privcapDigest/

the co-investment conundrumCan—and should —an LP take the leap?

The Monthly Magazineof Privcap.comApril 2013

in this issue:

Can you kill a PE firm?/ 04The 3-D printing revolution / 08 KKR’s power play / 18Carlyle’s next generation/ 20Loving a first-time fund/ 24

This publication is exclusively for Privcap subscribers © 2013 Privcap LLC

privcap Digest / April 2013 / 2

2 / Contents

privcap LLC

David SnowCo-founder and CEOGil TorrenCo-founder and President

Content

Matthew MaloneEditorial DirectorTanya KlichMedia Manager

Design

Miguel BuckemeyerArt DirectorVasheena DoughtyProduction

Contributors

Tom Stein & Tim DevaneyDanielle Fugazy

Contacts

EditorialDavid Snow / dsnow@privcap.com(646) 233.4558Matthew Malone / mmalone@privcap.com (646) 801.2337Sponsorships & SalesGill Torren / gtorren@privcap.com(646) 233.4559For subscriptions, please call 855-PRIVCAP or email subscribe@privcap.com

about privcap Digest

Privcap Digest is a monthly publication exclusively for Privcap subscribers. It offers in-depth features and edited summaries of the most recent and important thought-leadership from Privcap.com. The Privcap editorial team has extensive experi-ence reporting on the global alternative investment industry.

For inquiries about the Digest, please contact Matt Malone at mmalone@privcap.com.

Copyright © 2013 by Privcap LLC

All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechani-cal methods, without the prior written permission of the Privcap LLC. For permission requests, contact Gill Torren at gtorren@privcap.com.

QuotableA roundup of market intelligence shared on Privcap.com

Snow’s NotesThe case of Hicks, Muse shows that when it comes to private equity, it’s hard to pull the plug. By David Snow

NY’s Tech BoomEric Hippeau of Lerer Ventures on why all roads in tech don’t lead the Silicon Valley. By Danielle Fugazy

Small Firms, Thinking BigTerrence Mullen of Arsenal Capital Partners on why entreprenuers need private equity. By Danielle Fugazy

Deal Story: Makerbot James Robinson of RRE explains why your food may one day come from a “printer”

Must See Privcap’s upcoming programming schedule

FeaturesThe Co-investing ConundrumCo- and direct investing may be all the rage, but is it wise for an LP to dive into the deal game? By Matthew Malone

Igniting Growth and InnovationGrowth capital is a growth industry—our experts show how to get in on the action. By Tom Stein and Tim Devaney

Restoring powerKKR’s Marc Lipschultz on the “revolution” in U.S. energy investing

Carlyle’s Next GenerationA conversation with Glenn Youngkin, COO of The Carlyle Group

How to Love a First-Time FundAndrea Kramer of Hamilton Lane on vetting a fledgling fund

From Our SponsorsExpert Q&A Jeff Bunder of Ernst & Young Sandile Hlophe of Ernst & Young

in this issue

Interview transcripts in this issue have been edited for clarity and length.

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Up Front

privcap Digest / April 2013 / 3

professionals from the following firms and organizations recently appeared on privcap: Noson Lawen Partners • Adams Street Partners • StepStone Group • Cogent Partners • Cambridge Associates • Zurich Alter-native Asset Management • ILPA • MVision Private Equity Advisers • Pantheon Ventures • BlackRock Private Equity Partners The Carlyle Group • LLR Partners • Siguler Guff • Argosy Capital • Bertram Capital • Ernst & Young • CDC Group • Lincolnshire Management • SHM Corporate Navigators • Fir Tree Capital • Highland Capital Management • KKR • Sound Harbor Partners 

Quotable/

I think if someone’s on artificial life support, do you consider them

breathing on their own? I would say that the economy hasn’t proven that it can breathe on its own yet.”patrick Boyce, Highland Capital Management, from “Distressed Investing for All Seasons” )Link

The mega deals come much more prepackaged from the larger

sponsors... In the middle market or the growth equity stage, many of these deals require a bit more legwork on the co-investment partner’s behalf. So they really need to do a lot more diligence themselves.”Nitin Gupta, Caspian Private Equity, from “Co-investment Done Right” )Link

I think that one of the things people have to realize in private

equity is sometimes, it’s better to be a follower than a leader.”T.J. Maloney, Lincolnshire Management, from “Investing in Manufacturing Companies” )Link

The mega-funds had very large deals and they extended a lot of

these deals at a cost. And it hurts the returns. They’ve been holding them a long time.”Michael Elio, ILPA, from “How are the 2006 LBO Funds Looking Now?” )Link

Entrepreneurs need a lot of help. And I say that with all due respect

to entrepreneurs, but the world’s in-credibly challenging.”Terrence Mullen, Arsenal Capital Partners, from “Why Smaller Businesses Need Private Equity” )Link

Rather than placing a lot of bets, we’ll focus in on a few opportuni-

ties—usually in the same industries that we’re looking at when we’re doing more buyouts—and do a rifle shot to take control of these through buying up the debt.”Marc Utay, Clarion Capital Partners, from “Making It in the Middle Market” )Link

A roundup of market intelligence shared on Privcap.com

3 / Market Intelligence

On Camera

privcap Digest / April 2013 / 4

f you want to see what the coming pri-vate equity market “shakeout” is going to look like, look no further than the firm formerly known as Hicks, Muse, Tate & Furst.

It’s been “shaking out” of the market since 2001.

In 2000, Hicks, Muse was one of the largest private equity firms in the world, rivaling KKR, Warburg Pincus and Forstmann Little. The firm had some $10 billion under management, and operations in Dallas, New York, London and Buenos Aires. But a series of PIPE investments in telecom wiped out nearly $1 billion in investor capital and began a slow migration of LP dollars and human capital away from the firm.

The Hicks, Muse saga occurred to me as I read the umpteenth article about how this industry is “bracing” for some sort of GP apocalypse, in which hundreds of firms will vanish from the earth. But as I’ve pointed out before, it’s very hard to kill a private equity firm. The term “zombie” is used in our market for good reason—private equity firms can have a hole blasted through the head, but on-ward they stagger, murmuring “brains, brains” (or “fees, fees.”)

As Hicks, Muse demonstrates, private equity firms have the unique ability to function for years after a catastrophic event. It’s a luxury not enjoyed

by those toiling in more liquid asset classes (hello, LTCM, Amaranth, et al). And even though the mar-ket has now, 12 years later, finally “shaken out” most of the old Hicks, Muse, several of its former employ-ees have launched new funds—thereby adding to the population of private equity firms in the world.

What allows these wounded firms to stagger on? Illiquidity, long-term capital lock-ups, and fees. A portfolio of interests in private companies can’t be unwound overnight. It’s also a GP’s duty to shepherd an investment to its best possible exit, even when that exit might be years hence.

Saying goodbye The exodus of talent from HMFT, now called HM Capital, was slow but steady. Charles Tate left in 2002 and now managers an IP-focused invest-ment firm called Capital Royalty. The most dra-matic change came two years later: the firm’s charismatic and best-known founding partner, Thomas Hicks, resigned to pursue family office investments under the name Hicks Holdings.

In 2005, the entire European arm of Hicks Muse, led by Lyndon Lea, spun out to create Lion Capital, now a major GP in its own right. Jack Furst left in 2008 and now runs Oak Stream Investors.

