aylott:
I’m not sure that’s true. There have been some examples of some buyout firms establishing venture teams. There are some buyout firms that feel that having a venture program or a small venture fund alongside their private equity business is additive because they get to get, they get to see innovation and it’s kind of earliest form and that can inform where they want to look in that buyout strategies. I don’t, I haven’t seen a lot of that actually, Ross there’s some definitely some examples. And I think you’re right. I think the, probably the issue is that it’s a very different skillset, a different mindset. You need dedicated resources for it clearly. And so it’s difficult, it’s difficult to integrate. And a private equity mindset is different from a venture mindset in many ways, private equity is all about preserving capital, not losing any capital.
I mean, venture in venture capital it’s, it’s, it’s almost expected that money will be lost. As I said earlier, loss ratios are still somewhere in the 30 to 40 range. I think it might even be higher. I don’t have the numbers in front of me, but it’s almost expected that a part of your portfolio will fail and, and as entrepreneurs that’s okay. You’ve got to focus on your winners in, in venture. So it’s a very different mindset, and I think it’s hard for a private equity firm to have that sort of similar approach. But no doubt, as you mentioned, there’s been a few firms that are doing it and some doing it successfully,
Ross Butler:
Going back to the sector idea, does that also apply in terms of specialization? Does that also apply to the buyout world in the same way?
Dan Aylott:
Yeah, definitely. And it’s probably a little more advanced, I would say, in, in, in buyouts potentially where we’ve Cambridge associates long been investing in managers that have sector specialisms. So again, predominantly, or I would say the US has been ahead of the head of Europe in that. So, in, in sectors like healthcare and sectors like technology, there’s actually a few opportunities in Europe for those types of, of investments, but we still believe that sector specialization and deep domain expertise, is a positive for, for investors. And we’ve, we’ve got the performance numbers to show that actually the, , if you’re a specialist, you, you outperform your generalist counterparts. And I think in areas, for example, like healthcare in, in Europe, where again a fairly underserved space for specialists, it’s an, it’s a sector that has long been invested in by generalist managers.
But we, as I said, we believe in that sector specialism, and that’s an additional domain expertise such that, managers that have that focus should have an advantage. And so we’re definitely watching that. There’s a, there’s a handful of managers where we’re interested in, in Europe for our clients and looking to invest the capital on their behalf in, in those strategies across the size range, by outsize ranges. Yeah, not so much, actually. So I would say that specialization tends to start in the smallest end of the market. And there’s a number of factors there. So probably related to spin out so often, we’ve seen sector teams or sector heads spin out of generalist firms to set up a dedicated sector fund. Those funds naturally being first-time funds being more focused and more specialized will be smaller.
Now over time, we fully expect some of those, those funds and those managers to grow and expand and, and become larger. But there are very few large specialists in the European market, unlike in the US where we’ve seen the emergence of some very large say technology players and increasingly healthcare specialists, certainly some consumer specialists in the U S that are now multi-billion dollar funds. I think we’ve got some way to go in Europe before we have that level of opportunities at the larger end, but we’re seeing several interesting things at the smaller end of the market where, arguably markets are more efficient. I think they’re more efficient, they’re more reasonably priced from a valuation perspective. And where investors and managers with real domain expertise have an advantage. So I think it’s interesting for the low middle market and the middle market at this point.
Ross Butler:
Dan it’s mid-April, and I understand this is your first day back in the office for the best, best part of a year. How’s it, how’s it going to affect ’em and how has it been affecting kind of day-to-day business where you are?
Dan Aylott:
It feels very strange to be back in the office today. It feels like my first day at work again, but having been on calls like this on zoom for the last year I think we’ve all got quite used to it. So it’s been very interesting to see how managers have dealt with, with this pandemic how they’ve dealt with deal origination sourcing of new transactions, which largely has been done virtually on calls like this and the fundraising process. So, I’ve been involved in a number of DDS over the last year where everything has been done virtually. I have personally find I’m looking forward to being able to get back to meeting managers in their offices. But actually I’m always amazed at how well this industry adapts and, and in particular for this crisis and the specifics around the pandemic, I think the industry has moved incredibly to adapt to this new environment.
It will be interesting to see how things unfold as easing unlocks. I think that the preference for meeting face to face and that sort of real interaction with, with, with managers will still prevail. And I think we’ll have definitely be meeting in person again, hopefully soon. I think the industry is probably more aware of the carbon footprint it has now in terms of travel. So I fully expect, and I know here at Cambridge Associates, we’re definitely thinking that through in terms of what makes, what makes sense and, and going forward in terms of our travel policy. But I think it will, I think it will have to come back in many ways. I had a manager asked me the other day, we’re planning our annual meeting in November.
Ross Butler:
What format would you prefer for AGMs etc? In-Person or virtual?
Dan Aylott:
Actually both. Please! I think investors will want the option. I think going forward they’ll will demand to have different ways of doing things. So it will be very interesting. I it’s been, it’s been really surprising to me how quickly the market rebounded from a fundraising perspective. So, Q1, and I think through the majority of Q2 last year, everyone was focused on their portfolios, trying to understand what COVID meant for their portfolio companies shoring up those portfolios. Making sure that, their companies can survive this period. And then I think beyond Q2 as, as it emerged that certain sectors strategies where we’re going to be fine and resilient through this, I think the fundraising market really came back and, technology, healthcare, all the things that we’ve talked about, very resilient through this.
And I think that will continue. I think that’s an acceleration in innovation if you like that, we’ll just, just continue. So it will be interesting. I think this is going to be a fascinating period for everyone in the industry to see how this unfolds. But I’m expecting to continue to do some of this, some of this sort of virtual meetings and discussions and conversations with managers, with colleagues but I’m also expecting to have some more interaction face-to-face as things ease and as, as, as prospects live writer globally,
Ross Butler:
I do hope so, Dan, and thanks so much for sparing your time and your insights.
Dan Aylott:
Pleasure. I really enjoyed it. Thanks Ross. Appreciate it.
Simon Witney on sustainability and corporate governance.
In this episode, I’m speaking with Simon Witney, who’s probably the best known private equity lawyer in Europe. He’s currently a senior consultant at Travis Smith where he spends much of his time advising clients on sustainability. He’s been chairman of the BVCA’s Legal and accounting committee and Invest Europe’s Tax legal and regulatory committee. He is a visiting professor in practice in the law department of the London School of Economics, where he teaches.
And he has a new book out published by Cambridge university, press called Corporate Governance and Responsible Investment in Private Equity. Our conversation is in two parts. Firstly, we look at the new sustainability regulations and what they mean for companies and investors. And then we go on to look at corporate governance itself.
You can watch the video version (with speed controls and bookmarks here.)
