October 14, 2014
Interviewed by: David Snow
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Cursed With a Weak Bench

Privcap presents reason No. 5: “Your Bench is Weak.” A GP’s team at the beginning of their partnership with an LP may not remain intact for 10 years during the life of the fund. Experts from MVision, StepStone and Zurich Alternative discuss how a “weak bench” can make an LP pass on a GP’s next fundraising. Part 5 of a 5-part video series.

Privcap presents reason No. 5: “Your Bench is Weak.” A GP’s team at the beginning of their partnership with an LP may not remain intact for 10 years during the life of the fund. Experts from MVision, StepStone and Zurich Alternative discuss how a “weak bench” can make an LP pass on a GP’s next fundraising. Part 5 of a 5-part video series.

Cursed With a Weak Bench
Five Reasons Why You Won’t Raise Your Next Fund

David Snow, Privcap: We’re joined today by Michael Elio of StepStone, Moose Guen of MVision Private Equity Advisors, and William Chu of Zurich Alternative Asset Management. Gentlemen, welcome to Privcap. Thanks for being here.

Unison: Thank you.

Snow: We are talking about reasons why you, the GP, may not raise your next fund. There are many. We have identified five. Now, let’s talk about the fifth reason why an LP might say “no” to your next fundraising expert and that is having a weak bench. In other words, you failed to convince your investors that you’ve got the right team and a motivated team for the next 10 to 15 years of managing the next fund. Mike, what are some weaknesses that an LP would see in a team put forth to manage your capital over the next 10 years?

Michael Elio, StepStone: There are quite a few inadequacies we could probably come across as far as a weak team. You have to remember, 10 to 15 years is a very long time. So, when an investor is giving their capital to this organization, they need to know if the folks in charge are the right people to invest their money, and if the team has the right age and depth to handle this money over a very long period. In order to keep a team together for a very long time, which LPs want, those economics need to filter through throughout the organization. I’m not saying all the way to the lowest levels, but enough of it needs to flow through that you have confidence that the team will stay there in one piece to manage not just through the investment period, but through the whole harvesting period as well.

Snow: A lot of people, when they think, “Oh, it’s a weak bench,” will bring up the issue of succession and ask if the senior founders of the firm will be there in the next 10 years. Even if it’s clear that they will be there, there’s also a weakness in seeing an under-motivated or under-incentivized mid-level of talent who look like (sometime between now and 15 years from now) they could spin out to seek greener fields.

Moose Guen, MVision: The industry was formed by legendary personalities who had vision, who motivated followers and who inspired people to give them huge amounts of capital. Today, those types of personalities are extremely rare to find. What you have is institutions and it’s almost as if we’re becoming leveraged asset managers and not necessarily PE firms anymore. And, within that new world, the infrastructure and the management of that infrastructure is absolutely crucial. The investors want to identify that the execution plan of the firm is able to provide that fund return they’re seeking. As the funds get larger and they have larger budgets, all of a sudden, they’ve got very impressive benches. All the skill sets are there and they’re structured. And they move things around, they look at providing that fund return and they provide these consistent returns. The question then is will those firms stay like that or can they evolve? If they evolve, they have to institutionalize. If they institutionalize, the individual’s gone, right?  Very interesting.

Elio: The industry did start with some very large personalities, but LPs over the years have learned that some fires burn hot and short. So, if they want a long-term relationship, they need a deep bench and they need to institutionalize so that these returns can continue over time. If you’re investing institutional money into an institutional organization, you expect certain levels, as you mentioned, of expertise and specialization across the platform. We need to make sure that, though our history was dynamic and vibrant, the culture that that individual can bestow, which we’ve seen in certain organizations, can still continue…

Snow: William, when you look at the line-up of talent that will be managing or is asking to manage your capital over the next 10 to 15 years, what do you like to see and what troubles you if you see a weakness?

William Chu, Zurich Alternative Asset Management: One basic thing that LPs generally would ask for would be a deal attribution sheet. Simply who led the deal, who worked on the deal, who were the members that transacted as it relates to this particular situation, and also who served on the board. To really understand roles and responsibilities is very important. That’s fairly basic right now, but some GPs don’t actually provide full attribution. They say that the firm owns this. So, I would seriously encourage general partners to have all their facts and information, and to be transparent at the end of the day. Because if you want to ensure that your investor is going to be a happy investor, the last thing you want to do is give them negative surprises or lead them down the wrong path where they can do their own homework, rightfully or wrongfully. The other part that I appreciate is that general partners are now much more open and transparent around the GP economics.

Snow: Is it frustrating for you as an LP to meet with a GP who doesn’t want to reveal deal attribution or partnership economics? To what extent does that happen, and if it does, does it color your view of that GP?

Chu: Yes and no. If it’s been a consistent practice historically and it’s simply not something they are willing to share, you can beat your head against the wall and try to make change, but that’s probably not the most effective way of doing it. It’s on a case-by-case basis, to be candid, but ideally you want to be as open kimono as possible to your investors, because ultimately they’re going to be entrusting you with capital for you to go manage for the future.

Snow: What are signs that a mid-level of workhorse GPs who are out there adding value, sourcing opportunities, might leave because of a weakness or inequality in the partnership economics?

Elio: It’s a very small world, this private equity space, and we have seen groups that have succeeded and done well. And if you look at the deal attribution, which is something we also focus on, most of the mid-level folks are generating the returns and you see them starting to get to the point where they have enough economics to want to stick around to get the carry from the prior fund. But, once those realizations happen, if there’s not enough economics for them to stay, that’s where you can see problems arise in the future.

Guen: Right, and the whole point is the motivation of the compensation because historically in the U.S., it’s deal-by-deal carry. And when one has these out-of-the-park type returns, all of a sudden, the three of us just got $100 million each. You’re the head of the firm, you get $250. But we got $100 million each.

Snow: But you guys did the work?

Guen: It doesn’t matter, right?  He likes working with you, but the two of us want to have our name and want to have our own business now. And we’ve got $200 million we can go form a firm with.

Snow: So unfortunately for LPs, extreme success can breed instability in the partnership, correct?

Guen: At the end of the day, change is good and to let the two of us go off and form our firm, it doesn’t mean we’re not friends anymore. But it means that we want to go do something different. We want a technology-focused fund and you guys want to continue with your strategy. We just have a different view, right? Sometimes success of a firm means other firms.

Snow: That’s a good point, because a lot of people associate spinouts with failure, right? You don’t think you’re going to get carry, so you might as well just leave and set up your talent somewhere else.

Chu: There are always going to be situations, particularly as it relates to deal professionals, who like the hunt. The pursuit of a transaction and sometimes when a firm grows from a small buyout fund to a mega-, to a mid-market buyout fund to a large or mega-buyout fund, you lose a sense of that hunt. Because you’re successful, you also encourage others to pursue their own passions whether it be in the smaller or mid-market front. And that’s sometimes a good thing.

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