The remaining founding partner, John Muse, is winding down HM Capital and has become non-executive chairman of a successor firm called Kainos Capital Partners, which picks up on one of Hicks, Muse’s core specialties: food. That narrow focus and expertise has proven attractive to at least one big, sophisticated investor—recently Kainos announced a partnership with the CPP Investment Board. The Canadian pension arm acquired $468 million in food assets from HM Capital and will commit $138 million to a new Kainos fund.

Energy was another Hicks, Muse specialty, and spawned yet another firm, Tailwater Capital, led by former HM Capital partners Jason Downie and Edward Herring.

Market analysis by Privcap CEO David Snow

As Hicks, Muse demonstrates, private equity firms have the unique ability to function for years after a catastrophic event. It’s a luxury not enjoyed by those toiling in more liquid asset classes.

. CONTINUES ON NEXT PAGE

4 / Commentary

Snow’s Notes

Hicks, Muse’s Long, Last BreathThe Dallas firm shows that when it comes to private equity, it’s hard to pull the plug

privcap Digest / April 2013 / 5

It’s hard to account for how much capital these separate entities control, but if Kainos and Tail-water are successful at raising new funds, the HM offshoots will likely oversee as much capital as the original firm controlled at its peak in 2000.

Believing in reincarnation What does this gradual unraveling tell us about the likely shakeout in the private equity market? Certainly, firms that have underperformed will not raise new funds. Even firms that performed relatively well will find it hard to raise new funds, or at least funds anywhere near the size of those that came before. But their fade from the market will be just that—a fade. More impor-tantly, the people from these organizations will find new opportunities. Make no mistake: Show me one private equity firm in wind-down mode and I’ll show you three new ones looking for cap-ital, staffed by credible direct-investment pros who are trying to show that the sector-specific deals they did at their prior firm were solid, even if the firm’s overall track record wasn’t.

5 / Commentary

So next time someone sends you a “shakeout” article, send back the most recent article about the new lives of HM Capital people. Or direct their attention to Forstmann Little, which labors on despite the fact that its founder, Ted Forstmann, passed away in 2011, having years earlier decided to wind down his firm. The firm’s remaining assets, including the talent agency IMC, are being liquidated by law firm Akin Gump—which, by the way, doesn’t work for free. ■

L Follow David Snow on Twitter @SnowsNotes

privcap Digest / April 2013 / 6

6 / Takeaway

By Danielle Fugazy

Eric Hippeau of Lerer Ventures on why VC is no longer just about Silicon Valley

n early 2011, AOL acquired news site The Huffington Post for $315 million. Among the beneficiaries: Lerer Ventures, a venture firm that invested in the company eight years ago. It’s one of many success stories for the

New York–based VC, which specializes in investing in seed-stage technology companies that haven’t completed a formal round of financing. The strategy, while risky, exposes the firm to significant upside.

Specifically, Lerer invests in Internet technology, web-based applications and services, mobile, social, and consumer products, e-commerce, publishing technology, and ad technology. “All of that happens to be what New York specializes in as well,” says Eric Hippeau, a managing director with Lerer. “The New York technology world is booming at the moment, and this time around it’s here to stay. There’s a whole infrastructure now that’s in place to support entre-preneurial businesses and technology-based busi-nesses in New York.”

Given Lerer Ventures’ investment strategy, it’s not surprising that the firm has invested in transforma-tive technology players such as Warby Parker, Birch-box, and MakerBot.

New York’s tech BoomClick to watch this video at privcap.com

Eyewear company Warby Parker has raised $13.7 million to date. Lerer was one of the compa-ny’s first investors in 2011; the firm later contrib-uted to the company’s Series A round.

“Warby Parker is a good example of our e-commerce investing,” says Hippeau. “It’s a company that is in the business of disrupting the eyeglass market. The company allows you to buy prescription eyeglasses online that you choose through a variety of models, all of which are very stylish. That pair will then become your main eye-glasses—and all of that is done for less than $100.”

Lerer was also an early investor in MakerBot In-dustries (see related “Deal Story,” page 8. Founded in 2009, MakerBot manufacturers 3-D printers that can create prototypes of various shapes and objects. The New York–based company has completed three rounds of financing and has raised approximately $11 million in funding for VCs.

“We are at the beginning of this revolution where you’ll be able to create products very easily in 3-D on your computer,” says Hippeau, “and then you’ll have kind of a ready-made assembly line that will start making them. You can personalize them, and you can make quantities that are more affordable. We’re not quite there yet, but you can see the very begin-ning. This is what’s known as the ‘maker’ revolution, where people in America are starting to make things again. And that’s a great thing.” ■

“ The New York technology world is booming at the moment, and this time around it’s here to stay.”

privcap Digest / April 2013 / 7

7 / Takeaway

By Danielle Fugazy

Terrence Mullen of Arsenal Capital on why entreprenuers “need” private equity

s growth opportunities for smaller companies become increasingly limited, small-business owners can benefit from the help of private equity firms now more than ever.

It’s that idea that keeps Terrence Mullen, a partner with Arsenal Capital Partners, busy these days.

“With all due respect to entrepreneurs, the world’s incredibly challenging. In a more benign growth environment, say in the 1990s or the last decade, growth was reasonable, if not abundant. Today, growth is not abundant, and there are significant structural and fundamental problems with the U.S. economy,” says Mullen.

The fact is that, unlike North America, some parts of the world are seeing double-digit growth. So Mul-len sees access to global economies as a key challenge for smaller entrepreneurs and a critical component of growth.

Arsenal will typically bring in experienced man-agement to help a portfolio company become global or, when it makes sense, will help outsource different

small Firms, thinking BigClick to watch this video at privcap.com

components of a business. “They enable small com-panies to act with global sophistication,” says Mul-len. “Many people in our firm have worked for Global 500 companies and have run businesses around the world. So the arbitrages that we can bring to these small businesses create a lot of value for them.”

Global expansion has always been an important strategy for the New York–based private equity firm. In fact, by the time Arsenal sold its 10 portfolio com-panies out of its first fund, six of them had opera-tions set up in China. Going forward, the firm will continue to implement this strategy for its Fund III, which has raised $325 million thus far and is target-ing $750 million, according to reports.

“To help small companies grow and compete globally is a major advantage for Arsenal versus most of our lower midmarket peers, who just don’t have the global reach or sophistication,” says Mullen.

In addition to growing companies, Arsenal has been taking advantage of the exit opportunities as well, because strategics have been interested in paying up. In 2012, Arsenal was able to sell portfo-lio company Novolyte Technologies to BASF, which turned BASF into a global supplier of lithium-battery electrolyte technology. Novolyte is based in Cleveland and operates in the U.S. and China. BASF is based in Germany.

“When you build high-quality businesses, corpo-rates are interested,” says Mullen. “They are looking for high growth, high quality, but they are very dis-criminating on the standards.” ■

“ With all due respect to entrepreneurs, the world’s incredibly challenging. Today, growth is not abundant, and there are significant structural and fundamental problems with the U.S. economy.”