Patrick Sheehan of ETF Partners talks to Fund Shack’s Ross Butler about creating sustainable prosperity with venture capital. You can watch the video version here.
Patrick Sheehan is a founding partner of ETF Partners, a leading European growth capital firm investing in innovative companies that have the potential to create a more sustainable future.
ROSS BUTLER
Patrick, welcome to fund shack. You set up ETF partners way back in 2006, then called the Environmental Technologies Fund. It must be strange that everyone’s caught up with you.
PATRICK SHEEHAN
It’s wonderful that people are much more conscious about sustainability and that’s great actually. You know, I’d like to think that haven’t quite caught up to be honest about it, but I’m being picky. No, we, that I I’ve been in venture capital over 20 years in Europe, in Silicon Valley back again and, and wanted to do my own thing. And so, so actually I and my colleagues sat down and thought what what’s worthwhile, right? What gives us a sense of being useful? And, and the idea that we could show that venture capital had a role to play in solving really big problems was it was just very attractive back then. And you know, I think the only thing we got wrong was we were a decade too early, but I think that’s by starting early and suffering the pains that any entrepreneur does actually of battling along for a decade has been good for us. And, and I think that’s probably why now we, we really feel we have a, an authentic leadership position.
ROSS BUTLER
Yeah. You were in Silicon Valley and had a successful venture capital career out there before you did any of this stuff.
PATRICK SHEEHAN
I’m really of confess to everyone listening, I started in venture capital in 1985, but back then it was a very different world that was in the UK sort of pre venture capital, if you will. And then Silicon Valley, my time, that was the.com era. So, so I’ve lived in a few different eras and, and the world keeps surprising us, right. We’re in a new one now.
ROSS BUTLER
Your thesis, while it was called the moments technologies fund, your investment thesis, must’ve evolved fairly significantly in the last 16, 14 years. 15. Yeah.
PATRICK SHEEHAN
I’d love to say yes, but not really. I think it was, I mean, in essence, it’s unchanged in, in the actually, you know, I’m an optimist and optimists are the people who can make change happen. I tend to think. So. I think it’s important to be optimistic. And I, I really feel that technology can supply a lot of the answers to achieving sustainable prosperity and venture capital can be really in a range of those technologies. And so that belief is unchanged. That’s, that’s what we do. And we’re never going to change what that is. We’re still investing across Europe, but change is not subtle under the hood. Actually, I’m happy to go into it, but it’s around learning where we can apply venture capital and where we actually it’s a bit harder because I think if we go back 15 years, we, we, we, we saw the needs. And so we wanted to apply venture capital, but it’s, you know, you can’t use a scalpel on every operation, right?
ROSS BUTLER
Well, this is exactly what I wanted to talk to you about actually, because we’ve got this global problem and it’s going to take a lot of solving, where does venture capital fit in?
PATRICK SHEEHAN
So I think it’s really important, but it brings, it has constraints as well as benefits, right? So venture capital allows people to take bigger risks and bigger opportunity, but, but actually we all typically all invest from 10 year fixed life funds. We need results in that timeframe where we have a potentially large, but still strange capital. So it works on, on some sets of problems, whether it can be quite quickly, very rapid growth. It works less well on a range of others, which are also important for the writer. So you know, I don’t think it works for nuclear fusion particularly well, there, there are some venture backed startups in that area. That’s I think massively important technology for 20 or 30 years time perhaps. Right. So, so we deal in the big term, which I think is, you know, results in, in a few years to 10 years, but not more. And, and we have to find companies that can grow pretty rapidly with relatively constrained capital, even in this venture capital environment. And so that’s a subset which has focused us more and more on digital technologies. And by the way, we can invest outside that area. But the sweet spot for us becomes digital technologies that deliver sustainable benefits. And it’s still pretty broad, but, but it’s not everything right
ROSS BUTLER
Out with the solar panel Passover or raised out with the wind farms. And then with smart digital technologies that help help us be more efficient.
PATRICK SHEEHAN
From our narrow perspective. Yes. But when we started out 15 years ago, there was a boom in solar, by the way, just to give you an illustration. And I remember when we talked to our investors at the time saying to them that there were then in 2006, seven over 50 thin film photovoltaics, it’s not just all federal tax, but just this one time. And, and there’s really the market for one or two, right. And revenue growth rates of those companies was probably 70% per annum, but there was very little margin in it. So we said, well, we’re probably never going to do those. Right. And that’s, that’s a low margin. It’s, it’s like the computer memory business used to be right. It’s all going to go to China. And, and sadly it has. So we have to be very careful of the sectors we play in, right. But there’s, there’s enough real innovation and added value to sustain and create durable businesses. So that really hasn’t changed going back to what hasn’t, hasn’t changed actually, Europe when we started was a great place to be. And it’s just got better. Europe’s really coming of agents. So we, we, our focus is Europe and we find some really really fabulous companies. Now,
ROSS BUTLER
In what sense is it, has it got better repeats entrepreneurs and technology is being spun out, that kind of thing.
PATRICK SHEEHAN
Yeah. Well then venture capital’s matured over the past 15 years, it’s become much more global industry. And, and so people know the roadmap now in a way that they didn’t before and, and people are much more focused on high growth companies and how to create them and know what the game plan is. And so it’s not just, there are more repeat entrepreneurs. There are people who have worked for successful entrepreneurs and there’s a much bigger ecosystem. So overall we just see better quality opportunities because there are people who are much more, you know, a greater number of people who are highly engaged and, and well, it’s really honestly refreshing if I think back over, there’s been a rapid change in the past 18 months around sustainability. Right. but, but it’s, it’s refreshing now that entrepreneurs have been selecting us in some of the recent investments we’ve made because of our brand values and our real values. And they quizzed us not on the usual venture capital, blah, blah, blah, but on the, you know, are you sincere? Cause we want, we want to deliver a positive impact and we want to make sure that you’re right behind us. And and we are, and so they’ve selected us and that’s, that’s, that’s, that’s so refreshing. Right? So having backing people where there’s aligned values makes life so much more simple.
ROSS BUTLER
That’s interesting because given that you aren’t doing like large renewable projects, but you are investing in more digital companies. To some degree, I look at your portfolio and I think, well, that, that could make sense regardless of the climate change pressure. And so you could get an entrepreneur that has set up a business that you find attractive for, for a set of reasons. And instead of for another set of reasons, but increasingly it sounds like they are
PATRICK SHEEHAN
That’s, that’s exactly right. So we’re, we’re not backing uncommercial companies. And what I like to say is the need is the opportunity actually. And so there is great need, right? And that’s why major industries are transforming that speed. And that’s why there’s opportunity for us, right? Our investors want to make as much money as possible to be clear right now, no one cuts us any breaks this. We say to them, we want to, to do well and to do good. It’s not all so on the entrepreneurs, we back could be backed by anybody, but, but they do tend to like the fact that we have a common agenda, the common mission. And I think that creates a better level of trust. Really. So our competition is, is quite diverse and it is some environmental funds. It is some mainstream funds.
