April 1, 2012
Interviewed by: David Snow
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Assessing the GP Team

Assessing the skills of a GP team is the hardest and most critical task in alternative investing. Making these judgments across cultures and in developing economies is even more challenging.

In this must-watch video discussion for serious participants in emerging markets private equity, three veterans discuss the importance and process of choosing the right managers. The discussion includes David Marchick of The Carlyle Group, Maureen Downey of Pantheon Ventures, and Peter Furci of Debevoise & Plimpton.

Assessing the skills of a GP team is the hardest and most critical task in alternative investing. Making these judgments across cultures and in developing economies is even more challenging.

In this must-watch video discussion for serious participants in emerging markets private equity, three veterans discuss the importance and process of choosing the right managers. The discussion includes David Marchick of The Carlyle Group, Maureen Downey of Pantheon Ventures, and Peter Furci of Debevoise & Plimpton.

David Snow, Privcap: Today we are joined by David Marchick of the Carlyle Group, Maureen Downey of Pantheon Ventures, and Peter Furci of Debevoise & Plimpton. Well, why don’t we get started? Thank you all very much for being here today.

We are talking about the emerging markets and fundraising and investor trends focusing on the emerging markets. But I think there’s a very important thing we can talk about, which is finding the right team to add value and to promulgate the private equity strategy in the emerging markets, which is not an easy thing to do.

So maybe starting with Maureen, as someone who, for a profession, you assess the track records of people who are good at private equity in the emerging markets. What’s a useful way for investors to think about choosing the right team? Certainly, picking good GPs anywhere in the world is important, but when you go to a place where there’s perhaps less of the history of private equity, does it change the way that you assess teams?

Maureen Downey, Pantheon Ventures: I wouldn’t say it changes the way we assess teams, but we certainly focus on, very rigorously, the alignment between the team members. Because one thing that we’ve discovered in our 30 years of experience– and we started first investing in emerging markets in ’83– is that if you don’t get that right, there’s a good chance, just given emerging markets are tending to grow quite quickly, and that includes a GP landscape, that you have a lot of team instability and team break ups. That’s something you definitely want to avoid.

The other thing I would say is really trying to figure out, are they adding value? Or are they just benefiting from a rising tide? Because there are definitely times when we take a look at a track record and we do a lot of very granular analysis. We look at where they bought the particular company at, what they did to it– and that comes though reference calls, it comes through talking to the management of the companies– to really add value. Then where did they sell it?

Because I think that as particular markets evolved, there are GPs that will continue to evolve their skill set and may focus on particular sectors, but it’s very important to understand how they’re actually sourcing deals. How they’re able to work with, many times the entrepreneurs who stay within the companies. Then lastly, how exactly are they adding value?

And so it’s a quite a granular analysis. I would say there’s a quantitative aspect of it, but there’s very much a qualitative aspect of it, which comes from, again, the 30 years of experience. I think a particular thing that David probably will want to comment on, or may want to comment on, is how do you pick the right company managers?

That’s something that we spend a lot of time talking about with the GPs we invest with because being able to pick the right people, motivate the right people, and maintain a good relationship is key. Many times we note in emerging markets that GPs are making minority investments and not necessarily control investments. So your ability to source, attract, and maintain good relationships is key.

Snow: Well, there’s a number of different ways that a private equity firm– especially a big international private equity firm like Carlyle, perhaps– could think about bringing the right team to the opportunity in the emerging market. You could have some people from the home office coming in who have deep private equity experience and maybe some regional experience in the emerging market. You could have a Western trained team of GPs who have spent a lot of time in the West and are now returning home to be successful in private equity.

Or you could just have the pure locals who might not even speak English very well, but who deeply understand the business communities in which they are investing. Is there a right mix of those, at least from your firm’s perspective, David?

David Marchick, Carlyle Group: I think there’s been an evolution. I’ll just give you an example of our evolution in China.

