The Arbor Square Blog

All things Private Equity…

Notes on the Economy Series

Data to Q4 2016:

Fourteenth Edition

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For the fourteenth edition of the Arbor Square: Notes on the Economy Series we have gathered 37 data points to provide you with an indication of the health of the economy in Q4 2016, with a particular focus on the UK and the broader European market.  In this, the second edition in the series since the UK’s decision to leave the European Union, it is not surprising that Brexit continues to weigh upon business sentiment and confidence.

While there is the overriding sense that all may not be well, with inflation now at its highest level since June 2014 and the first decline in retail sales volume (most recent 3 months on previous 3 months) since December 2013, the UK economy continues to grow and the number of people in employment is at its highest level since records began.

In 2016, private equity’s fortunes have reflected this dichotomy.  While there has been a decline in the volume and value of buyouts in Europe compared with 2015, it is predicted that, once all the data is in, 2016 will have proved to be the best year for fundraising since the global financial crisis.

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Notes on the Economy Series

Q3 2016: The Post Brexit Referendum Environment

Thirteenth Edition

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For the thirteenth edition of the Arbor Square: Notes on the Economy Series we have gathered 37 data points to provide you with an indication of the health of the economy in Q3 2016.  In this edition, the UK’s decision to leave the European Union has understandably loomed large, with Brexit appearing to be negatively influencing risk appetite and business confidence.  However, there is still cause for optimism with several indicators performing well.

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Notes on the Economy Series

Q4 2015: Concern and Optimism  

Twelfth Edition

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The twelfth edition of the Arbor Square: Notes on the Economy Series paints a somewhat mixed picture.  Arbor Square has gathered 38 data points to provide you with an indication of the health of the economy in Q4 2015. This edition demonstrates that while there are several encouraging indicators, including positive unemployment figures, there are still many factors which are a cause for concern.

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The Dark Art of Networking

John Kenneth Galbraith once said: ‘Business conventions are important because they demonstrate how many people a company can operate without’. Harsh words, but perhaps in some cases fair. And, with late winter private equity conference season now well and truly in full swing, and the biggest event of all – Super Return International – just a few days away, it’s certainly worth re-considering how best to extract value from these industry get-togethers. With regard to Mr Galbraith’s observation, I think what a conference should actually demonstrate is who in your team is capable of generating real ROI from such events (the ‘I’ being quite considerable in terms of time and, in most cases, financial cost).

Now I have to admit that I’m a bit of a freak when it comes to conferences. I don’t know if it comes from having been in the industry for many years and having been fortunate enough to make a lot of good contacts (and friends) in that time, but I really like networking. I enjoy catching up with people I know, meeting new contacts with new funds and new plans, telling people about Arbor Square, and generally figuring out how to get the most from an event. Of course, I’ve found myself in situations where my best laid plans have been challenged, for example the conference in Madrid which was conducted entirely in Spanish (a language which, unfortunately, I don’t speak), and have been mightily frustrated on many an occasion to find that the key people I wanted to ‘bump into’ haven’t turned up. And then there was the dilemma of how to introduce myself to TPG’s David Bonderman having realised that he was standing at the urinal next to me…. But all this is more than offset by those conversations and business card exchanges that you just know will lead to business somewhere down the line – something to chalk up as direct ROI against that event.

I’m not sure it’s natural to like these events quite as much as I do, or to think of them as a ‘mission’ in quite the same way. But you don’t have to like them or approach them with military precision to get real value from them. Indeed, interested in the art of networking as I am, I did a bit of digging around and found an interesting typology of networkers by executive coach Michelle Tillis Lederman, author of The 11 Laws of Likability: Relationship Networking…Because People Do Business with People They Like. She describes four key types of networker and offers suggestions as to the approaches they should take to best effect:

1) The Observer – Defined as someone who tends to hang back in a crowd, this person watches but doesn’t initiate, and rarely follows up after making new connections. As a result, their network is small and they are not at the front of people’s minds as a ‘resource’. The advice for the Observer is to make slight changes – consider following up via email or through social media, or perhaps invite someone to a one-on-one coffee or lunch. Perhaps tag along with a group until you get used to joining in.

