The World Is Not Very Flat In Emerging Markets......

Raising Funds in Emerging Markets

The private equity industry in the emerging markets have been growing at astonishing speeds, however the bulk of capital has traditionally been sourced from North American and European institutional investors. There is serious change in progress. As economic stagnation continues in the developed nations, general partners are looking to institutional investors from many of the emerging markets.

To this end, general partners are realizing that traditional ‘unwritten rules and understandings’ between GP’s and LP’s, so strongly advocated by organizations such as ILPA, are being ‘re-written’. When approaching investors from emerging markets, one must first understand the business culture in an emerging market. At the risk of over-generalizing the facts, there are many similarities in how investors approach deals in any emerging market.

The first thing any general partner will notice is that many institutional investors from emerging markets will want to take part in the investment decision. The second thing any general partner will also notice is that institutional investors will want quicker exit times from portfolio companies and ultimately a shorter life-cycle for the fund itself.

So why do investors from emerging markets want these provisions before making a commitment?

We need to understand the dynamics of an emerging market before we can answer this. Tracking of an investment and a lack of world class (and... trustable) management has always been a point of concern in the emerging markets. One way to solve the problem was to have the investor take an active role in the company in order to protect its interests.

Wild economic swings are a common characteristic in any emerging market. The term ‘long term asset allocation’ has a different meaning to an investor from an emerging market than to an investor from a developed market. Traditionally, investors in emerging markets like to exit within two or three years from any deal.

Many traditional investment ‘rules’ have clearly been transferred to the private equity realm. The rules are changing and many general partners and industry organizations from developed markets must adapt if they wish stay in the business.

 

What can the Balkan Region Learn From the Western Markets?

It is often regarded that the Balkan Region must have to ‘learn’ from Western markets and not the other way around. I’ve now been living in Turkey since only last summer so it hasn’t even been one full year, however I can assure you that there is plenty of learning to do on both sides of the coin.

I do not believe in the fact that ‘best practices’ and ‘know-how’ are what the region can take from western markets. More often than not, many industry experts in this region have received their grooming in western companies in the first place. They automatically bring ‘most’ of the practical knowledge with them as they represent western funds/capital.

There are, however some general complaints I often hear from local private equity and venture capital players. These are:

1.     Lack of good deals

2.     Unreliable management

3.     Inadequate book-keeping and accounting practices

4.     Deal sizes often too small

5.     Lack of overall transparency and growth opportunities

Ironically, these have been the EXACT same complaints and arguments I hear from Californian investors. It seems private equity and venture capital must solve similar challenges in each region. After all, we are in the business of identifying the right deal and increasing its value before exit. This template is the same wherever you go.

So, what is it really that the Balkans region can learn from the West?

The answer is not what it can learn from the west, but what it can teach itself.

Most funds in the US are capitalized by actual US investors whereas a large majority of the funds in Turkey (and I’m assuming the Balkan region as well) is capitalized by foreigners – primarily US or European investors.

In my opinion, the critical lesson all Turkish investors must ‘teach themselves’ should be the ability to communicate the reasons why foreign investors should choose this region as opposed to any other. Turkish funds must realize that international investors do not have adequate knowledge about Turkey as they do on other places such as China, Brazil and Russia.

I have yet to see a compelling presentation as to why any investor should choose Turkey over other developing nations for their investments. I have not yet seen rates of return on private investments as compared with other nations across the globe (or even for that matter, with other European nations).

If Turkish funds want to capture more investors then they must be able to show them actual concrete evidence why choosing Turkey would be an advantage.

Consolidation in Private Equity and a New Opportunity

There has been one common underlying theme to all of my interaction with other private equity general partners over the past several weeks. There is an absolute expectation that we are at the beginning of a massive consolidation within the private equity industry.

What’s interesting (but not all that surprising if you think about it) is that the possibility of large private equity firms merging with large hedge funds has become regular conversation.

The reasons are obvious: the 30% plus increase in write-offs and write-downs have virtually stopped the entire industry in its tracks. Many firms that were able to raise funds last year are not able to make investments and those that have invested are heavily leveraged with diminishing portfolio valuations.