ROSS BUTLER
I find your, your ETF’s flavor of environmentalism, very easy to swallow because it’s, you, you caught it optimistic and it is. But it’s also, I find very different to the kind of very pessimistic and is Knight anti humanistic anti-human view of environmental in the environment. And you’re, you’re effectively saying we, we, we have an efficiency problem. We just need to do more with what we’ve got or more with less. And, you know, that’s human progress in a nutshell, really.
PATRICK SHEEHAN
I mean, it’s the story of civilization really. And you know, I think the challenge of climate change is critical. The challenge of well, broadly of sustainable prosperity is critical, but, but good luck trying to convince someone, we need a more sustainable planet. Therefore everyone should be poorer. I mean, I would argue that that’s just not practical, right? We’ll spend so much time arguing about it. It’ll never happen. And so the, the, the way to make progress fastest is to use the system. We have capitalism, right? There’s many faults with it, but it’s there. Let’s not spend a decade changing it. Let’s just use it and get on with it. And, and to aim for delivering prosperity because there’s durable demand for it. And it isn’t incompatible by and large w we’re living more sustainably and a progress creates efficiency. And so I’m sure there are flaws with this argument at the nausea and by the way, and you know, it’s not innovation delivers unexpected things, so we’re not always right. But, but as a general theme, I think it’s profoundly important to think that way. And an innovation is absolutely the key.
ROSS BUTLER
You don’t say sustainable growth, you’re saying sustainable prosperity, which is a slightly different thing.
PATRICK SHEEHAN
Yes. Cause prosperity, I think is a better word. When people think of growth, they think of increasing consumption. I think actually, you know, you can have prosperity with decreasing consumption. You know, there’s only so much time you’re only going to eat in a meal, but we probably enjoy eating nicer meals. Right. So it’s, it’s moving towards a better quality world rather than a higher volume world, if you will.
ROSS BUTLER
So I’ve said that I liked your view of environmentalism, but I guess the flip side to that is to what extent does that view and how venture capital solves climate change really affects the big, the big problem? What, what’s the scale of the solution that venture capital brings? Is that a tiny piece or is it an important piece?
PATRICK SHEEHAN
It’s a really good question. It doesn’t solve everything to be clear. So how it fits in as an important piece of the puzzle though, I think so venture capital is not going to help with the rollout of solar. It’s not gonna help with, with delivering renewables at mass scale. That’s, that’s, you know, maybe a big infrastructure funds will do that. There’s different types of money, but it’s still an, a lot of money, but where venture capital plays a role as improving the efficiency of all that. So this is not solving the problem in the next year or two at all, right, when next year or two is urgent, we need more renewables, I think, but it is solving the problem of the next decade or two of making sure that we’re as efficient and effective as possible over that timeframe. And you know, you look at the cost curves of things like solar and wind.
Solar has probably fallen 90% in cost in the past 10 years, when more than 50% of costs in the past 10 years, that’s innovation and that’s and, and I think you can safely extrapolate that cost curve for another decade based on innovation. So it’s really critical. The impact of that is not quite so linear either because once these, these technologies become cost competitive or even cheaper, then they change other industries, right? And as you roll them out, the rate limiting step not becomes not the cost of their deployment is the intelligence with which you can use them. So other technologies are required. And then I think in that, in that, in that wave of know how to, to make efficient use of these new renewables of the electric car industry and the consequential problems, you know, et cetera. Now, I think venture capital has an enormous role to play and a lot of prior experience to draw on.
ROSS BUTLER
Yeah, it’s a classic venture capital conundrum though. The world is being disrupted by a mega-trend, what are the, all the unexpected con unintended consequences around that, that we can, we can explore it when people talk about this dramatic decline in the cost of solar and the learning curve and so on. It sounds amazing. Is it as amazing as it sounds though, because I mean, there are obviously the intermittency issues and so on. I kind of, whenever I hear it, I think, wow, the world is about to change dramatically and the energy companies are stuffed, but it doesn’t seem to be the case.
PATRICK SHEEHAN
Well I think we live in a world that’s quite hard to forecast. I think you can forecast cost reduction curves, by the way. I think you, it’s hard to forecast the consequences of the very easily. But, but if I go back in time 10 years ago, if I tried to talk to the CEO of an energy company, I couldn’t, and then I, then I might more recently you’ve talked to the marketing department who were claiming to do things on behalf of the energy company. And, and there was that, that sort of denial and obstructive constructive confusion. But in the past year or two, I can talk to the CEOs of energy companies. And by the way, I can say to them, you’re a bit stuffed, aren’t you? And they probably say yes. And so what’s important is these are bright and smart people. They live on the same planet as us. I’m not getting it. Then they are really engaged on how to solve the problem. And so they are beginning to innovate and do things. And so I, you know, I’m not one of these people who thinks big, big companies are the problem and evil. I think actually they are now beginning to change rapidly and will really be part of parts of the revolution. And so I think we need to support them rather than just attack them.
ROSS BUTLER
We live in a world where everyone wants to quantify everything, but it’s very difficult to be able to quantify potential impact. And, and so, so what I wanted to ask you was what are the most promising areas where the kind of incremental change, the incremental improvement could make a difference. But it’s going to be a very subjective answer, I guess you’re going to have to give.
PATRICK SHEEHAN
Yeah. And the best things tend to surprise us. Of course. So happy to answer that question, but there’s an implied agreement in what you said that, you know, that, that actually the most impactful things are often the hardest to quantify, right? Because you can quantify the predictable and the predictable is often less impactful. Holy See, now how it’s impactful. One of the problems of funding innovation suddenly the government and policy level is it’s really hard to quantify the benefits of the unknowns from innovation, right? And so that tends to be a stumbling block. So we are very focused on delivering innovation and impact, and we try to quantify it by the way for each of our companies, but we don’t get too hung up about it. Right. Otherwise you fall into let’s do that because it’s measurable as opposed to let’s do that because we think it’s impactful, right.
Even before the pandemic, we had started to look very hard at the logistics sector because it’s, it’s being quite, it had to been quite resistant to technology and actually quite a, quite a polluting industry. It depends on how you measure it. And so we we’d started to make one or two investments there. We made one before the pandemic certainly struggling. We made one after that, they’ve actually unsurprisingly and I’ll be doing very well. And so, so, you know, logistics and efficient distribution I think is, is a very important area for us. Mobility, I guess obviously remains profoundly important because the whole car industry is changing rapidly. And that, that has consequential impacts outside of its own industry into many things, not most obviously energy, but many other sectors as well. We we’ve looked and keep looking very hard at the what’s called the energy transition.
