Bloomberg yesterday (8/2/2017) posted a fascinating piece on the Bell Canada Enterprises (BCE) leveraged buyout that fell apart during the financial crisis. The article is "How the World's Biggest Buyout Deal Crashed and Burned" and it's worth a read.
The Wall Street Journal reported today in the article "From $2 Billion to Zero: A Private-Equity Fund Goes Bust in the Oil Patch" that EnerVest Ltd.'s 2013 energy-focused private equity fund is "now worth essentially nothing." According to the article, the $2 billion fund "borrowed heavily to buy oil and gas wells before energy prices plunged" and "is now worth essentially nothing." Investors in the fund included leading pension plans, foundations and other institutional investors.
It's rare for a private equity fund to become almost worthless. The article states that only seven private equity funds larger than $1 billion have ever lost money for investors, according to Cambridge Associates LLC, a leading investment adviser. It's more common for early-stage venture capital funds to suffer losses, and I know of a few funds of the 1999 to 2000 vintage years that lost a significant portion of their value.
This is a good reminder that investing in private equity, growth equity and venture capital funds is risky, and includes the risk that the fund may become worthless and the investor may lose their entire investments.
Link to article:
First time investors in private equity funds are sometimes alarmed / confused / surprised to learn that their fund investment has a negative return in the early years of the fund’s life. Then, to their relief, as the fund ages, the fund’s return increases. This is known as the ”J-Curve” and it is a common phenomenon in private equity, particularly early-stage venture capital.
A simplified hypothetical representation is of the J-Curve is below:
I believe that pension reform is a critical issue that states must address. The Investor's Business Daily article "As Illinois Goes Bankrupt, Michigan Embraces Bold Pension Reforms" discusses some of the steps Michigan has taken to address its pension funding gap.
In a nutshell, Michigan has shifted public school teachers to a defined contribution plan, but allows teachers to opt for a more traditional defined benefit pension, but one that splits the costs 50/50 between workers and the state. It's an interesting article and worth a read.
For investors that are new to investing in private equity funds (venture capital funds, growth equity funds and buyout funds), one area of confusion is often around how the fund cash flows work from the investor perspective. This blog post attempts to explain this.
As an initial matter, it is important to understand that private equity funds are very different from mutual funds. When an investor invests in a mutual fund, the investor will write a check on day 1 and at some point later in time will withdraw money from the fund. Private equity funds operate on a very different basis - known as a "called capital" basis. Let me explain.
Investing in private equity funds is a long-term process. Private equity funds have finite lives, unlike mutual funds. Most private equity funds come to market with a 10 year term with up to two one-year extensions at the discretion of the manager. This suggests a fund term of 10-12 years. However, most funds exist for much longer than 12 years from the initial call of capital to final liquidation.
I view the life of a private equity fund as having four phases:
The four phases of a fund’s life can be viewed graphically:
The private equity world has a lot of terminology. In a prior post, I discussed the structure of a private equity fund, and introduced the terms "limited partners" (or "LPs"), the "general partner" ( or "GP") and the "management company." In this post, we'll explore fund "sizes" and a little bit of how investments in private equity funds work.
The "size" of a private equity fund is based on the total amount of money all investors commit to invest in the fund - known as "committed capital." Because a private equity fund invests capital over time, the fund does not need all of the investors' money at the inception of the fund, and so the fund "calls" capital over time. Private equity funds typically have initial terms of 10 years, but most of the new investing occurs during the first several years (usually 3-5 years) of the fund, known as the "investment period." As a result, the fund calls the bulk of capital from the investors during this investment period.
Let's use an example.
I have shopped at Nordstrom for a long time, and so it was with interest that I read this week that the Nordstrom family is considering taking the company private in a buyout transaction.
For investors new to investing in private equity funds, the mechanics of how funds work can be a bit confusing. This post introduces the typical private equity fund structure that's used in the United States - the limited partnership.
Basic Limited Partnership Structure
In a basic limited partnership, there are several passive investors (known as "Limited Partners" or "LPs") and the manager of the fund, (known as the "General Partner" or "GP"). The diagram below illustrates this basic structure.
In the VentureBeat article "VC investing still strong even as median time to exit reaches 8.2 years" author Adley Bowden of Pitchbook discusses a few items that gave me pause.
Private equity funds (buyout, venture capital and growth equity funds) are typically structured as limited partnerships, which have two types of partners: limited partners, or LPs, which are passive investors in the fund; and a general partner, or GP, which is the manager of the fund. As I evaluate funds, one of the fund terms that receives special attention is the amount of money the GP will commit to the fund - which is called "GP Commitment" or "GP Commit."