From what I’ve been hearing, I think there is a two pronged approach to the inevitable consolidation we will witness within the private equity industry. The first approach seems to be the easy way out. It involves establishing ‘joint ventures’ and effectively consolidating know-how while pushing for a new ‘leaner/meaner’ image within the industry. This approach, in my opinion will not work as LP’s are not stupid (except those who took the Madoff bait, but that’s another blog post all together). LP’s are not looking for a new ‘image’ or a ‘name’ but they are looking for ‘transformed’ industry players who no longer go by the dying private equity game plan of yester-years (last year).

This leads me to the second approach and within this approach, I see a real opportunity.

The fall of many of the massive investment banks has left a serious hole in the entire financial sector. I’m rather skeptical about whether large traditional banks can fully replicate and replace what these investment houses were offering. I think this is where some incredibly new and exciting opportunities lie. I think private equity firms must re-organize and re-think their proposition to LP’s and quickly take advantage of filling a gap left by these investment banks.

I know I’m thinking about it. Are you? If you are, then please let me know. 

Putting the Angel back into Angel Investing...

The concept of angel investment groups has evolved much over the past seven years. It used to be that these organizations were semi-formal groups of high-net-worth individuals being able to discuss and invest into (primarily local) novel ideas and entrepreneurs. An added bonus offered to members of these groups was (and continues to be) the social aspect of being surrounded by like-minded and like-demographic ‘rich friends’. 

The method for investing into new ideas and entrepreneurs was relatively easy and un-intimidating. General group discussions took the place of more formal due diligence exercises and there was a very distinct difference (some refer to it as an invisible wall) between angel investments and venture capital.

The times have certainly changed.

Many angel investment groups (including the one I’m involved in: Icon Angels) have internationalized and formalized the angel investment process to a point where deals are fashioned together the same way as in any venture capital fund.

I’m a firsthand witness to a very real phenomenon within these groups: the impact of group think.

Due primarily to this new formal environment (investment process) of the angel groups, many ‘creative ideas’ are no longer being considered as investment grade and when they are actually presented to these organizations, they are often rejected by the very processes that were so essential to the development of new ideas only less than a decade ago.

I’m finding that entrepreneurs with projects still in the ‘idea’ phase are no longer the projects angels are keen to explore. The novelty (and the adventure) of investing into a seed idea that could possibly bloom into the next Google or Apple is no longer a risk many angel groups are able to digest during their regular ‘round-table’ discussions and unfortunately the main culprit is the phenomenon of ‘group think’.  I often tell these daring entrepreneurs that their only real chance of finding the capital to launch their project is by identifying the lowest hanging fruit – their family and close friends.

There is a way to beat the group think phenomenon.

I believe it is now time for angel groups to focus on specific sectors where its members are well versed in the details, trends and strategies of identifying the right idea ready to blossom. Such an organization will remove that ‘one’ angel that may know just enough to be dangerous about a certain subject to derail a potentially brilliant idea within a group of angels who may not fully understand the subject matter.

If given the time, I hope to explore more focused angel groups with investors who are subject matter experts and are able to conduct detailed round-table discussions on novel ideas. This is all in the hopes that we can push through more deals and bring back adventure into angel investing once again!

In order to stay true to the angel investing principle: Is there anyone out there who is adventurous enough to help me put it together? ;)))

The 'New' Private Equity Sector...

First and foremost, I wish everyone a wonderful 2009. I hope for good health, happiness, high fortune, and a crises-free year ahead.

Having said that..... it was rather difficult to focus on the positive with articles such as the one published by Financial Times about the private equity sector. However this particular one carries an important message: the private equity sector is in a consolidation (or dare I say, maturity) phase. This 'phase' is nothing new to anyone who has seen past economic bubbles created, only to be destroyed (burst) in spectacular fashion. The growth of the private equity sector reminded me of how we built up the internet bubble during the 1990's. Anything concerning the internet received funding and similarly, anything concerning private equity received investors over the past five years. It seems those days are over. 

I predict that investors will now demand (and in fact have begun to demand) increasing transparency in terms of investment strategies, reporting and return targets from private equity firms.  This will result in a transformation of the sector as it will no doubt force many funds to consider (and develop) new investment vehicles that complement their current offering. 

I believe over the next year, the entire private equity value chain ranging from management fee rates, carried interest rates, reporting, investment strategies, accounting practices, and service offerings will be redeveloped. 