About ArsenalFounded 2000Assets under management: $1.1 billionArsenal Capital Partners: $300 million closed in 2003Arsenal Capital Partners II: $500 million closed in 2006Arsenal Capital Partners III: $325 million thus far, not closed

8 / Deal Story

privcap Digest / March 2013 / 8

rre ventures ⬌ MakerBot

As told by James Robinson, co-founder and managing partner, RRE Ventures

James Robinson of RRE Ventures recently told Privcap that while MakerBot’s desktop 3-D printer may revolutionize manufacturing, its most interesting application may be in your own home. The kitchen, to be exact. In 10 years, he predicts, a 3-D printer will become a standard household appliance, crank-ing out food from pre-packaged “recipes.” “You will literally be able to say, ‘Okay, tonight I’m going to print cookies’ or ‘burritos.’” As for the present, he says MakerBot is enjoying multi-hundred-percent year-over-year growth. Hear the whole story at )Link.

The StoryThere are over 15,000 Maker-Bot Desktop

Printers in use by engineers,

designers, researchers,

and individuals interested in

design and creation.

The DetailsThe companyMakerBot’s desktop 3-D printers allow users to translate a design into a plastic 3-D model

Started by Bre Pettis, Adam Mayer, and Zach “Hoeken” Smith

Other investorsThe Foundry Group, Bezos Expeditions, True Ventures, and Sam Lessin

Market share growthIn 2009: 16% of all 3-D industrial and personal printers In 2011: 21.6%

Click to watch this video at privcap.com

“ When I think about a world in 2020, I imagine 3-D printers becoming ubiquitous.” –James Robinson

16% → 21.6%

privcap Digest / April 2013 / 9

Must see /Upcoming programs on Privcap.com

9 / Calendar

Upcoming programs on Privcap.com

calendar April 1, 2013

Driving Growth in Manufacturing The resurgence of private equity opportunities in U.S. manufacturing sector

The View from Venture A conversation with Kate Mitchell of Scale Venture Partners

Unions and private Equity: A Changing Relationship? Brian Bernasek of the Carlyle Group on making solid “labor partners”

April 8, 2013

Set Up for Success: The 100-Day plan An expert panel discussion on this critical step in value creation. With executives from Baird Capital, Ridgemont Equity Partners, and Ernst & Young

Reaching and Remaining Top-Quartile A multi-segment interview with Andrea Kramer of Hamilton Lane

April 15, 2013

Deal Story: First Data Scott Nuttall of KKR discusses the mammoth transaction-processing deal

private Equity in Colombia Macro-trends within the country are creating a strong climate for dealmaking

Start-up Activity in Russia Axel Tillmann of RVC-USA discusses VC partnerships between Russia and the U.S.

April 22, 2013

Capturing Growth in Emerging Markets A conversation with David Wilton, CIO of Private Equity at International Finance Corporation, on two of the BRIC powerhouses

privcap en Español A Spanish-language overview of private equity. With Cate Ambrose of LAVCA and Maximiliano del Vento of Partners Group.

April 29, 2013

Deal Story: Dunkin’ Brands Scott Sperling of Thomas H. Lee Partners outlines the firm’s big bet on the coffee and ice cream franchiser

ESG Case Studies and Cautionary Tales Private equity veterans share cautionary tales on how a lack of environmental, social, and governance programs has put value at risk

privcap Digest / April 2013 / 10

10 / Commentary

the co-investment conundrum

Click to watch this video at privcap.com

By Matt Malone

Can–and should–LPs get into the direct-investment game? Julia Child, meet David Bonderman.

Perhaps it was inevitable that the “do-it-yourself” craze that pervades so much of consumer culture found its way to private equity. Humans are, geneti-cally speaking, an overconfident lot.

Take the growing enthusiasm among limited partners for direct and co-investment. Solo investing, it seems, is to the LPs what the chocolate lava cake is to those who watch a flour-dusted chef on The Food Network. It’s an imperfect analogy, of course, but one

can’t help but observe the trend and wonder whether LPs are setting themselves up for a sticky mess.

A few LPs have taken steps to become such GP/LP hybrids and, the data suggests, many more hope to do so. A recent Prequin report said that of the LPs it tracks in its database, 730, or more than half, are ac-tively seeking co-investments (43%) or are exploring the idea (11%).

Yet the GP/LP model was born from the theory that specialization works—LPs focused on vetting fund managers, while the GPs focused on making smart direct investments. Given the industry’s long-term track record of outperforming the public mar-kets, it’s hard to argue that the arrangement is fun-damentally flawed.

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“ You need to have a very direct effort to make direct investments.”–Nitin Gupta

canada envyDrew Guff, co-founder of investment advisor Siguler Guff and its direct investment program, argues that direct investment is more difficult than most LPs realize

Many LPs have “Canada envy” —that is, a desire to emulate the direct-in-vestment prowess of the handful of big Canadian institutions bypass most GP relationships and pursue private equity and infrastructure investments with internal investments staff.

Most of these LPs will never “be Canadian,” so to speak, because their own institutional mandates and corporate governance structures will prevent them from fully taking on the financial, compliance and adminis-trative burdens of managing direct-investment programs, says Drew Guff, Co-founder of investment advisor Siguler Guff and head of that firm’s direct investment program.

In a recent, wide-ranging interview with Privcap, Guff gave candid de-tails about the complexities and expenses of LP direct investing, excerpted here:

privcap Digest / April 2013 / 11

11 / Commentary

One major problem is that direct investing of any scale and consistent success requires a dedicat-ed staff–deal pros, analysts, legal teams—that can respond quickly (and competently) to opportunities.

“You need to have a very direct effort to make direct investments,” Nitin Gupta, a partner with Caspian Private Equity, told Privcap in a recent interview. “Secondly, I would say it’s that you need to be able to respond quickly to the GPs when they bring a co-investment opportunity to you. You need to be able to analyze it pretty rapidly and you need to be able to have a viewpoint on it and be able to go back with them and say, this may or may not work.”

Despite widespread interest in direct investing, anecdotal evidence suggests that many LPs are not, in fact, dedicating full-time resources to the effort.

One high-level private equity recruiter recently told Privcap that for all the talk of co-investment, there’s been very little in the way of hiring of di-rect-investment deal pros by limited partners. In-stead, LPs with an appetite to go direct have mar-shaled their existing resources, putting the burden on the same overworked staff who have a hard enough time managing the GP relationships they have in traditional private equity arrangements.

So this isn’t to say that some LP managers overseeing private equity investments aren’t ca-pable of making wise direct/co-investment deci-sions. It’s simply that many are already stretched in. Talk to most managers of private pension funds and they likely won’t boast of their budgets and free time.

The exception, of course, is the big-time pen-sions and endowments whose sheer size and capital allocations warrant and allow for dedicated direct programs. The Ontario Teachers’ Pension Plan, the China Investment Corp., the University of Michigan, and others, have made solo investing an integral part of their missions.

“ We’ve seen so many cases where there’s simply adverse selection, where a GP can’t get a deal fully funded, so he takes it out for co-investment” –Drew Guff

canada envy

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Drew Guff, Siguler Guff: LPs always want to have direct investing. Their preferences are to do direct investing together with their GPs and do it on a no-fee, no-carry basis. For a lot of LPs, that’s the Holy Grail—who wouldn’t want that? But the direct

investing world for LPs is fraught with risk. We’ve seen so many cases where there’s simply adverse selection, where a GP can’t get a deal fully funded, so he takes it out for co-investment.

