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I am pleased to be a speaker at the upcoming Emerging Manager Connect West conference being held on Tuesday, May 1, 2018 at the Marines Memorial Club in San Francisco . I will be speaking on the panel "Roadshow 101: Leading Emerging Manager Investors Discuss the Dos and Dont's for Successful LP Meetings." Here's a link to the conference website:
https://partnerconnectevents.com/emcwest2018/index.php
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,This one of a series of posts on fund performance metrics. Other posts in this series include:
We have discussed how to evaluate fund performance, but a common area of confusion is gross returns versus net returns. I briefly introduced this topic in LP Corner: Private Equity Fund Performance - An Overview, and this post expands on that introduction. When talking returns in private equity, it is very important to know what kind of returns you are discussing: gross or net returns. The difference between these two metrics can be meaningful, and so it is important to know what is being discussed. Gross returns, simply stated, are the returns a fund obtains from its investments, without deducting any management fees, fund expenses or carried interest. Net returns are the returns a limited partner (LP) receives from the fund, after deduction of all management fees, fund expenses and carried interest. LPs are about net returns, as net returns are the real returns an LP receives from its investment in a fund. When we talk about gross vs net returns, it can apply to gross vs net IRRs or gross vs net TVPI multiple. The graphic below shows the difference between gross and net returns for a fund. LPs invest in a fund. The fund invests in portfolio companies. Gross Returns are the returns the fund obtains from its investments in portfolio companies. Gross Returns are before deducting management fee, fund expenses and carried interest. Once the fund does deduct the management fee, fund expenses and carried interest, the return the LPs obtain from the fund are the Net Returns.  To read more, please click on "Read More" link below.
This one of a series of posts on fund performance metrics. Other posts in this series include:
We have now discussed the three metrics that are primarily used to evaluate the performance of private equity funds: (1) the multiples TVPI, DPI and RVPI; (2) IRR; and (3) PME. We will now discuss how to use these metrics to evaluate the performance of private equity funds. Overview There are several ways to evaluate the performance of a fund, or a portfolio of funds, with the main methods being:
Absolute Return Absolute return refers to a specific threshold requirement for a fund’s performance. For example, some LPs may say that they expect a 3.0x TVPI and 30% IRR net return from early stage venture capital funds, or a 2.0x and 20% return for buyout funds. If a fund’s return exceeds these metrics, then it “outperforms” the metrics. If a fund’s returns are less than these metrics, then the fund “underperforms.” A note about absolute return. Most funds experience a J-Curve, where performance declines in the first couple of years of a fund when fund expenses and investment losses exceed investment gains, but the fund’s performance improves over the next several years. The J-Curve is more pronounced for early-stage venture capital funds. The J-Curve looks something like this:  For more on the J-Curve, see my post: “LP Corner: The J-Curve.”
The point here is that using absolute returns are really only useful late in a fund’s life or after the fund is liquidated. If one were to apply a 20% absolute return metric to the fund in the J-Curve example above, the fund would underperform all years until the last year in the graph. To read more, please click "Read More" to the right below. This one of a series of posts on fund performance metrics. Other posts in this series include:
We have now discussed two of the three primary metrics uses to evaluate the performance of private equity funds: (1) the multiples TVPI, DPI and RVPI; and (2) IRR. We will now explore the third primary metric: Public Market Equivalent, or PME. Overview Broadly speaking, PME is a return metric that compares the return of a private equity fund (or a portfolio of funds) to the hypothetical return of a chosen public stock market index, such as the S&P 500 or Nasdaq, using the cash flows as the fund as a basis for investment in the stock market index. For example, a fund may have an IRR of 15%, while the PME obtained using the S&P 500 as the index is 10%, suggesting that the fund has outperformed the S&P 500 by 500 basis points (bps). There are several variations of PME, but these are commonly used:
LN PME The LN PME (also known as the Index Comparison Method or ICM) is widely considered the “first” PME approach (and it is often referred to simply as “PME”). The LN PME matches each contribution and distribution of a fund with a hypothetical purchase and sale of a reference public market index, such as the S&P 500. The residual value of the fund is not matched to the LN PME; rather, the LN PME residual value is based on the performance of the hypothetical invested capital in the index. With these cash flows, an LN PME return for the public market index is compared directly against the IRR for the fund. If the fund’s IRR exceeds the LN PME, then the fund has outperformed the public market index. If the LN PME IRR exceeds the fund’s IRR, then the fund has underperformed the public market index. Note that the IRR generated using LN PME isn’t a “real” IRR – it’s an estimation because of the manipulation of the residual value. One nice thing about the LN PME is that it is conceptually straightforward. However, the mechanics of LN PME have some issues. One issue for the LN PME approach is that the residual value for the PME index can be negative. This can occur if the fund has distributions early in the life of the fund, or has a series of large distributions late in the life of the fund. The problem is that a fund can’t have a negative residual value (technically a fund could have a negative residual value, but it would be a very rare case). As a result, LN PME isn’t used very often in private equity. The other forms of PME attempt to address the drawbacks of the LN PME. Let’s look at an example: First consider the fund that we want to evaluate. The fund is presented below:  To read more, please click on "Read More" to the right below.