This should be considered as a new opportunity for the private equity sector - it will eventually (and at the risk of sounding too optimistic: 'hopefully') erase its negative image and really open up to the general public as a viable and (for the lack of a better word)... 'safe' investment vehicle. 

Private equity groups face tough choices

Financial Times

For Philip Davidson, head of European restructuring at KPMG, the speed with which recession has hit Britain reminds him of “Looney Tunes” cartoon characters like Road Runner and Wile E. Coyote.

“A year after we started to hear about the credit crunch, the economy ran off the edge of a cliff,” he says. “But like the Road Runner we kept on going, with the legs still spinning. But then in September we started to plunge towards the ground.

“That’s different from the past recession and it’s taken a lot of people by surprise.”

One of the groups caught out is private equity. The lack of availability of debt financing has not only made it difficult for private equity funds to put new deals together, it has also made it tougher for the companies in private equity portfolios to deliver targeted returns.

This, in turn, increases the reluctance of private equity backers to put money into underperforming funds.
Mr Davidson says: “The extent to which their portfolio companies have begun to feel the effect of the loss of top-line growth has had a rapid impact on a lot of private equity groups. There are a number of private equity companies we believe that are facing portfolios that are not going to be able to deliver the returns they promised.”

That is likely to lead to a rise in bank lenders forced into debt-for-equity swaps, he says, reflecting a realisation by banks that, since the last recession, they believe that they will have to take stakes in companies and engineer a turnround.

He cites the case of Erinaceous, the property services group, that went into administration in April, as a template for what may become common in restructuring and insolvency situations.

The group’s insurance division was ring-fenced from the rest of the business and placed in a special purpose vehicle through a debt-for-equity swap, with Erinaceous’s banks running the unit. “The banks had a choice,” says Mr Davidson. “They could sell it vastly under value or they could shift through a debt-for-equity swap the insurance division and a few other assets into that vehicle that they are now running themselves. The insurance division is doing well now. We will definitely see more of this.”

Private equity companies will face tough choices over whether they can afford to take part, or see their original stakes whittled down.

The losers in this scenario will be the private equity houses that had invested heavily at the top of the cycle and will be left holding “maybe 2.5 to 5 per cent” of a company. The winners will be those that cashed out and have been raising new funds in anticipation of being able to acquire assets cheaply over the next two years.

Mr Davidson says that while banks generally do not like debt-for-equity swaps, since it ties up regulatory capital, the upside is that it allows them to “retain future value”, assuming economic conditions recover. They will generally hire turnround specialists – even tapping top talent from private equity firms – to help restructure the business.

“Let’s not forget that debt for equity can be a good thing because it can preserve the business, preserve jobs. Customers and suppliers have a company to deal with,” Mr Davidson says.

But he is critical of those who suggest the way to preserve distressed companies is through US-style Chapter 11 bankruptcy proceedings. In July, David Cameron, Conservative party leader, proposed importing elements of Chapter 11 into the UK’s insolvency procedures to give companies more protection from creditors, buying time for businesses to be turned round.

Mr Davidson says he can understand why the proposal has some attractions “conceptually”, especially since the perception in the US is that companies emerge from the process healthier. “Ten or 20 airlines went into Chapter 11 in the US a few years ago, people still flew on their aircraft and they came out the other end.”

However, he says most of the work of rescuing a business is done “behind closed doors” and the administration part of the process is “the delivery mechanism that finishes off the transfer of ownership from existing to new shareholders”.

“There is a superficial belief that if we change UK insolvency legislation we change the process but actually for the most part businesses are being saved, they are being restructured. So while it grabs headlines to say we need a Chapter 11 process, there isn’t any evidence to suggest we do.”

CalPERS Offloads 96 Private Equity Funds From Its Holdings

CalPERS (California Public Employees’ Retirement System) is one of the largest investors into private equity in the world. An interesting article was recently published by Dan Primack at peHUB with regard to the change in private equity holdings between the end of year 2007 and end of the first half of 2008.

The report suggests that 96 funds listed in the previous report did not make the new list – which means that CalPERS divested over 25% of its private equity investment portfolio during this time frame. Although some of these funds simply reached the end of their life-cycle, majority of the disposed funds ended up in the ballooning secondary markets.