And again, this is a vast industry already changing rapidly, and we’re looking very carefully at very smart data companies. I’m hesitant here because I don’t really want to say AI because it’s such a buzz word, but I’ll say it anyway because that, but using intelligence to, to make smarter, better informed decisions. And in this past year, we, we, we invested, I’ll give you an example in a company called deep sea that uses genuine artificial intelligence to, to improve the efficiency of the shipping industry. And that’s a big polluter and, and enabling ships to operate as a measurably improved performance is, is very impactful. Now it doesn’t solve the problem that the shipping industry is polluting, but it it’s actually an incredibly efficient and quick way to, to improve the situation.
ROSS BUTLER
Oh, that makes total sense because obviously heavy transportation is one of the hardest things to, to, to get off of oil, to replace or oil. And so any improvement there,
PATRICK SHEEHAN
And, and particularly for us, we’re looking at where can we use technology to, to create improvement. And we’re, we’re looking increasingly at sustainable foods these days and at the, the impact of the rise of the green consumer, you know, we’re seeing very interesting companies popping up now. Not, not so long ago, we invested in another gentleman neobank had a digital bank, like, you know, there’s Monzo or Revolut, many others out there, and they’ve become very big, very quickly. And we found these guys in Germany who really able and nice people, who’ve created a green equivalent of one of those. So tomorrow is, is the green revenue, the green Monzo. And you know, I’m very happy with it. And it’s, it’s, it appeals very strongly to in, you know, engaged people, people who are engaged in sustainability want personally to do something with their money that that’s helpful for for climate changes, as opposed to potentially harmful. And so, and so if we’re finding different themes not all of them obvious where we think there’s big impact happening or about to happen. Let me try a
ROSS BUTLER
You did a deal called the modern milkmen. One component to all of this is, is behavioral obviously. And some of that behavior just harks back to the past. So I did a little bit of work with P and G who were introducing reusable, adamantium shampoo bottles. And that’d be rolled out across Europe this year. And, and you know, you might say great innovation, or you might say, well, that’s kind of 1950s
PATRICK SHEEHAN
Sort of back to the future sort of thing. But, but now the modern Melbourne is, is, is a really interesting company, actually, because if you’re English, you mean when you think of an old fashioned milk van and whistling and walking around in the morning and that all died. And they died in the name of efficiency and supermarkets delivering milk in much cheaper plastic containers. But the founder of Bob Milton, who Simon is a very able entrepreneur, very thoughtful guy. He told me he was inspired by, by David Attenborough’s blue planet actually decided that he really ought to do something now in his third startup, that to get rid of waste. And eventually he focused on essential grocery deliveries as an area where it would be relatively easy to get rid of waste. So it is a little bit of a back to the future thing and that the milk comes in glass bottles. There’s no plastic, you know, there’s no, there’s no waste wrapping. And, but there, the front-end may look delightfully traditional. The backend is, is you know, there’s a lot of digital science, a lot of know-how, there’s a lot of efficiency through micro distribution centers. And some of the jargon flips at the back end from old fashioned to very, very modern. And that company is doing extraordinarily well, actually.
ROSS BUTLER
I wasn’t being cynical by bringing it up at all. It’s like, no one wants to throw stuff away. And, and, and most people will even be put out a little bit, I would say in order to just feel like they’re not being unduly waste where you don’t have to be a greening to.
PATRICK SHEEHAN
And honestly, when I tell people about it, they nearly all say, great. Is does that deliver in my area? Right? Yeah. That’s a fairly easy check. And then I think one of the things we are seeing is this is sort of an efficient localism, if you will. And it’s, it’s far more green to avoid transporting stuff around the planet. And, and frankly, there’s probably better quality produce if it’s more local and more fresh. Yeah.
ROSS BUTLER
So you are hesitant, you were hesitant to mention it, but it is very, very hot to, to what degree can it kind of create efficiencies that’s decreased simply put carbon emissions, would you, it,
PATRICK SHEEHAN
Well, I’m hesitant, hesitant to mention it because it’s overused as many buzzwords get, and it’s sort of from, from a, some cynical perspective, it’s just a good way to bump up valuation, to start waving your hands and start talking about AI. My second reason for cynicism is that the, the underlying science has not evolved very fast, right? Well, it has evolved is the speed with which computers can crunch numbers. And so using established, and if not old algorithms plus computing power, now you can deliver more. And so I think you know, I’d like to see more real innovation in the algorithms actually, but, but nonetheless computing power has evolved in such a way that there’s a far more applicability of these sledgehammers. And they’re very effective on certain classes of problems, right? So shipping is actually a really good class a problem.
And that, it, it it’s a bounded problem, as they say, it’s not, it’s not an open-ended question. You know, if you, if you wanted to use AI to find out about America, you know, forget it, it’s too vague question. But if you want to use AI to optimize a set of parameters that you know about, and, you know, you can’t have ridiculous parameters because it’s self-evident, then, then you’ve got a problem you can solve. So there, I think it’s really good for certain categories of optimization problem or certain categories of drug selection problem, but it, it’s not good for everything yet. And, and it will take a real intellectual revolution as well as a computing revolution. I think before we get to the science fiction end of the spectrum, it’s great for some things, but, but and we’re really keen that she’s to see more AI real-world applications that can drive efficiency. So we’re definitely on the lookout for those. And, and I think we will see more by the way, because of course, compute power continues to increase the storage costs continue to go down. And so, so applicability will rise for sure, but I think it’s, it’s, it’s nibbling at the real world rather than taking it over. Yeah.
ROSS BUTLER
I’m glad I asked that that’s fascinating and a slightly more prosaically you invest across Europe, even though you’re based in London. What’s it, you know, Europe has a pretty good reputation as as being environmentally aware and has been for some time, but what’s it like for entrepreneurial businesses doing business in Europe, perhaps in terms of government incentives, doing business with government, doing business with cities you know from a, from a, let’s say from a green perspective, and then just from a business perspective.
PATRICK SHEEHAN
So Europe is, is, there’s not one country, right? It’s complex and diverse and culturally different, you know, A-list but, but doing business with, with a sustainability agenda, I think is, is just a commercial advantage because there is more support, there is more Goodwill. And you specifically asked about governments and cities. Well, one of the outcomes of the pandemic is that European governments are gearing up to deploy a lot of in effect reconstruction money into the economy with a view as to the type of economy they want, and they want a green economy in Europe. And so, so actually we are expecting a lot of investment in and around the green economy and the acceleration of, of sustainability and that that’s, I think, going to be clearer and clearer as we go through this year. And you know, the UK is hosting cop 26 in November, I think, and there will be announcements in the UK, but actually the EU is putting money forward.