Unless there are a certain amount of incentives for GPs to be doing co-investing with their LPs, you’re not going to get the best deals coming to the LP. And for LPs themselves it’s very hard for them to staff for direct investing. Most of those organiza-tions are not staffed by people who have a back-ground in direct investing. They don’t understand

the issues of due diligence and they haven’t spent their careers investing directly and taking those risks. So it is a foreign practice for them. They, most of the time, need a very good Sherpa to guide them.

The entities that have probably done direct-investing most successfully are the big Canadian pension plans, because they have structured them-selves be large direct investment pools, and they’ve staffed with people with backgrounds to do that. Their governance and management systems are geared towards that. Other sovereign wealth funds are on what I would say is the much farther end of the spectrum, where government employees can’t be compensated in a manner that would essentially attract the best people who are used to taking direct investment risk. And that risk is not only just a financial risk, but a professional risk. So we’ve seen a lot of other pools of money that would like to be doing direct investing but haven’t yet staffed up for that. They’ve taken a hybrid model where they’ve backed GPs with a lot more money and would like to see co-investment coming from them.

Snow: Well, then, how have you structured your

“ You’re not just taking a risk of, have you done the homework of research on a number of managers? When you’re doing direct investing, you are really taking on direct risk—the operations of the company, its potential success or bankruptcy. And those risks are far, far greater.

privcap Digest / April 2013 / 12

canada envy

12 / Commentary

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firm to provide an avenue to co-invest and direct-invest in a way that makes financial sense for the LP community?

Why would a Gp need or want Lp direct-invest-ment capital?

Guff: There are a lot of reasons. When they do have enough money and they can fund it themselves, they certainly will, but there are opportunities that get to be larger. A lot of funds have restrictions on what percentage of the fund can be put into a cer-tain deal —whether it’s 10 or 15 percent. So they will go outside.

The other is, can you bring something more than just money to the GP? We can offer something more, whether it’s our Rolodexes or whether it’s connectivity to other CEOs, whether we can help them recruit people from the industry or whether

there’s just cross-fertilization with other things that we’re doing as a firm.

Let’s say that there’s an Lp that is thinking about building an in-house direct investment team. Can you walk us through the costs and complica-tions involved?

Guff: Well, it is very expensive, and that’s why very few institutions have done it successfully. First of all, you need people. You need people who have been doing direct investing, and that means they’re already fairly highly compensated. So the comp structure will change immensely. The sec-ond is, it’s more and more important to have very tight systems for compliance, for legal, account-ing, due diligence, and the oversight and manage-ment of the people who are taking the risks of doing direct investing.

Picking a manager is one set of skills. Doing a

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PE Allocation

Make-up of LPs with an Appetite for Co-Investments by LP Type

Make-up of LPs with an Appetite for Co-Investments by Size of

Private Equity Allocation

Source: Prequin

privcap Digest / April 2013 / 13

13 / Commentary

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A reduction of fees paid to general partners is generally cited as the motivation for direct/co-in-vesting, but the big-time funds have seen gains be-yond saving fees. A recent study completed by Josh Lerner of Harvard Business School and other re-searchers found that fees are only part of the equa-tion. Itd found that direct LP investments by large funds outperformed traditional PE investment ar-rangement by 13-19% IRRs, an outperformance the researchers also attributed to the fact that those in-vestments tended to be “local” to the LP. In others words, they had superior knowledge of the invest-ments because in many cases they were located in

the LPs’ backyards.It’s important to note that Lerner’s study speaks

to true “direct” investing—when the LP makes the full investment in a portfolio company. In October, for instance, the OTTP made a C$150 million direct equity investment in natural gas producer Canbriam Energy Inc., joining a group of existing private equity investors. An LP that sources and fully underwrites direct investments is acting as its own independent GP.

Co-investing–in which LPs typically provide small slugs of equity to deals that have been sourced, un-derwritten and largely financed by others–is, in a

canada envydirect investment is an entirely different set of skills and involves more risk. You’re not just taking a risk of, have you done the homework of research on a number of managers? When you’re doing direct investing, you are really taking on direct risk—the operations of the company, its potential success or bankruptcy. And those risks are far, far greater. They not only create potential losses for the organization, but they create headline risk. A lot of institutions don’t have the ability to stomach that.

So in terms of costs, you’ve got your people. Their comp would increase by two to five times what you would compensate a funds-only team. And then you also have incentives. Once you’ve hired those people, how do you get them to stay and keep them for the long term? Because if you are a pension fund that’s going to build that in-house function, your time frame is infinite. Ideally, you don’t want someone who can vest at all just by being there a few years or just by putting a deal in-house. They’ve got to be tied to the success of the deal and for the success of the stakeholder, the pensioner.

So, you know, whether it’s a retired teacher or a retired fireman, if I were hiring and setting up a function like that, I would want my people to not be able to share in those incentives until the retired policeman, fireman, or teachers have seen their retirement savings grow by the success of that deal.

So it’s a little bit different model than what you get at the big buyout firms. They tend to have, you know, vesting periods over which people can vest. But in general the industry is pushing those out longer. And for a pension fund, if they were build-

ing it in-house, I would think they would need to orient their incentives for an even longer term.

What kinds of institutions have you seen around the world that have shown the keenest interest in establishing the big in-house Gp teams?

Guff: Without a doubt, the Canadian pension plans have done it—have built this model most success-fully.

Who’s got Canada envy?

Guff: Oh, everybody has Canada envy! Some of those you’ll see them partnering strategically with big GPs, and that’s probably a great idea, because to be able to revamp the entire management of the pension fund, to have a direct investment capabili-ty, is probably too hard to do versus a kind of hybrid or partnered model. Other sovereign wealth funds would all like to do what the Canadian plans have done, but very few have the governance standards and systems that allow them to do it, and very few have the timing ability to be able to turn some-thing around very quickly.

Many of the sovereign wealth funds come from the emerging markets. There are these big pools of capital that have been built up in China and the Middle East. And when done well, they have very good risk controls internally, and most are coming up to standard. They meet together, and they’ve really brought their governance standards up to a much, much higher level, which is terrific to see. But within that, it makes it hard for some of them to have rapid response times to co-investment

“It’s always a conflict. Those things happen

all the time, and we’ve seen several funds

that have gone through that

cycle. They built in-house direct

teams, and then a conflict arose

and they just couldn’t really

stomach it anymore.” —Drew Guff

privcap Digest / April 2013 / 14

14 / Commentary

canada envy

opportunities that come up. And here’s where the Canadian plans can act more quickly some-times from some of the other sovereign wealth funds. But again, the sovereign wealth funds are creating partnerships and almost JVs with their GPs, where they’re more concentrated in certain GPs and expect to have some opportunity to do co-investment and direct investing on a much cheaper basis.

Isn’t another risk that a very senior person at the

sovereign wealth fund or similar institution tells his investment staff, “Hey, it’s great that we’ve got this direct investment function. I’ve got a buddy who’s starting a company, and I’d like you to meet with him.”

Guff: It’s always a conflict. Those things happen all the time, and we’ve seen several funds that have gone through that cycle. They built in-house direct teams, and then a conflict arose and they just couldn’t really stomach it anymore. So they had to shut down the effort. One or two bank-ruptcies or deals that didn’t work out, even if the entire portfolio did well. Having to stand up in front of television cameras and talk about a failed deal in your state or in your city is sometimes just too hard to do. So that’s the issue of headline risk, where so many of the public-relations pitfalls make it impossible for public pension plans to have a direct function. ■

sense, direct investing “lite,” and is not without ad-ditional risks. The most obvious is the oft-cited “lem-ons” problem: if a deal is so great, why would a GP of-fer the LP a piece instead of investing on its own?