They (peHUB) put together an interesting Excel document which compares all of CalPERS’ private equity holdings from 1990 until the end of Q2 2008. I’ve taken the liberty to make a slight adjustment to the table and shaded those funds that DID NOT appear in the new report, therefore were disposed of by CalPERS.

Once again, we are seeing a considerable liquidation effort by some of the most critical investing institutions in the world. For those private equity funds with investable cash in hand (coupled with a considerable degree of patience and a good business network), there should be a large number of interesting deals floating around in the secondary markets.

I’m not exactly sure as to the actual number of Turkish private equity firms that have investments from CalPERS, however it would be naïve to think that none have engaged with the organization in the past.

Here is the Excel file for Download - CALPERS.xls. 

Top Mistakes While Raising Funds

Positioning a company so that it attracts the right investors can be a very challenging process. Yet somehow, many entrepreneurs forget that the investors that they are presenting to often have started up and sold multiple companies – after all, that is the precise reason why they are angels. All entrepreneurs must remember one thing: these investors can smell exaggeration and a shaky plan from the first paragraph of an executive summary – 100% of the time. This is no joke!

Having said this, I often review business plans with the same mistakes over and over again and as a result, I wish to share some of my insight so that companies do not fall into the same trap. I recommend that entrepreneurs follow these simple points before sending any investor its business plan or investor presentation.

1. Be realistic in developing any financial projections. There is very little reason to believe that any start-up company will capture 8% of the US GDP through its proprietary transaction engine or that although the company is losing $1million for the first two-years of operation, it will make a profit of $36 million on its third year.

BTW: Believe it or not, these are real examples of some of the presentations I've received in the past! The figures are all what is actually written in their investor presentation. The irony is that many start-up owners honestly believe in these outlandish forecasts and to some point, we really must commend their courage in being able to stand in front of a group of investors and argue their point to the very end.

2. Make sure the company assumptions are based on sound research, as investors will question them heavily. Any declaration that the company plans to ‘Capture 1% of the market’ is a sure way to lose any potential investors.

3. Investors are never interested in ‘who will sign’ a massive contract with the company in two weeks and that the company cannot disclose who it is. Investors want to hear who the current customers are and what the current business development strategy is. The same advice goes for any assertion of signing ‘rainmaker’ personnel once funding is completed.

4. Regardless of what a company is doing, it has competition. There are two levels of competition: direct and indirect. Company managers must be realistic and present the threats as they are because the truth ‘will’ surface and when it does, the company will lose tremendous credibility. Management should stay away from making claims that the ‘100lbs gorilla’ of the industry is too slow or too caught up in its own bureaucracy to be able to directly compete with you.

5. Be Realistic. Be Realistic. Be Realistic. Mangers need to build a business plan with this in thought: “if I were an investor, why would I sign a $5 million check to fund this idea?” Every manager must continuously remember the fact that these people (angel investors as well as venture capital firms) have been ‘around the block’ and that they can sense shaky deals with a simple glance at any given business plan.

Angel Investing Across International Borders

Funding early stage companies through angel investments has been a widely used financing channel in the United States for many years. Not to be outdone, the rise in angel investing in both Europe and Asia since the start of this decade has certainly benefited many local new innovative firms. I see every day through my work at Icon Angels that there is still a tremendous amount of fear amongst individual investors moving their capital across borders. The thing is, I believe that there is real legitimacy for such fear as an individual investor only because there can be many unforeseen market risks such as unfamiliarity of the marketplace, inability of individual investors to conduct proper due diligence work, and the complexity of laws and regulations in different countries.

Seeking international funds from international investors can be a very different and an awakening experience for those who are not familiar with the industry. There are several key points all parties must follow such as:

- Both parties must be certain that they are making a deal with legitimate parties. In this age of political volatility, it is essential that everyone is dealing with the right person.

- All parties must make sure to complete a strict due diligence exercise before making decisions. A due diligence process need not be expensive and cumbersome that only massive corporate finance houses can deliver.

- It is always a benefit to any investors or company (whether on an international or local platform) to have their business plan and financials certified by an internationally recognized institution such a bank or a law office. It adds tremendous credibility and increases the comfort level of many investors.

- It is important for companies to be realistic in their forecasts. International investors tend to be more ‘reactionary’ and will dismiss a great business model if they feel that the management is too optimistic with growth figures.