Denmark is putting money into its economy on, along this agenda, et cetera. So I think governments will be a source of capital of potentially large scale of capital, but it will move slowly and probably with a certain momentum rather than you know, what’s the phrase these days, this is not a speed boat. Cities you think should be faster, but, but actually when we have companies that they invest in smart or selling to cities, looking to become smart and intelligent, and it’s not an easy market because procurement cycles are still long, right? They’re still somewhat political, et cetera. So there’s great opportunity, but, but it’s not easy. But that said, if you’re an entrepreneur thinking about, or actually on sustainability, these are not the only benefits it’s, it’s frankly, much easier to recruit people. So we find our companies can by being genuinely focused on sustainability recruit better people more easily and how great to staff loyalty and greater satisfaction, you know, and that then extends beyond staff into their ecosystem generally. So, so I think actually in essence being green is increasingly just good business.
ROSS BUTLER
Hmm. Well, that’s such an important point because I mean, PE people in the businesses that you back is the most important thing. So if you were getting better talent for less money, or just better talent per se, it’s not the less money, sorry,
PATRICK SHEEHAN
But because you have to, you know, the deal is you have to give people the best opportunity. You have to give them as learning opportunity, but, but, but newer generations are find this much more appealing. And so it is easier to get better talent.
ROSS BUTLER
Good to go back to, you mentioned cop 22. And one of the criticisms of, of the the state led targets, I guess, is that that they can be seen as bad value for money. If you’re going to spend so much money on something that you pretty much know is going to be pretty inefficient, surely you should channel a bit more into an area that’s very, very kind of laser targeted on also making a return. Yeah,
PATRICK SHEEHAN
Innovation delivers a huge bang for the buck. And, and governments could sensibly deploy more capital there. But but, but typically infrastructure projects get more capital because they’re easier to quantify. So let’s, let’s make it pertinent to the UK. You know, only one of our geographies, but, but we’re spending 50 or 70 billion. I forget how much on a new train line from London to, to Birmingham Manchester. And, you know, maybe that’s a good thing, but it’s a hell of a lot of money. And a small fraction of that would have a profound impact on not just addressing climate change, but on the economic competitiveness of the entire country. So, so, but how would you rationalize that quantify? Well, that’s a bit harder, right? So, so the, the uncertainty and the femoral nature of innovation means it’s relatively underfunded. I think
ROSS BUTLER
Patrick, I wonder if you could leave me feeling really optimistic about the world, because, you know, w we’re all inundated with climate change doom and gloom, you have an optimistic outlook, you know, when you’re when you’re not in work mode and, and not in necessarily ETF mode, but just Patrick sheer mode, how do you generally feel about about progress on this score and, and where we’re headed?
PATRICK SHEEHAN
I am somewhat schizophrenia. I overall I’m optimistic because I think, well, there’s always a crisis, right? If you go through history I used to argue with my fellow students when I was a student about, about the upcoming nuclear apocalypse, right? And, and at least half of them thought there would be one before we got to the age we are now. And I was always on the, on the optimistic end of the spectrum saying the trend of civilization is, is positive. And that there are bumps in the road. If we apply ourselves, then we can do magical things. And you see that repeated through history. It does, I think bad news sells better, right? And it, and it is easier to stoke fear than to stoke hope. But, but, but actually there’s been an astonishing progress in the quality of living around the world, in our lifetime, right there, the, the there’s a billion, fewer Chinese people in poverty life expectancy’s gone up, Health’s gone up.
Education is going up. The internet has profoundly changed the way which we can collaborate. And by the way, you see the power of collaboration and the speed we can now deliver vaccines. People said it was impossible to deliver a vaccine in 18 or less has been less. And so actually, I, I think w w there’s a lot to go out. And if we, if we worry too much, you know, we’d like to fall off the tightrope, but there is no choice. Now, if we want to sustain a good standard of living for the, what is it, seven or 8 billion people on the planet we have to go forward and we have to be creative. And we, we have to be optimistic within that. I think we have to plan rationally, right? And on the concerns long-term planning long-term funding of innovation and technology being one sub sub set of that I think is really important. And there’s probably not enough of that. And so, so I’m a little bit schizophrenia, but not the optimistic.
ROSS BUTLER
I asked you to leave me optimistic and you’ve done exactly that. I’m really glad I asked the question, Patrick, thanks so much for sharing your thoughts and sparing your time.
Vania Schlogel is managing partner and founder of Atwater Capital, an LA-based international private equity firm. You can watch the video version of this conversation here.
Vania Schlogel is managing partner and founder of Los Angeles-based Atwater Capital, a private equity firm with an exclusive focus on media and entertainment. Vania cut her teeth at Goldman Sachs and KKR. She was on the board of Pets at Home, and she was CIO of Roc Nation, Jay-Z’s entertainment agency. And she currently sits on the boards of private equity back to media and entertainment businesses across the US, Asia and Europe.
ROSS BUTLER:
Vania, welcome to Fund Shack. You are quite an unusual private equity investor in as much as the creative industries don’t scare you. In fact, that’s what you focus on, specialize in. How did you get interested and involved in it?
VANIA SCHLOGEL:
I saw so much value from marrying those two worlds. So the very kind of disciplined and rigorous private equity side of things with the innovation from the creative world. And I just always had the natural interest in it. The creative side of things, obviously as, as, as an individual who consumes content and music myself, and as an investor really experienced that marrying those two worlds could actually help an investment in terms of equity, value creation, generating returns on behalf of our LPs. And then I know this not many folks were doing it, so it seemed like a natural opportunity to get in.
ROSS BUTLER:
So what, what, when was your kind of Eureka moment that actually there’s an investment opportunity in this industry?
VANIA SCHLOGEL:
When I was at KKR one of the investments that I was involved in was the buy and build strategy that built what is BMG today. One of the world’s largest independent music publishers, and it was really my first foray and ability to actually invest in the creative industry. And I think one of the things that was very successful about that investment is we, as investors were able to go in and provide a body of knowledge and expertise as to what we were good at and focus on that. And I think what we did really well is let the creative guys focus on what they’re good at. And so we were backing a great management team and company with capital and M and a and integration expertise. But then we also knew when to not overstep our bounds. I can’t recall who said it, but there’s, there’s this joke in the music industry about the CEO that wants to see himself in the music videos? I think the most successful thing we did is we made sure that we were not the CEO that wanted to be in the music videos or the shareholders or board members, however, you’ll term it. And, and that was my Eureka moment where I said, this is a great investment. It’s a lot of fun. I tangibly understand it. I get along really well with these creative executives. And from there on, it just became as you know, what happens in life, you one thing, and then suddenly more opportunities keep coming in that vein.
ROSS BUTLER:
So you, you had it with a traditional private equity house, but why do you think the traditional private equity market doesn’t see it as necessarily a big sector ?