“We’ve seen so many cases where there’s simply adverse selection, where a GP can’t get a deal fully funded, so he takes it out for co-investment,” said Drew Guff, co-founder of Siguler Guff, in a recent interview. “And limited partners have to be very wary of that.”

Some GPs would argue that co-investment opportunities are driven by the need for more equi-

ty in great deals, not because they want to decrease their fund’s exposure to bum deals.

Ultimately, it’s difficult to tease out the motiva-tions, a scenario that always favors a more conserva-tive approach.

So what’s a returns-hungry LP to do? When it comes to investing on its own, tread lightly. For many, a more prudent approach is to push for lower fees and spend time analyzing and building relation-ships with a smaller set of competent managers.

Better that than spend a pile of money on a plan that may come out, well, half-baked. ■

“ Oh, everybody has Canada envy! Some of those you’ll see them partnering strategically with big GPs, and that’s probably a great idea, because to be able to revamp the entire management of the pension fund, to have a direct investment capability, is probably too hard to do versus a kind of hybrid or partnered model.

privcap Digest / April 2013 / 15

igniting growth & innovationGrowth capital is a growth industry. Both venture outfits and private equity firms are now scouring the landscape for growth-stage businesses in hopes of a more predictable—and outsized—returned. Many PE funds have gained experience with growth capital in emerg-ing markets in recent years and, having watched the model succeed abroad, are applying it in the U.S. market. The increased demand for the growth-company profile makes it harder to source and execute good deals. We spoke with three leading PE professionals—Jeff Bunder of Ernst & Young, Chris Masto of FFL, and Deepak Sindwani of Bain Capital Ventures—to understand those challenges and how to profitably overcome them.

Key Findings

Finding 1

Growth companies have growing pains—and need help to manage them

A company that reaches the growth stage requires a lot of help in addition to capital. New talent is at the top of the list, because the people who are skilled at growing a company to the next level are often different from the people who are good at launching one.

“You need the founder up front to drive the ini-tial vision, the spark, the creativity to work those hours and evangelize,” Sindwani says. “But at some point—when a company transitions to a phase where it’s about ‘I’ve figured out what my business model is; how do I scale it?’—that has its

own set of challenges. Growth companies need to really be focused on ‘Do I have the right team on the field? Do I have the right athletes in each position?’”

Masto points out that founders who are wrapped up in the work of building successful companies usually don’t have time to gaze down the road. “As companies are going through rapid growth and dealing with all the immediate chal-lenges of running their business and focusing on making this quarter or making this year, there’s often not a process of stepping back and recheck-ing the long-term plan.”

Where should the company be in five years, and how will it get there? That kind of strategic planning is really where young companies can use some help—and where an outside perspective is incredibly valuable, Masto adds.

15 / Deep Dive

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Click to watch this video at privcap.com

➊ Growth companies have growing pains—and need help to manage them ➋ Suddenly every private equity firm likes the growth-capital space ➌ Alignment between capital provider and entrepreneur is key to a happy marriage ➍ Founder transitions can be difficult but critical ➎ Sometimes founder frugality is an impediment to growth

privcap Digest / April 2013 / 16

The first step toward success is figuring out if the founder truly wants to tie the knot in the first place. “Entrepreneurs who have been successful building a business and have been used to doing things in certain ways aren’t always really inter-ested in changing that arrangement and bringing in someone for a real partnership,” Masto says.

Founders who are serious about a partnership often call professionals like Bunder for advice. He helps them size up funds and their approach to growth capital. They walk through individual deals a firm has done and talk through the firm’s method of partnering with entrepreneurs.

“And importantly, there’s an element of sec-tor that plays a key role—actually, subsector,” says Bunder. “It’s what the firm can bring to an entre-preneur in terms of strategic growth vision from a subsector standpoint, because there are skills and expertise that reside in funds. But it’s differ-ent across the fund landscape.”

For their part, GPs need to understand an entrepreneur’s goals for the growth capital he’s seeking and make sure those plans and the firm’s plans are parallel. “Are both sides coming to the table expecting the same things?” Sindwani says. “That’s where the best marriages happen. Obvi-ously things go wrong in the middle. Do the peo-ple I’m working with have the steadfastness and the character to deal with the issues that come up, as they do in every business, and are they aligned in terms of what we are seeking to do?”

Finding 4

Founder transitions can be difficult but critical

One of the toughest transitions for entrepreneurs who take growth capital is reevaluating their role within their company. “It’s emotional,” Bunder says. “You may see a little schizophrenic behavior on the part of the entrepreneur. They want to bring their business to the next level, create a legacy, but at the end of the day they want to

16 / Deep Dive

Finding 2

Suddenly every private equity firm likes the growth-capital space

Different investors have different ideas of what a growth-stage company is. Sindwani says his firm looks for businesses with proof of concept and po-tential. “Is the company operating on its own, do-ing its thing organically, where if we added more fuel to the fire we could do it faster?”

Masto notes that a company’s market sector often determines its growth capacity. “We try to spend our time in markets that we think have strong growth characteristics to set the funda-mental tailwinds for a company to grow.”

Though investors define growth companies dif-ferently, many agree that the growth-capital space is a good place to be. “There’s been a movement around venture and growth capital,” Bunder says, “and you’ve got a number of players now, both from venture and private equity, looking for busi-nesses. Private equity is starting more and more to dip down into this growth-capital market.”

Many private equity funds have gained experi-ence with growth capital in emerging markets in recent years. “The model has been proven over-seas, and firms are more comfortable investing in the growth-capital space,” Bunder adds. “Un-fortunately, it means a lot more competition for businesses these days.”

Finding 3

Alignment between capital provider and entrepreneur is key to a happy marriage

A deal between a private equity firm and a growth-stage company is like a marriage. Firms that choose the right partner will enjoy a happy future. Deals done in haste will likely end in an unpleasant divorce.

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“ Entrepreneurs who have been successful building a business and have been used to doing things in certain ways aren’t always really interested in changing that arrangement and bringing in someone for a real partnership.”–Chris Masto

privcap Digest / April 2013 / 17

keep their business small —that family feel. And there seems to be that constant internal debate in an entrepreneur as to how to go forward. In many ways it’s learning to give up roles and re-sponsibilities.”

The shift is easier for founders if it’s gradu-al and if they have input when outside talent is brought aboard, Masto says. “When making those additions, be very careful to find the right cultural fit, people that can work well with that entrepreneur and bring the skills and experi-ences from the outside but integrate well into the culture so that there’s not a shock to the sys-tem. The process of managing the pacing of that change and finding the right cultural fit from outsiders is very tricky.”

Finding 5

Sometimes founder frugality is an impediment to growth

Sometimes GPs partner with entrepreneurs who spend too much money. But sometimes they have the opposite problem: founders who have careful-ly built their companies to stability and sweat bul-

17 / Deep Dive

“ You’ve got a number of players now, both from venture and private equity, looking for businesses. Private equity is starting more and more to dip down into this growth-capital market. Unfortunately, it means a lot more competition for businesses these days.”–Jeff Bunder

lets when it’s time to write checks and accelerate growth.

