Allen Latta's Blog on Private Equity - Allen Latta's Thoughts on Private Equity, Etc.

LP Corner: Private Equity Fund Cash Flows from the LP Perspective

7/3/2017

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.

LP Corner: The Four Phases in the Life of a Private Equity Fund

6/24/2017

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:

Formation;
Investment;
Harvesting; and
Extension.

The four phases of a fund’s life can be viewed graphically:

To read more, please click on "Read More" to the lower right.

LP Corner: On Committed Capital, Called Capital and Uncalled Capital

6/10/2017

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.

A Nordstrom Buyout?

6/9/2017

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.

LP Corner: US Private Equity Fund Structure - The Limited Partnership

6/3/2017

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.

VC Time to Exit Reaches 8.2 Years - Pitchbook

5/20/2017

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.

LP Corner: Thoughts on GP Commitment

5/13/2017

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.

Does Private Equity Have A Public Relations Problem?

5/5/2017

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.

This article comes on the heels of some other public comments made by others in the industry and outside the industry which have re-kindled a long-standing debate about the merits of the private equity industry.

I have previously posted about this topic, and I think the prior posts help to frame this article.

Prior posts:
http://www.allenlatta.com/allens-blog/mike-moritz-on-private-equity-aka-leveraged-buyouts
http://www.allenlatta.com/allens-blog/a-response-to-mike-moritzs-article-on-stephen-scharzman

Link to Reuters article:
http://www.reuters.com/article/us-milken-conference-privateequity-idUSKBN17Y2MT

Allen Latta to Speak at Emerging Manager Connect West 2017 Conference

5/2/2017

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

Article: Nasdaq 6000: What It Reveals About Tech Stocks And Venture Capital

4/26/2017

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:
http://www.nasdaq.com/article/nasdaq-6000-what-it-reveals-about-tech-stocks-and-venture-capital-cm779469

LP Corner: What Are Buyouts? Here's My Definition

4/22/2017

In a couple prior posts I've discussed my definition of venture capital and compared early-stage venture capital to growth equity. Those posts can be found here:

In this post, I'll describe buyouts.

To read more, please click on "Read More" to the right below.

LP Corner: Venture Capital vs Growth Equity - A Comparison

4/15/2017

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.

An IPO Hotter than Snap?

3/30/2017

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/

A Response to Mike Moritz's Article on Stephen Scharzman

2/14/2017

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 on Private Equity (aka Leveraged Buyouts)

2/9/2017

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

Silicon Valley Needs Startup Drano - Article

1/19/2017

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

Venture Capital Scandals

12/29/2016

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:

Opportunity. There's likely more opportunity for a startup executive to commit fraud, as accounting, sales and operating systems are typically not in place or if in place, not robust enough at startups to prevent fraud. Venture Capital funds have fewer opportunities for fraud, as there are fewer moving pieces. A VC fund pays the GP management fee and carry, pays for certain fund and transaction expenses (legal, accounting and insurance are typically the largest fees), makes capital calls and distributions, and makes investments - and that's pretty much it . A startup has many more moving pieces.
Culture. Startups in many instances are like the Wild West - immense opportunity, gun-slinging attitude, and young entrepreneurs who typically don't have a lot of management experience. Compare this to a venture capital fund, which typically has an in-house CFO and back-office team that is experienced and establishes a more structured, professional culture than many startups
.Accountability. Most startups fail. If a startup executive realizes that the company isn't going to make it, there may be a temptation to maximize personal gain over doing the right thing (shutting the company and returning money to investors). If a company fails, the winding-up process is typically very quiet and private (known as an assignment of the benefit of creditors).

"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/

Venture Capital in a Slow Correction? BloombergBusinessweek Article

10/20/2016

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.

Link: http://www.bloomberg.com/news/articles/2016-10-20/the-tech-bubble-didn-t-burst-this-year-just-wait

Calpers Sees Private Equity Returns Slowing - Bloomberg Article

10/7/2016

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

Reasons for the reduced outlook for private equity returns include an "unprecedented" $1.47 trillion in capital overhang in the private equity market - known as dry powder - which PE firms will use to invest in companies. As PE firms are expected to invest the capital they raise, this could present a problem as PE firms compete for deals, increasing entry prices.

Another interesting point in the article is that Calpers has had negative cash flow for the five of the past seven years, which is leading to a shortfall forecast at $9.2 billion by fiscal 2032. What's troubling is that this forecast is based on a 7.5% annualized return from Calpers' investments, when a prominent consultant has projected a more conservative 6.0% annual return rate. If the 6% annual return rate is accurate, the shortfall could be much higher.

Link:
http://www.bloomberg.com/news/articles/2016-10-07/calpers-sees-next-headache-in-slowing-private-equity-cash-gusher

A Tale of Two Endowments

10/3/2016

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.

Link: http://www.thecrimson.com/article/2016/9/29/a-tale-of-two-endowments/

LP Corner: What Is Venture Capital? Here's My Definition

9/24/2016

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.

Allen Latta to Speak at Venture Alpha West Conference in San Francisco

9/13/2016

I am pleased to announce that I will be a panelist at the Venture Alpha West conference on September 28, 2016 in San Francisco at the Hotel Nikko. I will participate on the panel "Managing a VC Portfolio Across Cycles." Link to conference website: https://partnerconnectevents.com/venture-west-2016.

Unregistered "Finders" May Not Be Keepers

8/26/2016

Need help raising capital? “Finders” – individuals who help raise money for a percentage of the money raised – on the surface seem like an appealing way to raise capital. It seems to accomplish the goal: the fund or startup raises the money needed, and the finder is paid a “success fee” out of the monies raised (known as "transaction-based compensation"). The big “However” is that many of these finders are operating in a gray area of law, which can have very significant implications for the fund or startup. This blog post outlines some of the issues relating to finders. Note that this post is not to be construed as legal advice – consult with your attorney.

To read more, please click on "Read More" to the right below.

Prof. Damodaran Updates His Valuation of Uber

8/18/2016

Professor Aswath Damodaran, a Professor of Finance at the Stern School of Business at New York University, is a leading expert in the fields of corporate finance and equity valuation. Yesterday, Prof. Damodaran posted a very interesting article on his Musings on Markets blog called "The Ride Sharing Business: Is a Bar Mitzvah Moment Approaching?"

In this article, Prof. Damodaran examines the ride sharing market, the business model, and an analysis of a ride-sharing company's transition from surface measures of growth to more substantive measures of monetization. He then updates his valuation of Uber, which he valued at $23.4 billion in September 2015, to $28 billion, which is significantly lower than the reported pricing of Uber's recent financing rounds.

It's a fascinating article and well worth a read. He also has a downloadable spreadsheet which contains his valuation model. Finally, he has added a video explaining his valuation methodology.

Disclosure: Prof. Damodaran was a teaching assistant for an economics course I took while I was an undergraduate at UCLA.

Links:
Damodaran's NYU page: http://pages.stern.nyu.edu/~adamodar/
Damodaran's blog: http://aswathdamodaran.blogspot.com/
Damodaran's blog post on Uber: http://aswathdamodaran.blogspot.com/2016/08/the-ride-sharing-business-is-bar.html

Link to a prior blog post on this topic:
http://www.allenlatta.com/allens-blog/gurley-v-damodaran-on-ubers-valuation

IPO Market Is Worst Since the Financial Crisis - Fortune

8/2/2016

I knew the market for initial public offerings was bad, but wow. Here's a link to the Fortune article "IPO Market Is Worst Since the Financial Crisis."

Link:
http://fortune.com/2016/08/01/ipo-drought-sorry-private-equity/