VANIA SCHLOGEL:
Well, I,do think they see it as a big sector. I think that there is more appropriately put there’s a lot of opportunity from actually investing in the sector, but then taking the next step of being really operationally involved and plugged in with the creative sector. And I think the primary reason, honestly, why it is not a big operational focus for large private equity shops is because they’re very, very good at what they do on an operational level. So implementing an ERP rollout or optimizing a supply chain, these are scaled replicable, operational strategies and processes that they can apply to their portfolio companies, really building a deep partnerships. And the operating level with creatives is time-consuming and not always replicable to other portfolio companies. And so it’s more of, I think, a scaling issue and we’re kind of happy being the smaller fund that goes ahead and steps into that role as a partner to a lot of larger GPS.
VANIA SCHLOGEL:
Yeah. It’s a chemistry thing, presumably that, you know, people that set up creative business are probably quite different to almost any other kind of business, I guess, and you have a good kind of chemistry with them. It sounds like.
VANIA SCHLOGEL:
Yeah. And I think at the core, in any case investing is a human centric business, but when you do delve into the creative aspect and, and partner with creative executives who are very much more around, you know, emotion and being led by intuition, it is very important to jive on a personal level and to really take the time and build those relationships. And I will say that despite the fact that we have wonderful working relationships with a lot of creative executives, myself and a lot of Atwater’s executives are also personal friends with our creative partners. I think that works really well for the industry.
ROSS BUTLER:
It’s quite a rare individual to be both creative and to be able to be more financially focused as well. Do you come across many creative entrepreneurs that can and do do both?
VANIA SCHLOGEL:
It is, I would say it’s more of a rarity. I definitely have noticed that a lot of a subset of folks that do this really well seem to be founders and entrepreneurs. So we back, for example, certain portfolio companies Oscar Hoagland, who’s the co-founder and CEO of epidemic sound. He does really well in terms of liaising with both communities. And so it’s not a common skill-set. We do see it, but I would say I see it most often among CEOs and founders, and maybe it’s because I don’t know us founders, we have a, a little bit of that craziness, the risk taking the innovative, whatever you want to call it, but just enough there that we’re willing to kind of get out of maybe the modality of thinking in a, in a typical private equity or consulting or whatever.
ROSS BUTLER:
So you will come your private equity firm Atwater it makes it a virtue of being operationally involved in these creative businesses. To what extent do the businesses that you invest in kind of welcome operational input and to what extent do they need it typically? Yeah.
VANIA SCHLOGEL:
Well, let me answer the second question first, because I think that’s the easiest every business, every individual, any organization of people can improve in one way or another. That doesn’t mean that our ideas are always right. And in fact, that’s one of the first things that we strive for in our relationships with management teams is feel free to kick us in the teeth and tell us if these ideas are completely asinine. And we genuinely mean that. And but is the, is the opportunity for improvement there? Absolutely. And the best founders and management teams recognize that then going to your first question about how welcome is that we as a fund, so we’ve invested about a hundred million dollars since I founded the fund in 2017. And in all our investments today, we’ve been a minority shareholder de facto.
VANIA SCHLOGEL:
That means that even if I wanted to, from a governance perspective, I cannot come down with edX from above and say, this is what you must do. And in any case, I genuinely think that’s kind of bad, bad governance and a poor way of managing these relationships because a lot of the CEOs and founders that we work with have been in the business for years, sometimes from inception. And so it’s incumbent upon us to actually come up with ideas an operating level to, to present a Rolodex within the industry that is exciting for management because we’re very open about the fact that yes, despite the fact that we may be represented on the board and can vote shares a certain way. My personal experience has been in less management really wants to work with you. Your operational strategy is not going to be that effective. And so it is a foundational thing for us to come in as investors and really form number one, deep personal relationships. And number two, actually show up with the goods because we’ll get called out right away by these very demanding founders and CEOs. If we’re not showing up with something that’s helpful for their business,
ROSS BUTLER:
And what’s the competitive environment like for attractive assets in this sector,
VANIA SCHLOGEL:
I would say our sector is more, is more right for proprietary deal sourcing than potentially other sectors. And it goes back to what we just talked about, which is that kind of creative and founder led group of folks. There’s so much that is based upon relationships and how well networked are you in the sector? How well-liked are you do founders talk about you in a positive fashion. And it’s interesting, both what I’ve witnessed is both on a positive and negative level founders. It will, it will spread like wildfire among founders, if you are seen as either a great partner or not a very good partner to management. So I actually think within the sector being, being well-networked and well-liked lends itself to proprietary deal sourcing, which means it’s outside of a normal process being run for example, by an advisor. And in that kind of case, that’s actually the ideal scenario because it’s not a competitive process. Aside from your main competition being against yourself, are you presenting a compelling case to the founder and CEO and the existing shareholders that you’re worth it, that they should sell some of their shares to you because you’re going to, going to bring value.
ROSS BUTLER:
Yeah, I can imagine that the LA creative great vine is quite sophisticated and active, so the word would get round, but you’re not just you’re based in LA, but you have an Asian presence and you recently did a European deal as well. Talk to us a little bit about your kind of geographic coverage.
VANIA SCHLOGEL:
It’s really funny because prior to parasite winning an Oscar, which is a South Korean movie, we would always get the strangest looks when I would explain that we have offices in Los Angeles and Seoul, South Korea, because most funds are based in New York and London and San Francisco. And then when they go to Asia, they immediately typically go to Hong Kong or Singapore, you know, kind of a financial hub. And the way that we explained it is we’re operational investors. And hence we launched in Asia in a very operationally relevant geography. So South Korea has the fastest internet speeds in the world. It’s a thriving and healthy democracy. It’s intellectual property protection laws are very robust. All that put together means that the monetization methods and kind of the business ethos, also legal protections endemic to South Korea, feel very natural for Western portfolio companies to launch into a, so you have to get over.
VANIA SCHLOGEL:
Obviously some of this is natural, no matter where you expand to globally, but, but you know, you need to be comfortable with the language barriers the cultural differences and being respectful and mindful of that. But once our portfolio companies launched there it feels much more like a fish in water in terms of them looking around and saying, Oh, okay, I can still sell my intellectual property for example, and monetize it the way that I would, whether I were based in Sweden or New York or, Seoul. So that’s one of the reasons that we set up a presence there. And going back to the example, also a parasite winning an Oscar, we identified very early on that for whatever reason, Koreans are very good storytellers. And so there’s always been a large body of a great intellectual property and content trends coming out of South Korea.
VANIA SCHLOGEL:
And so as the fund focused a lot on entertainment, media, and content, it made a lot of sense to us to be present in cities that were driving these trends. And it’s one of those markets where a company can launch. And admittedly, it’s a very small country and a very small core addressable market, but given the ability to export cross border a company can look into expanding into adjacent geographies, Japan, Southeast Asia, China from the, that kind of launchpad in South Korea. I would almost liken it to Sweden in that sense, what Sweden is to Europe, pretty small addressable market, but, you know, Spotify did all right.