This is most often an issue with bootstrapped businesses, Sindwani observes. “If the person hasn’t raised outside money or has invested their own money or built up balances on their own credit card, they’ve got a certain feeling about what they’ve put into this and how much they’re willing to spend and how fast they want to drive.”

In the end, he says, it comes back to alignment. “It’s all about maximizing the enterprise value of the business over a certain time frame, and it’s really case by case. For some folks, I don’t think capital is right. Because if they can get there without the capital, or if there’s a misalignment of the right speed at which to go, then it’s going to be more of a mess to have two misaligned folks at the table.”■

Participating in the Privcap thought-leadership series “Growth Capital” are Chris Masto of FFL, Jeff Bunder of Ernst & Young, Deepak Sindwani of Bain Capital Ventures, and David Snow of Privcap

privcap Digest / April 2013 / 18

18 / Sector Focus

the energy ‘revolution’

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Domestic energy production is booming, with natu-ral gas discoveries driving a rush of capital to build out the industry extraction and distribution capabili-ties. Among the savviest and most sophisticated en-ergy investors is Marc Lipschultz, head of the energy investing group at KKR. In this interview, Lipschultz surveys the domestic energy market and describes why it qualifies as a bona fide “revolution.”

privcap: What is KKR’s view on natural gas as an investment?

Marc Lipschultz, KKR: We’re highly interested in natural gas. The revolution has been spurred by the advent of shale resources, which really can’t be un-derstated. It is completely transforming that nature of the energy industry, certainly in North America, but really globally.

Upstream, midstream and downstream—why KKR thinks the U.S. energy play is here to stay

Bio

Marc Lipschultz (New York) joined KKR in 1995 and is the Global Head of KKR’s Energy and Infrastructure business. Mr. Lipschultz currently serves as a member of KKR’s Infrastructure Investment Committee and the Oil & Gas Investment Committee. He has played a leading role in many investments, including DPL, Inter-national Transmission Company, Texas Genco, Energy Future Holdings, East Resources, Hilcorp Resources, El Paso Midstream, and Colonial Pipeline. Mr. Lipschultz is on the board of directors of Energy Future Holdings. Prior to joining KKR, he was with Goldman, Sachs & Co., where he was involved in a broad array of mergers and acquisitions as well as the firm’s principal invest-ment activities. He received an A.B. with honors and distinction, Phi Beta Kappa, from Stanford University and an M.B.A. with high distinction, Baker Scholar, from Harvard Business School. Mr. Lipschultz is actively involved in a variety of nonprofit organizations, serving as a trustee or board member of the American Enter-prise Institute for Public Policy Research, Bard College, the Center for Curatorial Studies, the Michael J. Fox Foundation, Mount Sinai Medical Center, and the 92nd Street Y.

Click to watch this video at privcap.com

We’re going from a world where North America was an importer, to North America being a natural gas exporter and able to redevelop an industrial base on the basis of a newfound level of energy independence. So with all of that change, there is tremendous opportunity. Obviously it takes a lot of capabilities to be able to invest behind that change because there are a lot of unknowns, but it is a nearly unprecedented opportunity.

What opportunities do you find most interest-ing?

Lipschultz: First off, I would say that investing in a lot of different parts of the energy complex is a wise strategy. Within any given segment there will be interesting places and times to participate, and there will be other times when you’re better off not to be involved, like when a particular subsector gets overheated. We’re trying to find ways to marry our capital, operating capabilities, and technical capabilities with partner companies that have a real opportunity and need someone to help take the opportunity into a new business, and ultimately a profitable investment.

For us there’s no single sector or subsector. With that being said, we do think that within the energy complex, the upstream sector is really interesting, and a lot of capital is required.

Marc Lipschultz

privcap Digest / April 2013 / 19

19 / Sector Focus

From an investing standpoint, where are we in the natural gas “revolution”?

Lipschultz: The word revolution gets used quite a bit, and you could argue that perhaps the term is overused, but I actually don’t think it’s exag-gerated. The changes are revolutionary. In terms of where we are, it’s hard to say. We’re not in the earliest innings. The early innings were really the founding and early development of critical fields like the Marcellus Shale and the Eagle Ford Shale and the Bakken. We’re not in the earliest innings, but we’re not midway through the game yet. Now we have to figure out what works well, what are the right operating techniques, what kind of infrastructure do we need to actually get the product out of the fields to the places they’re go-ing to be used? We’ve got to ultimately develop all the downstream capabilities to use this newfound bounty.

When we look out 10 years, the opportunity to continue to be a partner to this sector is crystal clear, but the opportunities will come in different ways and in different places. We’re past some of those really big early discoveries, but now there’s lots left to do as we develop the industry.

Many investors are focused on natural gas, but are there still good opportunities in other parts of the energy world, such as power?

Lipschultz: There are definitely opportunities in other areas. The amount of opportunity available in upstream oil and gas is substantial. With the right capabilities, we think you can create some-thing quite compelling, depending on how you

construct your investment and whom you work with, and that doesn’t exclude the opportunity for investment in other parts of the energy value chain. So, for example, there’s a lot to be done in developing the pipelines, transportation, and processing that goes along with all these new upstream developments. Renewable resources remain an area of interest, and obviously that depends more on government policy and power-purchase agreements than it does on things like the trading price of gas. Upstream certainly does present a very large target, and one which we and many others are putting quite a few resources into, but it’s not the only area.

Given the flood of talk concerning energy today, what important points may be getting lost?

Lipschultz: Not all unconventional resources are created equal. Not all have equal access to markets because of the constraints on infrastructure, so what we’re going to see and already are seeing is a much greater dispersion of winners and losers. And we are at a stage where operational excel-lence is going to count more and picking your as-set positions will count more. Diversification will count, too. Energy private equity has gotten a lot more crowded; if something is relatively easy to digest, comes with its own team and a relatively easy-to-understand controlled-development posi-tion, there’s an awful lot of buyers for that. That area feels relatively crowded to us, compared to going to the asset level and working really closely with the company to develop a position of mutual interest.■

“ The word revolution gets used quite a bit, and you could argue that perhaps the term is overused, but I actually don’t think it’s exaggerated. The changes are revolutionary. ”

privcap Digest / April 2013 / 20

20 / Keynote

Carlyle captures volumes of information from its portfolio companies. What does that data tell you about the state of the world today?

Glenn Youngkin: Let me walk you around the world and tell you what we’re seeing. The United States really had a slowdown in the fourth quar-ter—surprisingly slow. Our sense is it was caused by all the factors going on in the fourth quarter, from the fiscal cliff negotiations to the election. But what we’ve seen in the first quarter so far is reasonably healthy growth. Not strong growth, but solid.

China, interestingly, has really rebounded. We, of course, saw China slowing more than con-ventional wisdom—and in the second half of the year particularly. As the leadership transition was undertaken, we watched China rebound. We’re seeing quite strong data out of China today.

South America and the rest of the emerging markets are following suit and will see reasonably strong growth this year. Again, not extraordinary growth, but it will underpin pretty solid global growth.

carlyle’s Nextgeneration

The Carlyle Group started the year with over $170 billion under management and is active everywhere, in virtually every strategy. Glenn Youngkin joined Carlyle in 1995 and is now COO, involved in all the firm’s activities. He offers a firsthand look inside the private equity giant.