2) The Reactor – This is someone who wants to make new connections but is more comfortable with someone else taking the lead. Perhaps they struggle to keep a conversation flowing, but are responsive to other people’s attempts to connect. The approach used by these types is more subtle, but sometimes a lack of confidence may get in the way. It is suggested that if the Reactor ‘stretches’ themselves a little more they will likely gain comfort. Setting goals to proactively reach out to new contacts is advised, especially given that it is unlikely such a networker will come on too strong and be seen as a nuisance.

3) The Initiator – This person is actively networking and taking a balanced approach. This approach is typified by someone who seeks opportunities, brings others into conversation, and follows up regularly. They have found ways of effectively staying top-of-head amongst their peers. The advice for an Initiator? Don’t change.

4) The Director – A Director is strategic and methodical about networking. It is a high priority for them and they take a numbers approach. To some, the approach may seem insincere or over-the-top. Such people are advised to give others more breathing room and to employ a lighter touch. They should try to ensure people feel that they value the time they are spending with them and not just looking for the next or more interesting contact in the room. They should consider timing, frequency and depth of conversation.

Interesting and thought provoking, especially for someone who, while hoping that he comes across as an Initiator, has to admit to some worrying underlying Director tendencies…. I’ll be working on this in Berlin next week and hope to see you there for some mutual rapport building.

Kevin McNally
Arbor Square Associates

The Power of Storytelling

The human brain has a natural affinity with narrative – we are born storytellers. We constantly tell each other stories, matching and comparing new stories to those that are already stored in memory in order to understand one another. At a subconscious level, our brains are continually working to structure, simplify and order complex information into meaningful patterns, ironing out inconsistencies and conflicts in order to preserve the integrity of the emergent ‘story’. We tend to remember information much more easily when we encounter it within the context of a narrative framework than when we’re presented with a string of facts.

This cognitive quirk is of considerable value to private equity firms seeking to communicate their ‘model’ to prospective investors. We’re continually telling our clients how important it is to build a compelling narrative before a fundraising in order to have the best chance of getting their message across to LPs in those early meetings. Stories are also easy to remember, with the ‘gist’ of a good story remaining lodged in the memory long after the facts have started to fade. Embedding this narrative, therefore, has implications for reputation building and ‘word of mouth’ marketing. LPs talk to each other. An intuitive, well structured, compelling story is one they’re likely to share.

The private equity investment process naturally lends itself to a narrative structure. Just like a story, it has a beginning, middle and end – companies are sought, evaluated, backed, grown and exited. While this underlying process is a feature of all firms, the actual execution is where firms differentiate themselves, and therefore where the story gets really interesting.

Pitching one’s story to maximum effect is not as straightforward as it might sound. Each individual GP’s story exists within a broader narrative context, which to some extent is defined by the investors evaluating a fund. For instance, particular LPs might take comfort in certain structures and messages, which have become embedded in their over-arching private equity world-view. So the sensation of ‘recognition’ in the minds of an LP when a GP starts talking this language is sub-consciously comforting. However, when a GP comes along proposing something which seems to be at odds with this world-view they are in danger of ‘turning off’ that investor. While this is particularly the case with ‘innovative’ fund structures or non-standard T&Cs, it also applies more broadly. For example, ‘backing quality management’ or ‘a partnership approach’ are messages that became strongly associated with mid-market private equity over the past cycle. While messages such as these have led to a perceived lack of differentiation amongst mid-market firms, they have also perhaps served to get LPs nodding along with this as an ‘accepted’ way of doing things.

