A 2004 study, recently updated, adds to the debate about whether management or the company is the important focus of investment screening. The study, written by Steve Kaplan of the University of Chicago, Berk Sensoy of USC and Per Stromberg of SIFR, found that over 90% of successful VC-backed companies have the same business model at the time of IPO as they had at the time of initial VC funding. Conversely, only 72% have the same CEO, and that number drops to 44% by the third annual report. Interestingly, the researchers also examined a sample that included both VC-backed and non-VC backed IPOs for 2004, and found no demonstrable difference in the human variable’s importance.
You might question the sustainable value of management, however, the results may be a bit sterile and simply reflect the effecient evolution of business aided by experienced VCs. As a company grows from early stage to a self-sustaining critical mass, the nature changes from entrepreneurial and adds other dimensions. This requires a changing culture of management, which often requires new skills at the top which may not be displayed by the founder or (incumbent CEO).
While we think management is critical to the success of VC investment, it is also certain that if the company is in the wrong business, because the market is not ready or passed, then even the best CEO won’t make the numbers.
As we expected, there appear to be more money than deals in clean-tech.
New Energy Finance reports: 2006 was another record year for Venture Capital and Private Equity investment in the clean energy sector, with $18.1 billion invested in companies and projects. This represented a 67% increase on 2005 ($10.8 billion), and beat New Energy Finance’s original forecast. However, this rapid growth in VC & PE investment only tells half the story: a significant amount of money ($2 billion) resides in funds and has yet to be invested. During 2006 clean energy VCs invested only 73% of the total money available to them – a symptom of a competitive market where demand for deals is outweighing supply, thereby driving up company valuations.
Cleaning Up 2007: Growth in VC/PE Investment in Clean Energy Technologies, Companies & Projects by NEF
Since Autumn 2006 attention to the sector rose as various reports came out: The Stern Report, various IPCC reports, the movie The Inconvenient Truth and so on. Private equity managers all rushed to get in on the game because they saw it as an easy way to raise money and thought that the fundamental economic drivers had suddenly changed. As is always the case with too much money chasing too few deals it is likely that many over paid. It is also likely that few had expertise or an understanding of the emerging economic dynamics of the enlightened consumer. Money will be lost.
The good result however is that more attention is being paid to this area, especially aspects like alternative energy.
The better managers are those that can also look beyond clean tech and make the connection with the growing LOHAS consumer profile as well.
A new study by two professors at Penn’s Wharton School lifts the lid on a “secret” of private equity managers. The findings of Wharton professors Andrew Metrick and Ayako Yasuda show that, “on average, leveraged-buyout funds can expect to collect $10.35 in management fees for every $100 they manage, whereas about half that, $5.41 for every $100, comes from carried interest.” Those numbers in total equate to over 15% of funds under management – a big number.
Investors that become aware of this statistic may negotiate more on the terms of management agreements where the GP is given the ability to be on both sides of the table when it comes to negotiating corporate finance fees. It should also encourage a move to more appropriate fee structures in which interests of LP and GP are more closely aligned, such as replacing carry with fund equity and making the management company a subsidiary of the fund.
The 53 page study dated September 9 which was featured in the Wall Street Journal will also hardly help private equity firms with their argument that the pending carried interest bill will damage the buyout industry.
Carlyle, the large successful private equity firm, has always been a cause for concern because its claim to excellence at its inception a decade ago was the raft of politicians on its board. The New York Post revealed recently that it paid $12.3 million in fees to a company tied to former state Comptroller Alan Hevesi’s top political consultant. Carlyle, which invests $1.3 billion for the state pension fund, paid the fees to Searle & Co., of Greenwich, Connecticut, from 2003 through 2006, when Hevesi served as comptroller. Apparently the fees were “in connection with Hank Morris’ work as a placement agent related to [state pension-fund] investments”. Searle, is not the medical company which was run by Rumsfeld which “lobbied” for approval of aspartame, but a small financial-service firm headed by Robert Searle, a longtime personal friend of Morris. Morris has been employed by Searle since 2003. Connections and behaviour like this do not depreciate the value of Carlyle, which is expected to launch an IPO soon. Investors prefer conflicted connections to integrity.
Here is a link to the consultation report by Sir David Walker on the UK private equity industry: Disclosure and Transparency in Private Equity. It offers a profile of the current industry and recommends guidelines for improving transparency. It does not focus on tax treatment, though there are implications for this.
Ethical Corp magazine reviews it here.
The consultation response period ends 9 October.