Europe, in our minds, has stabilized. I wouldn’t say it’s growing, but it’s stopped its decline. Even in the last year, when folks were still very much concerned about Europe’s overall profile, we were seeing real pockets of stabilization.

Our general sense is that global growth will be steady—slow, but steady. And some of the areas where there has been a pretty high level of con-cern—namely Europe and China—seem to have stabilized, if not really turned around, as China has.

How does that translate into investment oppor-tunity? Do you feel good about putting dollars to work in this environment?

Youngkin: The key question in looking at the overall investment climate is, “Where are the opportuni-ties going to present themselves?” We see a number of factors impacting that. The number-one factor is confidence on behalf of buyers to buy and sellers to sell. One of the hardest things to do when there’s uncertainty around the world is have confidence.

In 2012, we had a very strong investing year.

Click to watch this video at privcap.com

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privcap Digest / April 2013 / 21

A significant amount of our global activity is in China, India, South America, and now Africa and the Middle East. Those markets really need growth, and you need to have confidence that global growth is going to be sustained. We’ve had that confidence.

21 / Keynote

Through September 30, we invested $7.5 billion of equity around the world, which is a very large number, but actually lower than our four- or five-year run rate, which has been about $9 billion a year. We think that’s primarily driven by the fact that there was a lot of uncertainty as to whether the economy was going to recover faster.

A significant amount of our global activity is in China, India, South America, and now Africa and the Middle East. Those markets really need growth, and you need to have confidence that global growth is going to be sustained. We’ve had that confidence. We were investing heavily in those markets in 2010 and beyond. Our sense is that

growth is going to be there.And our sense is it’s going to be a very strong in-

vesting year. Capital markets seem to be behaving, the tone is good. The one thing that no one really knows is what’s going to happen in Washington, D.C., over the fiscal cliff, which seems to have an unlimited number of “overtimes”. We need some-body to kick the field goal and put this thing down so the rest of the world can react.

The data that Carlyle gathers from its assets and portfolio companies—you call this the Carlyle In-dex. What did the index tell you in the dark days of 2009, when many people assumed the world was falling apart?

Youngkin: Almost more important is what it told us during the go-go days of 2007. Midyear 2007 we were worried, really worried. When we looked at the portfolio data and compared it to what we knew was going on in the financing markets in other places, we recognized that some correction had to happen.

So we did two primary things. First, we man-dated across our portfolio that people start shor-ing up, which manifested itself in a number of different ways—from drawing down credit lines to making sure portfolio companies had plenty of cash, to postponing projects. Second, we shored up

Carlyle itself to make sure we were prepared. The partners injected capital into the firm. We didn’t need it at the time, but we were worried. Had we not taken some of those actions, we might not have weathered the downturn as well as we did.

Roll the camera forward to 2009. What we be-gan to see in the first half of 2009 was actually life on the shop floor. Order books, inventory levels be-ing drawn down, capital goods being ordered, CEOs coming to us saying, “It’s time for us to expand.” We drew a conclusion in the first half of 2009 that the world was not in dire straits—or not nearly the dire straits that the media portrayed—and really leaned forward. We invested about $5 billion in eq-uity in 2009. We wish we could’ve invested 10, but in a time of massive uncertainty people weren’t going to sell unless they had to. It was a wonderful time to invest if you could find things to invest in.

You’re the chief operating officer of Carlyle; you sit on the operating committee; you’re on the management committee. And so you spend a lot of time with the three founders. Talk about what it’s like to interact with those three and how they interact with each other.

Youngkin: The three of them have distinct respon-sibilities at Carlyle, and they trust one another in executing those responsibilities. They get together frequently to discuss how things are go-ing, and then they run off and do what their jobs require them to do. Carlyle works the exact same way. They’ve invited people into the firm to help run funds, help run the firm, help deal with our investors, help deal with communications and government affairs, all the different functions. It’s an incredibly liberating environment to work in, because you have founders who aren’t trying to do everything. They’re trying to create capabilities to do everything.

I’ve had the real pleasure of working with these guys now for five years, since I moved out of the investing side into helping them, in 2008, and I’ve never seen them argue. I’ve seen them disagree, but there’s a real respect among the three of them that has permeated the firm. There is a general level of respect in the way people treat one an-other. We’ve got a culture based on collaboration and respect that is fundamentally driven by those guys.

How does Carlyle process bad news when it comes in?

Youngkin: The way we deal with bad news is to throw resources at it and deal with it. It’s simi-lar to the way we deal with a portfolio company

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privcap Digest / April 2013 / 22

that’s not performing. An investor could be unhappy—which doesn’t happen often—but if an investor’s unhappy, or there’s an economic devel-opment somewhere that’s throwing us for a loop, or we have an employee who’s not doing what they’re supposed to be doing, we throw resources at it and we deal with it.

It’s very matter-of-fact. Gather data just like you would an investment decision, talk about it, and make sure you understand what’s going on, what’s the course of action. Then it’s “All right, who’s on point to go take care of it?”

You moved out of the investment side into the leadership of the firm five years ago. To what extent are you still a “deal guy”?

Youngkin: I still get to work with some of our investment teams at the investment-committee level. I primarily work with our South America team, so I still get the chance almost to be on the shop floor as the deals progress, decisions are made, analyzed, approved, and off they go. That keeps my toe in the deal side of things. I also get to oversee corporate development, so when we make an investment into Natural Gas Partners, which we just did in December, I get deeply en-gaged in that.

Having to deal with all the things that the ex-ecutives who run our portfolio companies have to deal with has been immensely educational. I have a much more balanced view of the challenges and responsibilities that our portfolio executives have, and also how hard it is to get things done. It’s a lot easier to talk about them in a board meetin-; it’s a lot harder to actually get them done.

What do you say when someone asks you a question that includes the word “succession”?

Youngkin: When I look at Carlyle, I ask the ques-tion, “What does Carlyle need to look and feel like in 15 years?” We’re going to need a group of senior people working in a collaborative fashion across a large financial-services firm. Then I look at what we’ve got today. Well, we’ve got a group of senior people working collaboratively across a very large financial-services firm. David, Bill, and Dan have already put in motion a lot of the com-mittee structures, cultural needs, and a group of people to fulfill all these responsibilities down the road.

I don’t think Carlyle’s ever going to have a single CEO. It’s just too big, there are too many responsibilities, and it doesn’t fit the way we work. So the fact that we’ve got a broad man-agement committee, the fact that our founders don’t serve on our operating committee and let the various senior leaders of the firm work, that means we’re on a path toward eventual evolu-tion.

Carlyle is a large organization—not just a large private capital firm, but a large organization. Are there advantages that go with the firm’s size?

Youngkin: Scale matters more than most people might think. It gives us the ability to have a global footprint. We have deep industry teams. We have the financial resources to launch funds. Scale provides all those things.

But it’s balanced with the second big attri-bute that distinguishes us, which is the way the

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22 / Keynote

“Scale matters more than most

people might think. It gives

us the ability to have a global

footprint.” —Glenn Youngkin

Glenn Youngkin of The Carlyle Group and David Snow of Privcap

privcap Digest / April 2013 / 23

23 / Keynote

firm’s constructed. The multifund model counter-balances some of the potential negative factors of scale. It gives our fund teams focus. So our South America team knows that they’re responsible for investing in buyouts and growth capital in South America. They don’t get distracted by trying to do a real estate deal or trying to do a deal in the United States.