Arguably, this narrative context has undergone an almighty shift in the wake of the financial crisis, with investors recognising that the ‘old ways’ are not necessarily the best ways. The rise of ‘operationally focused’ private equity models is a case in point, as is the growing dichotomy between ‘growth buyout firms’ and ‘traditional private equity firms’. More than ever, now is a time to think hard about one’s ‘story’. Has it adapted to today’s reality? Do all the elements chime as they should? Getting this right could prove crucial in this market.

Hazel Clapham
Arbor Square Associates

The Advisory Board Love-In?

I attended a small IR conference at the end of last year, and the IR executive of a very large, well-known GP told the room that one of his partners had recently suggested that the firm was so deeply held in the affections of its advisory board that were one of the partners to vomit on a board member’s trousers, far from being disgusted, they’d probably treasure them.  Classic!

I must say, having interviewed advisory board members of a good number of GPs over the years, it is indeed a very interesting relationship.  The feedback you receive about a GP from its long-standing advisory board members understandably tends to be much more detailed and nuanced than that of non-advisory board members, bringing to bear the context of a privileged relationship that often stretches back over multiple funds and cycles.   What’s more, as our IR executive’s anecdote suggests, feedback does often tend to be more positive, as if buying in to a firm’s model again and again over successive funds, and being closely involved in the evolution of that GP, cements a deeper-seated commitment amongst those LPs – what you could characterise as the phenomenon of the ‘loyal investor base’.  Part of me does wonder how much this loyalty is driven by a kind of ‘confirmation bias’ (i.e. the tendency of people to favour information that confirms existing beliefs and hypotheses), or by straightforward risk adversity (the ‘IBM’ argument), or even by the simple fact that personal relationships of mutual respect develop between GP and LP, and that this might well affect the objectivity of one’s judgement – a kind of emotional as well as financial buy-in.  I also wonder about the extent to which this phenomenon stifles the evolution and regeneration of the industry, with the same ‘safe’ brands receiving capital, often at the expense of newer, hungrier teams.  Indeed, I was speaking to an old hand in the institutional investor community last night who suggested that he’d love to launch a fund-of-funds that only backed new managers and limited its longer-term support up to a second fund, but no further.  With a decent proportion of 2005-07 funds unlikely to make carry, and a growing acceptance of ‘deal-by-deal funding’ amongst LPs it’s arguably a great time for talented deal doers to get out and build the next generation of brand name firms.

Anyway, back to the topic in hand.  I do also think that the privileged position of advisory board members gives them a unique perspective, and a much deeper understanding of a GP’s value proposition.  While performance is ultimately king, the team that delivers that performance is what really matters in private equity and the more an LP gets to know that team, the better.  Spending more time watching a GP in action, working through issues at the advisory board, being party to the strategic development of a firm helps LPs to build confidence in that GP.  It engenders a deeper understanding of how a GP’s mind works; how they gel as a team; who the dominant characters are; who the next generation will be; what lessons have been learnt from past mistakes; and ultimately where the true value (and the risk) lies.  It’s no wonder that existing investors, and advisory board members in particular, are often the first (and sometimes only) point of call for prospective investors undertaking reference calls on a new manager during fund due diligence.  Or that advisory board seats are so highly valued.

Loyal advisory board members are therefore a fantastic asset (and key advocate) for GPs, with their well-rounded, longer-term perspective.  But they can also lull a GP into a false sense of security.  While those LPs closest to a firm might be able to stomach a higher than optimum level of volatility in the wake of the financial crisis, or be willing to support a new strategic initiative, the wider investor base, and prospective investors, might not be so understanding or supportive.  They may cry ‘strategy drift’ and disappear into the ether when they are approached with a new fund.  So loyalty is really great for the GP (if not necessarily for the industry), and a GP’s advisory board can provide an unparalleled insight into a GP’s key strengths.  But as our IR executive’s anecdote so colourfully illustrates, you might not want to rely solely on your best friends when you’re looking for an honest, balanced view of your firm.

