What will the private equity firm of the future look like? Smaller, and with fewer partners, says Dan Schwartz in ‘The Future of Finance: How private equity and venture capital will shape the global economy’ (www.wiley.com).
Also, these firms could evolve to a more flexible structure, he says, citing Joncarlo Mark of CalPERS. “The money is there. They have the resources to hire the people from the investment banks and the hedge funds. You will also see some spin-offs of the big firms by top-performing partners who want to start their own firms,” explains Mark.
Another reason firms may become smaller is that it may enable better contacts with investors, notes Steve Byrom of Australia’s Future Fund, interviewed by the author. The ‘different private equity manager’ that Byrom visualises is a smaller manager with a smaller number of LPs (limited partners) where LPs have a greater say. “There may even be a shakeout in big names. All this may drive an even greater divergence between those doing pure play private equity and those doing alternative asset management.”
An interesting discussion in the chapter on ‘future scape’ is about ‘authentic private equity,’ a resilient and distinctive subset of the industry with ‘unlisted performance engineers,’ as PEP’s Tim Sims puts it. A perfect rational investment response, according to him, is to choose to buy control of ‘a carefully selected company, off the back of thorough diligence, with a team of performance specialists, who agree on a business plan, follow strict ROI guidelines, have long-run objectives and reporting obligations, and only get paid if they succeed.’
VCs of the future
The profile of the venture capital firm of the future will also evolve, says Schwartz. Unless markets change dramatically, the bigger firms will need to become more specialised and tap greater skill sets, he adds. “Kleiner Perkins promoted a precursor to this idea with its ‘keiretsu strategy’ involving the exchange of services and funds between its portfolio companies.”
An instructive quote of Dixon Doll, former chairman of NVCA, is that venture capital is about job creation, innovation, and applied science. “At the end of 2008, 12.1 million jobs in the US were attributable to venture-backed companies. Revenues generated by these companies corresponded to 20 per cent of GDP on annual venture capital investments representing 0.2 per cent of US GDP. Even more amazing is that 92 per cent of all the jobs that are created by venture-backed companies happened after the company goes public.”
Among the opportunities for private equity, the author mentions growth equity, which has had ‘a long history in Asia, where family-run companies own most of the business and have been reluctant to give up control.’ That began to change after the Asian financial crisis of 1997, when these corporations were forced to divest non-core businesses or to sell unprofitable divisions, he traces.
“Over the past several years, however, purchasing minority stakes has come back in style. The investors are now seen as adding value to the equation rather than being simply along for the ride. Funds have been granted various rights that give them more control at the board level and a say in exits.”
Where are the opportunities for venture capital? Alternative energy, mobile platforms, digital media, consumer goods, biotech, money-saving devices, and education, says Schwartz. “One aspect of all these new ideas is that they increasingly involve more than just producing a machine or device. They involve ongoing services, training, and sensitivity to consumer tastes, and they signal adapting to a more long-term investment model for venture capitalists.”
Geographies of focus
Importantly, much of the great technology and services in which venture is investing will not be built in the US or Europe, apart from perhaps prototypes and designs, the author forecasts. “Whether it is a flat screen or a lithium battery component or a handheld platform, the technology may be state-of-the-art, but the device will be made in China or Southeast Asia or India.” Why so? Because, even with currency appreciation, manufacturing costs in these locations will remain one-quarter to one-eighth of what they are in the Western world.
The book ends on a positive note by stating that the recharged private equity and venture capital industries may well emerge as cornerstones of the financial industry. At its best, its leaders have grown from opportunistic buyers to unique and important contributors to the global economy, the author avers. He expects, therefore, that the Government will want to be more involved, rather than burden the industry.
“Beyond the mega-deals, the vast majority of private equity and venture capital transactions are aimed at optimising good companies with unrealised potential or rebuilding those with troubled balance sheets, and creating new businesses out of great ideas and great people.”