ROSS BUTLER:
Absolutely. And so speaking of Europe, you’ve got some activity there too
VANIA SCHLOGEL:
Well. We’ve actually invested quite a bit in Europe. So we’re invested alongside KKR in a company called Neo nine studios, which is Germany’s largest production and distribution company in the country. I chair the board there were invested alongside EQT and epidemic sound, which is based in Stockholm. I also chair the board of that company. We just closed another investment alongside EQT in Malaga Spain, and a fantastic company called free pick.
ROSS BUTLER:
So under normal circumstances, your air miles are pretty significant,
VANIA SCHLOGEL:
Wonderful from the perspective of never having to pay for a personal vacation ever again. Yeah. I was spending a lot of time in Europe, I lived in London for six years. And so from a, from a sector perspective, I actually think it’s a wonderful geography to in, I think it’s multiples cheaper than a lot of us media.
ROSS BUTLER:
You’re relatively small funds to have a kind of what appears to be a completely global footprint and also personally global responsibilities, a portfolio of companies all over the place. And I guess that’s a function of being a sector specialist. Would you say
VANIA SCHLOGEL:
That’s exactly right. And I wouldn’t say we’re truly global because we genuinely as a operational fund, we have to spend time building relationships and liaising with folks. And so we’re very much present in Europe and Asia, we don’t touch geographies yet where we don’t have executives or very strong partnerships. So that would include, for example, South America Africa, those are geographies where we’re not present, but in Europe we feel very comfortable investing in the region you know, regulatorily regulatory perspective culturally even our role relationship Rolodexes, we feel very natural about investing in the region. And also importantly, we have such wonderful partners in terms of larger GPS that we work with as well as a lot of founders company founders that we know who also keep us connected on all the grounds.
ROSS BUTLER:
Well, I was going to come on to that because it’s very interesting, the fact that you you partner with some of the biggest buyer houses in the world on some of their deals. So they like you and they bring you in, they’ve got enough money of their own. What do they want from you?
VANIA SCHLOGEL:
That’s a great question. We feel a very strong duty towards our GP partners and today we’ve done, you know, we’ve, we’ve invested alongside KKR, EQT in TPG since the fund launched in 2017. And you’re absolutely right. We recognize very much that they have enough capital. They have a large committed funds and they certainly don’t need out water to come in to fill a hole. And hence there is a very strong expectation of performance on our side that in the Venn diagram of things not to get too nerdy, but they’re going to focus on, you know, these, these sets of operations. And we’re going to be over here focusing on our operational strategy and the two don’t really overlap. And that’s great that complimentarity of what we focus on and our expertise, I think is the reason why we get repeat business and repeat partnerships with these GPS.
VANIA SCHLOGEL:
And the other aspect is just we have a very, the way that we set up the operations of our fund are centered around our operational expertise. So I gave you one example, which is we’re present in South Korea because we understand it to be a trendsetter city in terms of content and technology trends, our LPs in South Korea. In fact, for example, Kakao is not only a partner of ours, but also an LP of ours. And if you imagine a digital media and technology group for a given country that owns the WhatsApp, Spotify, PayPal, Uber, and a few other assets of a country that is cacao, and they are one of our greatest partners in LPs. And so when we partner with the larger GP, we can actually go in as one of the only if not the only fund in the world that can say that and say, Hey, when, when this company, this portfolio company is looking to launch in Asia, we’re gonna consult and give a great body of expertise around having done this before. And Oh, by the way, we’ve got a fantastic digital media company there as an LP who now has a vested interest in making a success story.
ROSS BUTLER:
Yeah, that makes sense. So what, what specifically, what sub sectors, what types of creative companies are hot right now, interest you from an investment perspective?
VANIA SCHLOGEL:
We are very much focused on content and we focused on it from, from the inception and we built out a very strong investment thesis to the point where I almost feel sheepish saying content, because it’s such a broad umbrella term, the way that we segmented it is we got very deep into it. And so we’re looking for example, at content that is buoyed by the trend of online creator communities. We’re looking at content that has an over and exposure to growing over the top, or what’s called OTT streaming platforms like Netflix or Amazon. So while we spend a lot of time in content, we actually very delve down into those sub sectors that we feel have kind of acyclical component, but also from, from kind of a meta-thematic side being buoyed by digital trends and digitization, which COVID, by the way only helped to hasten quite frankly.
ROSS BUTLER:
Yeah. It’s interesting. Like when the, in the first internet, boom, like 20 years ago, everyone was constantly saying content is King, but looking back, I sometimes wonder whether actually for that first wave, but networks were King because the ones that did really well were the companies that capitalized on people’s people’s networks and kind of get the sense as you say, particularly with lockdown. And now that everyone’s got decent broadband and streaming services. And so on that the content might finally be having actually it’s it’s time in the sun. You’re gonna, when you think about that, like orthosis,
VANIA SCHLOGEL:
I’ve had this debate so many times about content versus distribution. And I think one of the most interesting case studies is what happened with Netflix. And I re you know, prior to launching house of cards in January of 2013 it was a pure play distribution platform, and I’ll never forget the production costs that were quite heavy for house of cards that Netflix had undertaken. If you actually have the interest and go back to a lot of the equity analysts and what they were saying about Netflix, it was brutal. I mean, it was just, this is daft, this is how many subscribers they would have to get to recoup this, and it just ripped them to shreds and what happens, they launched house of cards and in quick succession orange is a new black, the Marvel kind of TV series spinoffs, et cetera, and their stock price within the next year two and a half 10 next.
VANIA SCHLOGEL:
And, and so I think it’s I tell you that anecdote because where I land is that it seems more and more these days. It has to be the marriage both. Now, that being said I don’t know. I don’t mean that to say that there is not an opportunity for induction and content creators. I absolutely think that opportunity is there, but in, in order to really sell and continue selling in a systematic way and not be hit driven, these content creators need to focus on franchise defining or tentpole content to really have viable business models and also to try and own some of their intellectual. Are you going forward rather than just being a licensed, sor and working for fees in terms of the monetizing, their content? The other thing that I think is positive or content creators and intellectual property owners, is that pro in, in a, in a prior world, these content producers were selling into the traditional set of media buyers.
VANIA SCHLOGEL:
Then they were selling into the traditional set plus Netflix, and now the world has opened where now they’re selling into to Apple as well and other new entrance. And so it’s a great time to be a good content producer and intellectual property owner because the buyer set is proliferating. There’s just more and more buyers now of good and franchise defining content. I think one of the other things, and this is why we invested, for example, in Leonine is one. Yeah, the great things that happened from Netflix. And I actually mean this at associate level is because, so Netflix was able to aggregate eyeballs at a global level. There became this re-education process in the entertainment world that we are willing to watch local language, film, and TV, whether it’s the example of parasite, which is completely in Korean or dark, which is in German.