Hazel Clapham
Arbor Square Associates

The Constant Fundraiser

As I write this, I am conscious of the icon at the top of my screen alerting me to a steady stream of new emails landing in my inbox.  And the fact of the matter is that this stream would probably have pretty much the same flow-rate regardless of time of day and (with one or two exceptions) day of the year.  Today we live in a world of constant information flows, updates, questions and requests.

It occurs to me that there is an interesting parallel here with the modern-day role of a private equity fundraiser.  I’ve been in the industry for the best part of 20 years now and I remember a time not that long ago when fundraising was very much a periodic event.  Once completed, the relevant files were put back on the shelf and the team got on with deploying the capital it had managed to collect.  Three or four years later, the files were dusted off and the cycle started again.  Fundraising was largely headed up by the GP’s senior partners and dedicated fundraising and investor relations professionals were few and far between.

How things have changed.  The fundraising and investor relations functions of a GP are seen increasingly (and rightly) as key functions of the GP machine, ensuring that there is always enough oil to keep the cycle of new deals, value-creation and realisation turning smoothly.  What’s more, these functions have become far more complex and their remits far broader, requiring experienced executives often with deal-doing backgrounds themselves.  Late last year The Stevenson James Investor Relations and Fundraising Survey 2013 found that 80% of the LPs surveyed envisaged a ‘large to substantial increase’ in the IR function’s remit going forward (although interestingly, and somewhat worryingly, only 18% of LPs surveyed believed that GPs are fully prepared to meet this need).

Also, what’s become obvious from my discussions with many LPs in recent times has been the blurring of the boundaries between fundraising and IR.  The main reason for this, quite simply, is the fact that fundraising these days never really stops.  Even if a particular GP is not officially ‘in the market’, the process of ‘marketing’ is unrelenting.  Part of this, of course, involves ensuring that your existing investors are well attended to in terms of their increasing demands for information on portfolio developments, co-investment opportunities, your views on particular market trends etc.  But more than ever it is also about building relationships with target LPs whom you hope to attract into the next vehicle.  Time and again LPs tell us that they want to really get to know GPs before committing to their funds – observing how they invest, manage portfolio issues, find exit opportunities and, last but certainly not least, build the trust and respect of their investors.

The implication for GPs is the need to effectively manage a ‘shadow investor base’, a process that is in many ways not that dissimilar to the management of actual existing investors.  A successful approach to this will not only build the trust of potential future investors, but also help them overcome one of their key concerns these days, namely that they won’t have the time or resource to do the necessary due diligence that today’s market demands and may miss out on the best funds as a result.  As Steve Pagliuca of Bain Capital put it in the December issue of The Triago Quarterly: “The best funds are often oversubscribed, so limited partners ought to conduct that general partner evaluation long before the launch of fundraisings.  Then they can move quickly when a fundraising starts.  Meeting with general partners between fundraisings – having an ongoing, up-close and personal dialogue with them – is key to getting into popular funds.”

No surprise then that more and more GPs are adjusting their approach to not only maintain contact with target investors in between official fundraisings, but also to ensure that datarooms and other information resources are updated regularly and, in a controlled way, made available to a broader range of capital sources that hopefully represent their LPs of the future.  As with email management, a key challenge for today’s private equity fundraiser is coping in an ‘always-on’ world.

Kevin McNally

Arbor Square Associates


Co-investment rights – on the map for good?

Co-investments have been a topic of conversation in private equity circles for some time now and I’ve noticed how recent reports on the industry have been paying even more attention to this area.  A key theme in the latest edition of the Coller Capital Global Private Equity Barometer, published late last year, concerns the surveyed LPs’ views on co-investments and the fact this topic features so heavily in the latest release of this long-running survey (the data for which is compiled by Arbor Square) won’t surprise many private equity practitioners.  Indeed, the recent Grant Thornton Global Private Equity Report, entitled ‘A Time of Challenge and Opportunity’, found that 60% of the 156 surveyed GPs (from all corners of the globe) recognise the significance of offering co-investment rights in encouraging LPs to commit to private equity funds.