This one of a series of posts on fund performance metrics. Other posts in this series include:
In this post, we will explore internal rate of return (IRR) as a tool for evaluating fund performance metrics. Recap In my prior post, we discussed the basics of IRR in a fund context. In this post, we build on that to explore what happens year by year for that fund. In Example 1 in the last post, we introduced a fund, where the LP paid $30 million to the fund in a capital call at time = 0 and received $80 million back from the fund (as distributions) at the end of year 5. These simple cash flows yielded an IRR of 22% and a TVPI of 2.67x.  To read more, please click on "Read More" to the right below.
This one of a series of posts on fund performance metrics. Other posts in this series include:
In this post and the next post, we will explore measuring fund performance using internal rate of return or IRR. This post will provide an overview of IRR. If you already have a good grasp of IRR, you can move to part two of this series: LP Corner: Fund Performance Metrics - Internal Rate of Return (IRR) - Part Two. IRR Overview In a basic sense, IRR is the return from a series of cash flows over time. In the Private Equity space, IRR is commonly used to evaluate the performance of private equity (including venture capital, growth equity and buyout) funds. IRR is best calculated using Excel, Google Sheets or another financial spreadsheet program. Simple IRR Examples Let’s assume that an LP commits $30 million to a fund, and that the fund returns $80 million in distributions to the LP. (For a discussion on committed capital, see "LP Corner: On Committed Capital, Called Capital and Uncalled Capital.") On a multiple basis, this equates to a Total Value to Paid-in-Capital (TVPI) of 2.67x ($80M / $30M) – which sounds pretty good. But let’s explore a bit deeper. Note that in these examples, we are looking at cash flows from the perspective of an LP - payments made by the LP and money received by the LP. This is known as a "Net IRR" because it focuses on the cash flows to and from the LP. For a discussion of gross vs net returns, see "LP corner: Private Equity Fund Performance - An Overview." Example 1: Assume that when the fund has its closing (which is time 0 for purposes of calculating the IRR in Excel), it calls all capital from the LP (in reality, this doesn’t happen, but humor me as this is an example). In five years, the fund distributes $80 to the LP. This looks like this:  To read more, please click on "Read More" to the right below. This one of a series of posts on fund performance metrics. Other posts in this series include:
In this post, we will explore using multiples as a tool to evaluate fund performance. The multiples are:
Here’s some important terminology that will help explain the multiples:
 To better understand the above terminology, let’s look at the terms graphically:  To read more, please click "Read More" to the right below.
This one of a series of posts on fund performance metrics. Other posts in this series include:
Introduction How do LPs measure performance of a private equity fund? It’s not a simple as one would think. This post introduces a number of concepts, each of which will be discussed in more detail in future posts. The following are the basic metrics used to evaluate fund performance:
Each of the above performance metrics have positives and negatives. To read more, please click on "Read More" to the right below. 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:  To read more, please click on "Read More" to the right below.
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. To read more, please click on "Read More" to the lower right. 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:  To read more, please click on "Read More" to the lower right.
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. To read more, please click "Read More" to the lower right. 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.  To read more, please click "Read More" to the right below.
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", "GP Capital Commitment" or "GP Commit."