VANIA SCHLOGEL:
And so this put the emphasis and investment again in local language content. And I think that’s really important and social level. I don’t think we want to see a world where 98% of content is created and generated out of Hollywood and has an American perspective to it. I think we really want to honor diversity of content and also local traditions and cultures. And I think that’s one of the great not to go on a tangent, but it’s one of the wonderful things that actually has come from technological distribution is a refocus, any commercial case that now puts investment back again on local language content.
ROSS BUTLER:
I understand that a lot better now, because when you started speaking, I was going to say that all sounds great, but there’s, there’s only one Netflix, but I mean, Hey, that’s not quite true, but also it sounds like Netflix allows a whole ecosystem to happen as well in the same way, as, I guess, Amazon allows a whole ecosystem of suppliers to feed into it and get greater distribution. Yeah.
VANIA SCHLOGEL:
Yeah, absolutely. And I think to be fair, there need to any time one seeks a sustainability and health of an industry, there need to be countervailing forces. So while I’m also very positive on some of the positive things that Netflix has engendered why, why did we invest in Leo nine Leo nine took five companies and consolidated them into the number one player because scale at a local market level is a net necessary countervailing presence to a global technology player like Netflix. So I think for the health of the industry, also the, for the health of consumer choices going forward and for greater investment behind local content we as investors are placing our bets and trying to have scaled local players rather than just a fragmented market.
ROSS BUTLER:
Oh, these kind of film production companies, they, they are, they’re kind of like finance houses in themselves. Aren’t they, to some extent cause they’re then financing projects,
VANIA SCHLOGEL:
They are. Yeah. And that’s, that’s also why scale matters because content behaves very similarly to venture capital as an asset class, meaning you have a few real outliers in terms of performance and a lot of losses along the way. That is the nature of content that also scares a lot of investors. And so the way that we approach the sector is with eyes wide open and saying, we understand that’s how the asset class performs, but we also understand portfolio theory enough to know that diversification diversifies a way that unique hit risk. And so if a, an asset is scaled enough, it’s producing it. Number one, it’s producing enough new shows or films. And number two, it’s typically paired with an existing library that generates stable cash flows. And so I think there’s a perception versus reality gap. A lot of times when it comes to investors that investing in the content space, they just look at that unique project risk of it’s going to be great, or it’s going to be an absolute unmitigated disaster. We don’t view it that way. We view it as, as long as we can get into scaled ventures. A lot of that unique risk can be mitigated.
ROSS BUTLER:
Hmm. The fact that you’re partnering with big buyout firms also suggests that the risk profile isn’t that venturing. Yeah.
VANIA SCHLOGEL:
Yeah. That’s absolutely right. And, and Leonine, for example, spent the better part of two decades, for example buying up content and has eight, the best library in Germany. So as, as one example of why that’s so important when COVID hit and for a period in, in Germany productions completely shut down of new content, we were sitting on the country’s largest library. And so while we’re all hunkered down, bored out of our minds, looking for titles, and we’re going back to Tomb Raider and Home Alone and all those things that we watched in the past 20 years that library was generating fantastic cash flows for the company. And I think that’s a really good example of how an asset class that can be perceived as, so hit-driven actually ended up being one of the most sheltered and a cyclical assets as evidenced by what happened after COVID hit.
ROSS BUTLER:
Yeah. That’s amazing. Isn’t it? Do you want me, what’s your view of the future of private equity meeting, creative industries? Would it always be bore the specialist to some degree, or do you think there’s a larger opportunity opening up
VANIA SCHLOGEL:
Trend of a lot of pro previous operators within the media and entertainment space? Raising capital, for example, they’re, they’re doing a lot of fundless sponsor activity. I, I, you know, there are certain situations I can’t comment on now, but very well-known media executives who have identified proprietary deals as we talked about earlier and then going, and either partnering with private equity or with family offices, the rise of, of family offices, for example, has opened up a brand new and innovative kind of funding pocket. And, and they’re going about it that way. So it’s, again, it’s one of those industries that, and I mean, media and entertainment within private equity that is not only within it itself, but also the, the industries that are tangential to it. So media itself is constantly evolving, but also the way that private equity invest into media, it’s constantly open to evolution and sometimes outright tumbled. And so I do see that going forward, there’s going to be much more of a trend and continue trend of very well-known operators who have left their operating posts and want to try their hand at investing. And they’ll find funding, whether it’s through respect partnership. Spacs also, that’s part of the reason why there’s been such a rise in space.
ROSS BUTLER:
So is it because of the sector?
VANIA SCHLOGEL:
Exactly. Because who knows the media and entertainment sector better than, than folks who have a deep operating expertise within it. And so now they have creative ways of finding capital and because it lends itself to proprietary deal sourcing, I just think this industry is very unique relative to investing in other industries,
ROSS BUTLER:
Given that you’ve always been in investments and something’s doing creative, you’ve had quite a buried career cause you KKR, you’ve got your own shop. And in between you were a CIO ROC nation with, can you tell us a little bit about what Roc Nation is?
VANIA SCHLOGEL:
So rock nation is founded and helmed by Jay Z, who many people know. And, and one of the really interesting things about Jay, if you look at the history of his career. So yes, he is a very well known rapper and artist, but he’s also had a business savvy. So very early on, for example he structured the deal so that he the retention of his master rights reverted back to him, this is before artists were doing it at a broader scale. And I would say before Taylor Swift, for example, really got on that public messaging about it. And so he, he actually is, is a great example of someone who took his relationships and industry expertise and leverage that into an operational role by setting up rock nation. And so rock nation represents, I believe they started really in music now, they branched out to representing artists in outside of just music and then also athletes professional athletes and moving into those adjacent verticals and really what that comes down to is leveraging a Rolodex of relationships. And then having that credibility that, Hey, I care about your career, your art, I will be a good, good partner for you in a way that Jane the rock nation team can do.
ROSS BUTLER:
And, and culturally going from KKR to Roc Nation, and then to your own shop. I mean, they, they must be big leaps or was Roc Nation, very KKR-like?
VANIA SCHLOGEL:
Worlds apart. They are very, very different. And, and funnily enough, I would actually having experienced on the one, the Goldman Sachs and the KKRs and my career, and then on the other kind of the Roc Nation’s of the world I endeavored to set up the culture of Atwater to be a hybrid culture. So if you ever come to our offices, you know, you’ll see some funky art up, you know, music typically playing in the background. So it’s a little bit of a hybrid.