The fund construct also enables the firm to scale further. There’s a difference between asking 30 people to run a $5 billion fund and then giving them a $10 billion fund and saying to the same 30 people, “Okay, just do more of what you’ve been doing.” As we grew from $50 billion to $150 billion, the number of funds at work went from 50 to 150. We figured out that the scalability of our model was enhanced by the multifund construct. We could grow our business without overburdening the investment teams.

The third big thing that comes into the mix is people and culture. We’ve been amazingly blessed to attract new people to Carlyle, because a lot of these expansions have been built with people who have been hired from the outside. We’ve been good at bringing in spectacular people who fit the culture—which is the unifying piece. “One Carlyle” is our mantra. It’s our culture, so we don’t get stuck in the silos of each fund, but everybody

recognizes that they’re better off if they work together as a group.

That’s resulted in pretty good performance over a long period of time. The combination of the scale and the construct and the people, which are our building blocks, actually results in good out-comes. We don’t always have the best-performing fund, but we’ve been consistently good.

Carlyle is now in a number of businesses. Are there any big opportunities, big investment functions that you have ambitions to add?

Youngkin: I wouldn’t say there are big things that we’re missing. We continue to see investment ca-pabilities that we think could offer unique things to investors—there’s a long list of those.

Next on our list is international energy. We feel that with our infrastructure and power capabili-ties, commodities capabilities, U.S. oil and gas capabilities, and mezzanine and senior lending in energy, which has broad appeal to investors, has really good opportunity sets in front of it. It offers a pretty unique opportunity. So in the short term, that’s where we’ll probably look. Beyond that, there’s a long list of other things to do, and we just get at ’em one at a time, execute well, and hopefully perform. ■

I don’t think Carlyle’s ever going to have a single CEO. It’s just too big, there are too many responsibilities, and it doesn’t fit the way we work.

privcap Digest / April 2013 / 24

24 / Takeaway

By Tom Stein and Tim Devaney

Many LPs avoid first-time funds at all costs, but for those willing to take the leap, new funds present an opportunity for large returns.

So where does Andrea Kramer, managing director at Hamilton Lane and an active investor in private equity, stand on first-time funds? She believes that new funds can deliver the goods—but only if chosen wisely.

“The analysis takes time, particularly so with first-time funds. It’s extremely labor-intensive from our perspective,” she says. “If you put the time and the energy into it, you can find really good investors. But the point is that you have to spend a lot of time with them.”

That’s one reason some LPs simply won’t bother with first-timers. It’s a lot easier to back fund num-

Learning to Love First-time Funds

Click to watch this video at privcap.com

ber five, especially if you know the managers inside and have previously backed funds two, three, and four, Kramer notes.

Of course, there are also risks associated with tried-and-true fund managers. Change happens. Maybe a firm has lost some key partners. Maybe its last few funds have underperformed. That’s why it’s important to keep an open mind when presented with a new opportunity, Kramer says.

Once Kramer and Hamilton Lane have done the hard work—sometimes spending up to a year with the new managers before investing a penny—they will commit anywhere between 10 percent and 90 percent of the fund. “It’s one of those things where you can’t just dip your toe in this fund. You’re full-on committed,” she says. “It’s sink or swim once you’ve invested with them.”

That all-in approach sets Hamilton Lane apart from many other LPs. “We want to make sure that we’re going to generate great returns,” Kramer says. “And you do that by making sure you’ve set it up properly at the front end, not by spreading around the dollars.” ■

Analyzing a First-Time Fund Before investing, Kramer asks the following questions:

1. Can I work with the fund long-term?

2. Can the fund raise what it needs (particularly when I plan to commit a large percentage)?

3. Does the fund have a functioning back office that’s up to the task?

Source: Prequin

Investing in First-Time Funds, by the Numbers

53% of GPs would invest in new and emerging managers

17% say only if it’s a spinout

16% would not, no matter what

14% would at least consider it

Source: Prequin

Andrea Kramer

privcap Digest / April 2013 / 25

For how long has Ernst & Young worked with growth-stage companies?

We’ve had a long history. Some of the household names now that are public,

well-established companies were formerly small-growth businesses that we’ve serviced all along the spectrum of growth and it’s certainly an area that we focused on. We call it an entre-preneurship. (recommend we delete this) It’s a focus on working alongside businesses as they look to grow and need that level of assis-tance, and support and advice. We’ve been there for these companies and worked alongside these companies. It’s pretty fulfilling, because you end up seeing a business that may have started in someone’s garage that ultimately, over a num-ber years, has moved to become a major player in a market, achieved public-company status. Working alongside those companies is some-thing we value tremendously.

What unique challenges do growth-stage com-panies face?

Companies that are in the growth stage are perpetually changing. What we’ve seen

historically is these companies are not necessar-ily best in class in terms of governance, best in class in terms of operations or finance, and need assistance in these areas.■

25 / From Our Sponsors

Jeff Bunder, Global Private Equity Leader, Ernst & Young

email: Jeffrey.Bunder@ey.com Web: www.ey.com/privateequity

with Jeff Bunder of Ernst and Young, Global Private Equity Leader, Ernst & Young

expert Q&a/

Snapshot

Expertise: Extensive experience leading due diligence engagements for both private equity and corporate acquirorsEducation: MBA, New York University, Stern School of Business

Click to watch this video at privcap.com

privcap Digest / April 2013 / 26

What investment framework is required for suc-cessful private equity investing in Africa?

The ability to understand the social gover-nance issues related to a particular sector

and the drivers of growth and value in that particular sector become important and can be learned and improved upon. You understand your sector better as you invest in more portfo-lio company investments in that particular sector and as you evolve. So we found that PE firms that focus on approximately three-to-five specific sectors are quite successful.

Additionally, having a good understanding in terms of which parts of the African continent are you going to invest in is key. There’s always a perception that Africa is just one big country. It’s actually 54 different countries. With about five different regional and economic zones. So having good sector focus, good understanding of which countries and which regions, and what the returns expected for that sector would be gives you a better understanding of the invest-ment horizon.

What is the importance of local knowledge when investing across Africa?

Africa’s become quite a big investment destination so that a lot of companies are

finding that there are a lot of suitors out there. It’s become quite competitive. Unless you have a local partner to assist you in focusing and engaging almost exclusive discussions with particular targets, it could be quite difficult doing an investment. You might find the premium is much more significant.

Number two, Africa growth is driven by a lot of family-owned, small to medium size busi-nesses that are not traditionally listed, that have grown exponentially, that have the abil-ity and power to grow across various countries and regions. Those aren’t publicly listed. There’s very little information available in public about them. And that is where we’re finding that a lot of PE firms are leveraging our footprint and network. ■

26 / From Our Sponsors

Sandile Hlophe, Africa Service Line Managing Partner, Transaction Advisory Services Ernst & Young

email: sandile.hlophe@za.ey.com Web: www.ey.com/privateequity

with Sandile Hlophe, Managing Partner, African Service Line, Ernst & Young

expert Q&a/

Snapshot

Expertise: Extensive experi-ence in transaction advisory, merg-ers & acquisitions, project finance, debt advisory and financial restructuring Education: Bachelor of Ac-countancy and Post Graduate Diploma, Accountancy, CA (South Africa)

Click to watch this video at privcap.com