August 15, 2012
Interviewed by: David Snow
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Track Records and Transitions

In this kick-off to a three-part series on transparency in fundraising, Privcap convenes a discussion among three experts: Matthew Pedley of The Blackstone Group, Pawan Chatuverdi of Altius Associates and Jennifer Cho Rinehart of MVision Private Equity Advisers compare notes and discuss why investors are determined to understand and verify individual team-member contributions to performance. This is required viewing for GPs hitting the fundraising trail and LPs looking for best practices in due diligence.

In this kick-off to a three-part series on transparency in fundraising, Privcap convenes a discussion among three experts: Matthew Pedley of The Blackstone Group, Pawan Chatuverdi of Altius Associates and Jennifer Cho Rinehart of MVision Private Equity Advisers compare notes and discuss why investors are determined to understand and verify individual team-member contributions to performance. This is required viewing for GPs hitting the fundraising trail and LPs looking for best practices in due diligence.

David Snow, Privcap: Today we are joined by Matthew Pedley of the Blackstone Group, Pawan Chatuverdi of Altius Associates, and Jennifer Reinhart of MVision Private Equity Advisors. Thank you for joining Privcap today. Thanks for being here.

So today we are talking about the bold new era of transparency that we are in, and the private equity industry investors require much more information, both on an ongoing basis and in the fundraising market. And specifically, I’d like to talk about probably the most important information that is requested, which is information on track record. And let’s have a deep dive into that, maybe starting with Pawan.

For investors, it is very important. not only what the track record of a firm was, but how that track record was created, and actually kind of who did it. I’m wondering to what extent do investors care about the individual members of the team and their individual contributions to the track record?

Pawan Chatuverdi, Altius Associates: I think they care a lot about that, too.

Before I answer that question or comment on that, I think one thing to keep in mind is track records, the basics or the prerequisites. So you have to pass their test before investors, especially institutional investor gets interested.

But if they do get interested, they do want to know who are the individuals behind it. We always look at individual partners’ sort of track record in terms of who led the transactions, who was involved after that, who was involved in the exit and so on. So it’s critical, I think, to be able to answer those questions.

The exception would be when you have large organizations and they’re doing a deal a year, and it’s a group of people. There I think you could argue fairly reasonably that it’s not a person driving it, but a process and an institution driving the track record.

Snow: Matt, you’re at a very large organization with many, many track records, both for different strategies and different people. How do you respond to inquiries from investors who want to understand specific members of the team and what their contribution was to a track record?

Matthew Pedley, Blackstone Group: It’s actually rare that we get those types of requests. We’ll get detailed requests on our track record within a specific sector, or pursuing a specific strategy. But it’s rare that we get those at the individual level.

I would say the only exceptions to that would be of we’re raising a brand new strategy or a, for lack of better term, sidecar-type fund that has a much narrower focus, then the team members behind that new strategy or focus will have either a collective track record, or an individual track record as need be. But by and large, that’s not an issue that we have to face very often.

Snow: Jennifer, when you are advising GPs on getting ready for the next fundraise, do you tell them that they should sort out kind of who did what, or is it possible to simply say no, no, this track record is the record of the firm?

Jennifer Rinehart, MVision Private Equity Advisors: So we’ve worked with clients that have taken both approaches. But I do think in this era of increasing transparency, investors are very focused on who is doing what, when.

So even with very mature established funds that have been around for a long time, there have been senior partners that retire, younger partners that are coming on board. Investors want to understand who was involved, potentially at the sourcing, during the ownership, and at the exit.

Obviously, it’s very important when you’re talking about spin-out situations, but we find that attribution table being very important.

We also find that the investors we work with do their own work. So they’re not going to take your table at face value. They’re going to triangulate to figure out whether they think more people were involved at certain points in time.

Snow: I want to ask about spin-outs in a bit. But is there a standard or recommended way that, to the extent you want to keep track of who did what, you do that? Is it kind of deal by deal, or you just come up with, as you say a table of saying what contributions were made? Is that what you look at?

Chatuverdi: Yeah. Jennifer, you may have perspective on this, and you as well, Matt.

I think the way we deal with this, as Jennifer said, we ask for all of this information in terms of who led the transactions, who was on the board, if there’s been an exit, who drove that. But at the end of the day, you end up calling the portfolio company themselves to find out who did they work with. What was their experience? Which aspects did a certain person help them with?

So it’s never really trusting just one piece of information. It’s really combining all of these pieces to come up with a view as to what their team has done in the past, and whether we think it can keep doing what they’ve done.

I think one thing I should clarify also is– Jennifer alluded to this– these types of attribution questions probably become the most important when there’s changes in the team, and specifically departures. You mentioned retirements and such. Because that’s when these questions come to the fore. Is this group as good as it used to be? Is it better or worse?

Normal course, nobody leaves, I think it’s less of an issue because you must like the fund if you invested in it. And then you form your views based on the performance.