Reuters recently posted an article "Super-rich private equity stars rue 'lousy' reputation, say they are misunderstood." The article reports that Stephen Schwarzman of the Blackston Group and other private equity pros feel that the industry has a public relations problem.
I am pleased to be a panelist at the upcoming Emerging Manager Connect West 2017 conference on May 11, 2017 in San Francisco at the Marines Memorial Club and Hotel. I will participate on the panel "All In The Family: How Family Offices View Emerging Managers, And The Best Ways For Managers To Approach Them." It should be an interesting panel! Link to conference website: https://partnerconnectevents.com/emcw2017/index.php
I read an interesting article today titled "Nasdaq 6000: What It Reveals About Tech Stocks And Venture Capital." The article discusses whether there is a tech bubble in the public markets (no) and whether there's a venture capital bubble (possibly). It's worth a read. Link:
In a couple prior posts I've discussed my definition of venture capital and compared early-stage venture capital to growth equity. In this post, I'll describe buyouts.
Private Equity is a term that has two common meanings: (1) as an asset class, which covers strategies such as venture capital, growth equity, buyouts, mezzanine financings and distressed debt; and (2) as a transaction type, where it really means buyouts.
There is often some confusion between venture capital, growth equity and buyouts, and this post explores the similarities and differences between venture capital and emerging equity. More specifically, this post will explore the difference between early stage venture capital and growth equity. Venture capital itself has a number of stages, from seed, to early-stage, to late-stage financings. By comparing early-stage venture capital to growth equity, the differences are more clear and understandable.
The Fortune article "Snapchat Actually Isn't the Hottest IPO This Year" argues that MuleSoft is actually a hotter initial public offering than Snap. This argument is based on post-IPO trading metrics, such as first day "pop" (first day closing trade price vs IPO price) and price-to sales metrics. It's an interesting article. Link: http://fortune.com/2017/03/30/snapchat-ipo-snap-stock-mulesoft/
In a prior post "Mike Moritz on Private Equity (aka Leveraged Buyouts)" an opinion piece penned by the famed venture capital investor was discussed. Now there's a rebuttal to Mr. Moritz's article.
Mike Moritz, the famed venture capital investor at Sequoia Capital, has published an opinion piece on the New York Times called "Stephen Scharzman's Bad Business Advice." In this opinion piece, he takes a swipe at the leveraged buyout business, which is now known as private equity. He focuses on the amount of debt used in these transactions and the attendant cost-cutting that often includes layoffs. I have met Mike Moritz on a couple of occasions, and found him to be a very smart and opinionated person. His piece is worth a read, even if you don't agree with his positions.
There's a recent Bloomberg Gadfly article by Shira Ovide called "Silicon Valley Needs Startup Drano" that explores the imbalance in venture capital between funds flowing into venture capital funds and companies and the money being returned from these companies and funds. I enjoyed this article, both for its Drano metaphor as well as for its content. I have been very concerned about this imbalance for some time now, and this article explains it well.
My blog post "Fraud by Venture Capital Fund Managers" was originally posted in June 2014. My introduction to the post was that instances of fraud by venture capital fund managers were very rare. The post then highlighted a few cases of alleged fraud by venture capital fund managers
The BloombergBusinessweek article "The Tech Bubble Didn't Burst This Year. Just Wait" examines the current state of the venture capital industry. The article provides various data points, and quotes Benchmark's general partner Bill Gurley as saying that the venture capital industry is "in a slow correction." I agree with Mr. Gurley's assessment. While venture capital funds are raising money at an incredible rate, it seems that VCs are being more selective and valuations are slowly rationalizing.
Calpers, the largest US pension fund, is anticipating weaker returns from private equity, according to the Bloomberg article "Calpers Sees Next Headache in Slowing Private-Equity Cash Gusher." After several years of receiving strong distributions, Calpers believes that the outlook for returns may be diminishing, leading to an ever larger gap between beneficiary costs and revenue from contributions and investing, according to the article
The Harvard Crimson has an article "A Tale of Two Endowments" comparing the endowment performance between Harvard and Yale. David Swensen, Yale's Chief Investment Officer, has posted some impressive returns over the past decade.
I recently gave a talk about Venture Capital at UC Hastings College of Law (where I went to law school), and during the talk we went over the basics of venture capital. It seemed to me that it would be a good exercise to write out the definition of venture capital as I see it. So here goes…
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