When we first set up in China– 13, 14 years ago– we brought a successful investor from the United States, moved him to Hong Kong, and basically said, recruit a team. And mostly, the people they recruited were Westerners. That evolved to having a local national that was educated in the United States, that may have trained with one of the large investment banks, and then went back to China to invest.

Today, we are hiring almost exclusively nationals in the country in which they’re investing that are trained in that country, that have developed relationships with that country, that have their business school or other professional school networks, and they’ve worked in that country for their professional career. So we’re becoming much, much more local in the countries in which we operate. And the more mature we are in a particular country, the more local we are.

So when we set up right now in sub-Saharan Africa, we have a mix of nationals from various countries that have private equity experience. They’re all local. Then we may bring a mid-level person from Carlyle from somewhere else in our firm to help bring the culture and bring the deal strategy, the deal structuring experience. But our fundamental approach is to find locals in the markets that know the culture, know the language, that can operate within those cultures, and understand the nuances and significant issues, that as a Westerner or someone from that country, we won’t pick up.

Snow: Peter, as someone who’s been in the middle of many, many emerging markets private equity fundraisings over the years, have you seen– as David mentioned– an evolution in the kinds of people, or the backgrounds of the people who run these firms?

Peter Furci, Debevoise & Plimpton: Well, I’m continually impressed by just how strong some of these local private equity talents are. Particularly in the Latin American space, you have people who typically have some Western education and work experience in either Europe or the United States, but who are also very deeply connected to their home markets. These are actually extremely impressive people.

I think that’s really what investors are most excited about, is when a management team can actually bring together Western training with that analytical rigor and experience with local knowledge, being connected to the right sources, and access to deal flow. That’s really a very powerful combination.

Snow: Is a GP team at a disadvantage if it’s entirely deeply local, and perhaps there’s not– at least in the eyes of Western LPs– and perhaps there’s not the Western training or some of those pedigree types of backgrounds that you would have typically seen maybe five to 10 years ago in private equity?

Furci: I think investors are still very much looking for the right local team. I think that there’s more of a premium on being connected in the jurisdiction, knowing your way around, feeling like I’ve got an inside guy who’s actually going to direct me to the right spot here. I think though, that as global markets become more and more integrated, in particular as Latin America becomes more interrelated with China, with India, the need for local private equity teams who are also sophisticated globally is going to be increasingly important.

Downey: It depends in what space you play in. I think certainly at the larger end, where you’re buying larger companies and you’re doing things on a more international scale, it’s really important to have the local network, but also be able to be connected to other markets, be it developed or other emerging markets. Sometimes I think, on the mid-market side, if you’re just doing smaller growth or middle sized buyout deals, maybe less important.

It epends on the strategy. If you’re trying to take something international, or if you’re just trying to do a roll up within a particular country. So I think a little bit depends on the orientation. We always favor local. But we know that it usually comes with evolution.

Many times– I think as David mentioned– a team comes that was successful in the US or Europe and sets up a presence in a particular emerging market. Over time, they’ll hire more locals. And eventually some of the people may leave and form new funds.

That’s quite what’s happened in Asia, particularly in China or India. But I think having the local network is important. We find that to be one of the more attractive points.

Snow: David, as the various teams within the Carlyle group have interfaced with investors and you’ve seen the reaction, is it your sense that it’s possible to sometimes be too local? That there’s a group that’s deeply integrated into the local business culture, but maybe doesn’t have enough of a background in international standards of corporate governance or things like that, to get people comfortable with placing their capital with them?

Marchick: I think as Maureen said, it really matters the size of the company and the level of that company’s evolution. If you’re investing in a very small start up or early stage company, they were probably looking to go to the next town, province, or municipality, rather than the next country or the next continent.

If you’re investing in larger companies, you want to make sure that they can go public at some point, they can go international, they can do acquisitions overseas, that they have access to the best management talent. And so what we’ve tried to do in investing in those medium and larger companies is to try to marry our local teams that have the knowledge, the culture, the relationships, and the ability to maneuver in that jurisdiction, with our global network. Which helps them get access to international markets, international relationships, other sales opportunities, and our sector expertise, where we have deep industry expertise in six or seven sectors. And the combination of the local talent, the global network, and the industry expertise has allowed us to help those companies grow faster, strengthen their governance, strengthen their management, and do better under our ownership than  they would otherwise.