The attraction of co-investments to LPs is clear.  They provide a way for LPs to get more money into the ground faster and in a manner that avoids the level of fees associated with blind pools.  They’re not new, of course, but whereas in the past people used to talk about co-investments being used to super-charge returns, these days you’re more likely to hear about the ways in which co-investments can help to reduce LP costs.

However, despite the undeniable fact that co-investment rights are an increasingly important part of fundraising discussions, we often hear from GPs that LPs’ requests for rights often outstrip their actual appetite for, and indeed ability to complete, co-investments when they are presented with them.  Also, some GPs have expressed frustration that LPs are often not in a position to participate in follow-on funding rounds if such further injections of capital are required.

For sure, the LP community is a diverse one, featuring institutions with highly-differing levels of experience, sophistication and resource – some will always be in a better position than others to take up co-investment rights.  But in overall terms, the most recent Coller stats leave little doubt that LPs are taking co-investments seriously – which means GPs should too.  The Coller survey shows that just over half of LPs have co-invested with their GPs in the last two years, and only one in ten LPs has not been offered any co-investment opportunities in this period.  And they’re hungry for more – two-thirds of North American LPs and half of European LPs say they would like to be offered more co-investments in future.  What’s more, LPs do seem to be managing their co-investment programs actively, with a good proportion reporting that they have declined opportunities due to a lack of strategic fit or what they deem to be an unconvincing investment case.

GPs working on the road-map for the next fundraise need to make sure co-investment rights are clearly marked on.

Kevin McNally

Arbor Square Associates

Benjamin Franklin on Reciprocity

Here’s a little anecdote that I read about how Benjamin Franklin won over a wealthy and influential member of the Pennsylvanian Assembly whom he had ‘crossed’ by securing a second term as Clerk of the Assembly, against this fellow’s proposed candidate.  The story makes me think of the relationship between private equity firms and intermediaries, and the importance of reciprocity.

Anyway, the story goes that Benjamin Franklin knew he needed to get this Assemblyman onside, but didn’t want to appear too servile, so asked him if he could borrow a ‘certain scarce and curious book’, which he knew this chap to have in his library.  The Assemblyman obliged, and had the book dispatched immediately to Franklin, who thanked him profusely by way of a note that ‘strongly expressed’ his ‘sense of favour’.  The next time the two men met, the Assemblyman spoke to Franklin warmly for the first time, and from then on they became great lifelong friends.  As a result of this encounter, Franklin coined the following proverb:

“He that has once done you a kindness will be more ready to do you another, than he whom you yourself have obliged.”

In times such as these, the reciprocity game in private equity is perhaps not as simple as tallying up sale mandates versus places at the table on new deals.  The equation is much more complex, often taking into account buy-side collaboration, joint origination initiatives and informal collaboration (or gossip!), much of which requires an investment of time often with no direct financial gain on either side.  That’s not to say these interchanges have no value.  Getting your advisory or private equity counterpart to ‘invest’ in the relationship can strengthen that relationship, increasing the likelihood of working together when opportunities do arise.

For instance, as a PE investment director, calling your sector counterpart at an advisory firm to tap into their expertise regarding a particular opportunity, even one which is unlikely to result in a fee any time soon, not only keeps you top of head when similar opportunities cross that advisor’s door, but also perhaps pre-disposes that advisor to ‘do you a kindness’ on their next mandate.

From the advisory perspective, having a private equity firm extend their loyalty and support during the ‘hard times’ – e.g. ‘creating’ fee-earning opportunities on the buy-side or introducing portfolio company audit and tax work – not only keeps the home fires burning, but perhaps encourages that private equity firm to continue to invest in the relationship when sales mandates are being awarded.

To sum up, psychologically speaking reciprocal exchanges build the relationship on both sides, whether or not you’re the one directly benefiting.  So a good relationship is a deeply collaborative one, based on an ongoing exchange of ideas, intelligence and ultimately mandates, on both sides.

Hazel Clapham, Arbor Square Associates