Snow: Let’s talk about a big issue, which is spin-outs, and sometimes it’s called a first time fundraise, but in reality, a lot of times it’s groups that have a lot of experience investing and are now attempting to raise their own fund. What are some things that GPs involved in a spin-out situation, or possibly even within a firm like Blackstone, should keep in mind when they’re about to face investors for a fundraise? Jennifer, this is something you have a view on

Rinehart: Good legal advice I think is important, from counsel who’s done it before. I mean I think ideally you would want some mutual agreement on attribution from the platform or the parent company, and the spin-out situation. I think that ultimately it may benefit the parent company as well, because they will ultimately have to go fundraising at some point.

But in barring those situations, I think that the best advice is that we have changing regulations around the SEC, so you want to get good advice around what you can and cannot say during the marketing. I think it’s getting harder to take your track record with you.

But again, I default to the fact that the investors who are making a 10-year commitment to this team, will be doing a lot more legwork than just an attribution agreement. So they’re going to be calling the intermediaries that were involved, the sellers who sold the company, the management team. Not just the CEO, and see who was on the ground actually executing the strategy at each portfolio company, and that’s going to be the best way to deal with that attribution.

Chatuverdi: You may have a perspective on this. But when you have the larger organizations which are now pretty mature in private equity, some turnover and spin-outs, you should expect them, and maybe not a bad thing.

And oftentimes, if it’s not an acrimonious split, I think sometimes the individual partners at the parent firm where the spin-out happened from, or even institutions sometimes who put in some money. And that’s usually a pretty strong validation that this was a good situation, these guys are good, people who are closest to them are actually investing in them.

When it’s not pleasant is when these issues come up, and our general sense is, if it’s that sort of situation, we invest not so much in what’s the track record on paper, but your point, knowing the people. If you feel comfortable with the people we’ll go, otherwise, just based on paper track record, it’s a very hard decision to make.

Snow: So what happens when there’s not an agreement from the former parent company? How does an investor sort through that, and how can the team that is departing still try to show that they have experience and that they actually were the owners of some good deals while at their former employer?

Chatuverdi: I don’t know how you all position those types of groups. Like I said, our view is we have to get to know these people if that’s the case. We may have known them at their predecessor firm. If not, then it has to be a long enough fundraise where we get to know them.

Sometimes what works is these people will have some capital, either personnel or friends and family, and they’ll use that to do a few deals and kind of show what they can do.

But outside of getting to know the people, it’s a difficult call I think.

Rinehart: Yeah. So I think there is a couple different ways to mitigate it. So having natural reference points. So CEOs or companies that know you that are investing alongside you, even though it’s smaller amounts. Maybe existing LP relationships that you’ve developed over that time that know your work, being an early– it doesn’t have to be big closure, but a small closure is helpful.

The other ways to mitigate, so when the spin-out situation happens, people are often concerned whether they’ll be able to track the types of deals that they did historically. So having seed assets. We’ve had a couple of years ago, a group out in the emerging markets where they had seed assets that investors could actually diligence. So they knew what they were getting when they were investing in the fund, and that mitigated a lot of the unknowables about the team and whether they can actually source the types of deals that they want.

Snow: Matt, maybe digging a bit deeper into any challenges that there might be in taking a group internally and positioning them sort of with a circle drawn around them as a specific strategy. What is hardest about that in getting investors to understand a specific track record within what was once a broader strategy?

Pedley: If you’re talking about something like that, there’s usually some defining element. Maybe it’s a particular sector or a particular strategy. So in cases like that, it’s actually not that difficult to pick out the deals that fall within a particular sector or within a particular strategy.

So it’s relatively easy to identify those. And then it’s a pretty straightforward process of identifying everyone who has historically worked on those deals. And we work as DL teams, so there are often a number of individuals up and down the hierarchy, if you will. You’ll have very senior people down to very junior people, but will have been involved in any particular deal.

And so kind of the corollary to naming the deals is naming the people that will be responsible for executing that sector or strategy. And in some cases, those people will be 100% dedicated to that strategy, and in other cases they will be only partially dedicated to that strategy.

The important thing is just to be transparent. That’s the general theme. And let investors and prospective investors know that these are the people that are 100% dedicated to the strategy. These are the people that are only partially dedicated.

Snow: I have a question about, and this can be the final topic for this particular segment, but the issue of succession in private equity. When the founder is getting ready to leave, and again, I’m not asking any of you to comment specifically on any specific groups.

In general, how big of an issue do you think this will be? Will it be difficult for a group that loses its former supposed rainmaker or founder, to raise a next fund. Or will it more likely be the case that people will dig into the track record and say actually, the team that’s in place was doing most of the work, and maybe it’s not a bad thing that the founder’s gone.

So in general, where do you think the market will discover what the true outcome will be of a succession process? Jennifer–

Rinehart: Yeah, no. So we really get excited about groups at those inflection points where there is a transition. In the situation where the founder was not coming to the office every day, but there was this core team executing, generating high returns for 10 years. Those are extremely exciting to us, and I think we know that investors get very enthusiastic about those types of opportunities, because for the first time they’re actually driving the bus.