Downey: Maybe just going back to the initial question you asked me about how do you pick the right GP. The way I think about it– and I think David gave a really good example– is the deal flow that this GP is going to see, does it match the capabilities that they have?

One of the issues that we face quite a bit in emerging markets is somebody’s successful in their first two funds and then their third fund is like three times the size of their last fund. They’re now doing say, equity tickets that are more like $150 million versus $50 million. That’s a very different type of deal.

They may not have the skills, frankly, to add value to a company where you have to make a $150 million investment, because they don’t have the international contacts. Many times when you’re buying a company at $150 million, it’s in much better shape then when you’re buying something at $50 million.

So when I look at a GP, I’m like, do you have the skills that’s going to match the deal flow that this fund size is going to require? That’s frankly just one of the key things that we look at from the very beginning.

Snow: I want to return briefly to the subject of track record. Emerging markets private equity, by definition, has not been around as long as developed markets private equity. Therefore, your average team has not been as active as it might have been in another geography.

So should investors cut a break to talented GP teams? Then maybe just pay much closer attention to a slightly shorter track record? Or do you have to wait for fund three to back a Brazilian or an African fund manager?

Furci: Well, that’s a hard question, obviously. I think you can only evaluate a team on the basis of what information there is.

I think that if you– as Maureen was saying– if you really drill down into their processes, and what is it that they’re really doing, what is their philosophy of adding value, you could probably get a lot out of looking at a number of the transactions they’ve made. Even if they haven’t been harvested yet and fully understand, what’s your approach to creating value? You can probably derive a sufficient comfort level from those types of diligence conversations to assess, even though on paper these two teams may have broadly similar track records, who’s a real value creator and who may be riding a wave.

Snow: I’ll ask one more question, and maybe we could start with you, In emerging markets funds or where investors are entrusting capital with emerging markets fund managers, are they asking for special protections around any issues? Whether it’s currency or, as Maureen said, the chance that the big shot of the firm might leave and go do his own thing, or whatever the case may be.

Furci: Well, I think many of the protections you see in global private equity, like key man provisions.  A key man provision is equally important in Brazil, or India, or China, as it is in the United States or Europe. If you’re really betting on a particular investment team composed of three or four people, to the extent that two of them are gone, you want to know what’s going to happen. So certainly we do see that.

But I think that in terms of emerging markets specifically, we do see some terms that you don’t see in developed markets. For example, in a number of the Brazil funds we did see currency specific protections and inflation specific protections. Where investors came in and said look, an 8% hurdle rate– which is kind of the standard in global funds– that may not be appropriate for a country that has consistently high inflation or at least higher inflation than in the developed world. Therefore we want the hurdle rate to be inflation adjusted.

Similarly, you get into a lot of conversations with investors about well, should we be running the waterfall in dollars? Or should we be running the waterfall in Brazilian reais?

And very, very often, the investor’s views on those conversations are a function of where they think the currency’s going to move, as opposed to whether there’s a specifically right answer on that. So we actually do see a lot of attention to those issues.

Snow: Any special terms that you ask for in certain geographies that you would not ask for elsewhere?

Downey: I think we look at foreign exchange. It’s probably more of a kind of a macro consideration for us. Some of the terms that I’ve seen that are a bit interesting have to do with financings and being able to, for instance, use up to 1/4 of the fund to bridge a deal and then not have that count to the waterfall. Because financing is a little bit more challenging to arrange in particular countries than it is say, in the developed markets.

But there isn’t, I don’t think, specific terms that we use for the emerging markets. We have a very rigorous checklist that we go through. We pay particular attention, I think, to the allocation of the economics, not only within the ownership of the GP, but also within the carry because we really don’t want those VPs and principals frankly, to leave.

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