To read more, please click "Read More" to the lower right. 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. Stephen Davidoff Solomon's opinion piece "A Venture Capitalists's Misguided Critique of a Trump Adviser" rebuts Mr Moritz's article in a number of ways. Whether you agree or disagree with the opinions of Mr. Solomon and Mr. Moritz, this very public debate is pretty fascinating.
Link to prior post: http://www.allenlatta.com/allens-blog/mike-moritz-on-private-equity-aka-leveraged-buyouts Link to Mr. Solomon's article: https://www.nytimes.com/2017/02/14/business/dealbook/a-venture-capitalists-misguided-critique-of-a-trump-adviser.html Link to Mr. Moritz's article: https://www.nytimes.com/2017/02/07/opinion/stephen-schwarzmans-bad-business-advice.html 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.
Link: https://www.nytimes.com/2017/02/07/opinion/stephen-schwarzmans-bad-business-advice.html?_r=0 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. The bottom line is that too much money is going into venture funds and companies, and too little is being returned to investors. In my view, this will lead to overall lower returns for the venture capital industry and will highlight the need to be very selective when investing in venture capital funds in order to select only the best managers who can deliver exceptional returns.
Link: https://www.bloomberg.com/gadfly/articles/2017-01-11/silicon-valley-startup-pipeline-needs-shot-of-drano 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 Now Fortune has published an article "The Ugly Unethical Side of Silicon Valley" which discusses scandals at portfolio companies. I found this to be an interesting article. My opinion is that scandal is likely more probable at startup companies than venture capital funds for a few reasons:
"Fraud by Venture Capital Fund Managers" can be found at: http://www.allenlatta.com/allens-blog/fraud-by-venture-capital-fund-managers The Fortune article "The Ugly Unethical Side of Silicon Valley" can be found at (copy and paste in browser): http://fortune.com/silicon-valley-startups-fraud-venture-capital/ 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…
To read more, please clilck on "Read More" to the right below. The Wall Street Journal has two articles today that are of interest to shareholders of startup companies, primarily former employees who hold shares of these startups. The articles "Startup Employees Invoke Obscure Law to Open Up Books" and "Own Startup Shares? Know Your Rights to Company Financials" discuss laws that may require some startup companies to deliver certain financial data to shareholders which may help these shareholders value their stock.
Specifically, the articles reference Section 220 of the Delaware General Corporations Law, Section 1501 of the California Corporations Code and Rule 701 of the Federal Securities Act of 1933. These provisions may provide certain shareholders of some private companies the ability to obtain selected financial statements. Links: http://www.wsj.com/articles/startup-employees-invoke-obscure-law-to-open-up-books-1464082202 http://www.wsj.com/articles/own-startup-shares-know-your-rights-to-company-financials-1464082203 Business Insider had an article this week called "The steroid era of startups is over -- here's what 8 top VCs think will happen next" that made a number of good observations. In this article, eight venture capitalists discussed how the environment has been changing, and the article identifies a number of ways the changing environment will impact startups. The main categories are:
Link: http://www.businessinsider.com/what-happens-when-tech-boom-turns-to-bust-2016-5 Bill Gurley, General Partner at Benchmark Capital and a leading venture capitalist, has posted a sobering, but excellent article about the state of the venture capital industry. I generally concur with his viewpoint. While a long read, it's definitely worth the investment of your time.
Here's the link http://abovethecrowd.com/2016/04/21/on-the-road-to-recap/ There were no initial public offerings (IPOs) of tech companies in the first quarter of 2016, according to the National Venture Capital Association (NVCA). This is the first time since the depths of the Great Recession that no tech companies have gone public in a quarter. Six life science companies did hold IPOs, but the total of six venture-backed IPOs in the first quarter of 2016 is the lowest tally since the third quarter of 2011, when there were five IPOs. To add to the misery, there were 79 reported mergers and acquisitions of venture-backed companies, down from 105 in the fourth quarter of 2015 and down from 97 in the first quarter of 2015.
As liquidity events are crucial to the venture capital lifecycle, this is troubling news. Link: http://nvca.org/pressreleases/biotechnology-companies-leading-way-six-venture-backed-ipos-recorded-first-quarter/ |
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