I think in the cases where you have a firm where there were prominent founders that were rainmakers, so detracting deals and out their sourcing, I think in those transitions it’s important for the GP, we advise often that they’re inclusive with their investors about the transition plan, the succession management. And again, we come back to this attribution discussion.

So what were they doing? What was their primary role? How is that going to change over time, and over what period? And then using your attribution table, you can actually prove out how you’re executing on that. So there’s no overnight change. It’s actually over a period of time. Your investors are aware of it, and you’re executing on a planned succession.

Snow: Is that what you look at when you’re looking at a group that’s gone through, as Jennifer says, an inflection point?

Chatuverdi: Yeah, I think we are interested in those. And I don’t think it really always necessarily is a negative.

Generally, successions, as you mentioned, are pretty well planned out, and investors know fairly early when that process starts. So it’s rare that it’s an unexpected event, in which case I think it raises more questions if it’s sudden and unexpected.

Snow: Matt, if you were a betting man, would you bet that the departure of a number of founders across private equity would actually open up the eyes of the investors to a very talented team that was once the employees, or will it will be a more challenging transition?

Pedley: Well I think situations like that, to some degree, become a referendum on how institutionalized the practice has become. And if all of the judgment and decision-making capability was narrowly clustered within the minds of a very small handful of people, then I would presume it would be problematic, if those people were to no longer be in the equation.

But if the institution was successful in grooming up successive layers of talent from the junior levels, all the way on up to the senior levels, and involving all of them in the decision-making process, and honing their judgments, collective judgments, over the span of many years, then it probably becomes less of an issue.

So I think it really just comes down to an evaluation of how institutionalized the organization has become, and whether they’ve been successful in that goal.

Snow: Have there ever been any founders who, contrary to what would be best for the firm, insist that they’re the most important person in the firm, and this makes the presentation of the group track record more challenging? Again, without naming names. Has that ever happened?

Chatuverdi: That’s happened. We haven’t invested for them.

Rinehart: I think there have been IR teams that have struggled with that, and sometimes that is the role of bringing in a third party. Maybe a placement agent or an advisor to say actually we need more of the team on the ground and less of the founder in the marketing, and how can we use that to your advantage when you’re raising the next fund.

Because more and more, the investors are very focused on making sure there is a deep bench behind the founder or the co-founders, and understanding that this is not going to be an issue over the life of the time they’re invested in the fund.

Chatuverdi: I think the part related to that, which does happen more, is if there is a founder or a dominant senior person in the team. Then when marketing meetings take place, sometimes there is a tendency to maybe come across as dominant. And that can never really be a good thing. You have to show that it’s not a one person show if you’re raising an institutional fund.

Pedley: But there’s not much ego in the private equity industry. So that’s probably not often a problem.

Chatuverdi: Exactly.

Snow: Well, this has been a fascinating conversation. Thank you all very much for joining Privcap today.

Expert Q&A With Jennifer Rinehart, Managing Partner, MVision Private Equity Advisers

Privcap: Almost half of MVision’s clients have been first-time funds. Why?

Rinehart: When we were starting out, I think that we were looking for high return opportunities, and whether it was an existing fund or a new fund, we were indifferent. We thought we knew which investors we could bring on board to those types of opportunities.

I think as we’ve been growing our business in the US, those types of opportunities happen to be a little bit more prevalent. You see the next generation of leaders coming through in the private equity firms. There’s a natural inflection point. So we’ve seen a lot of opportunities on that front.

Privcap: What kinds of questions do LPs tend to have about first-time funds? 

Rinehart: I think they’re looking for seasoned teams. Experienced teams that have been executing on a strategy for a long period of time. They want to see that that type of strategy is something that they can repeat outside of that parent company or the platform that were previously investing at.

But I think if you can align all of those elements, and that you can show that the opportunity’s an exciting one, so it’s not just another plain vanilla middle market buy-out fund, but there’s something about the way they buy or what they buy that’s differentiated. I think there is a whole universe of investors that can get very excited about that.

I think the converse is true as well. There’s a whole universe of investors, no matter how good the experience or track record or strategy is, will never do a first time fund. So part of the knowledge that we bring to the table is that historical knowledge of which investors would be more inclined.

Privcap: What level of due diligence does MVision perform on its own potential GP clients?

Rinehart: So we would run the GP through our own due diligence process, which is very similar to that of your traditional LP. And I think we’re going through the strategy, making sure everything is internally consistent, spending time with the entire team, and really understanding where potential weaknesses may be.

So let’s not hope and pretend these issues won’t arise during the fundraising. Let’s be very cognizant about it, and try to be offensive in the way we handle those issues, and build it into maybe our materials, our marketing, the PPM, as opposed to being caught on the back foot as you’re fundraising.

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