VIEWPOINT THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES PRIVATE EQUITY PE & VC Key Stryker Rich: to Strong MDP’s Sage Pension Fund Decision Led Returns to Happy Exit VENTURE CAPITAL Why IBM Was Drawn to Cleversafe Q & A Selecting the Best Performing PE & VC Funds THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES Facts Are Facts Reality Versus Myth For the past three IVCA Viewpoints, we have sought to dispel the common myths that give private investing in private companies -- private equity investments in mature businesses in particular -- a bad rap. But the misrepresentations persist, and not just because of election-year antics of Maura O’Hara uninformed critics. IVCA Executive Director As you may recall, we have explored through real situations the topics of “Private Equity, Public Good,” the true beneficiaries of private investing in “I am a Private Equity Investor,” and the collaboration between PE/VC firms and their portfolio companies in “Partnering for Growth,” our last Viewpoint. This edition of Viewpoint strives to help people grasp the nuanced processes and methodologies behind investing in private companies. We explain through case studies how PE and VC firms go about the business of choosing a startup or established company to invest in, helping advise them, and assisting in actualizing their future -- whether as an independent company or as a unit of another company or investment firm. comments We also offer a rich dialogue with two Illinois pension funds and an investment consulting and asset management firm that manages or advises on trillions of dollars of holdings to illuminate how the net returns from PE and VC investments outperform their general portfolio or benchmarks. Here are the takeaways -- and we hope you will pass them along to the skeptics, cynics and nonbelievers. Growth is the key component and objective of both PE and VC firms. Improving the operations of their portfolio companies or investments is uppermost -- so their investors will benefit as well as the other essential stakeholders: employees, customers, suppliers, and the communities in which their employees work and live. For that latter evidence, peruse the case study of Madison Dearborn Partners’ investment in Sage Products, a mainstay corporate citizen in McHenry County. Some More Realities Job creation is almost always an outcome. Yes, some jobs are lost early on but as the strategy executive director’s director’s executive and operational changes take hold, new skill sets are required and overall employment increases. Operational improvements are the key to success. They take a liking to an investment prospect for the chance to make needed operational advances. Yes, they want to buoy an investment, but they desire that the investment remain stable in the market -- for their own reputations’ sake, if nothing else. Value creation is the mission. Let’s relate these stories and facts -- and celebrate the Art+Science of Investing in Private Companies. Investing in Private Companies –PE & VC–perpetually misunderstood Too often, PE firms are labeled as “job killers,” disparaged as “vultures” that strip their portfolio companies’ assets or borrow heavily against them. A New York Times series on PE in mid-summer perpetuated that notion. As for VCs, detractors blame them for hyping their startups in search of billion-dollar-plus valuations for their “unicorn” investments. Regulators are tightening their scrutiny. Adams Street Partners’ Terry Gould, who heads the global with the U.S. As a result, over the last two decades, the U.S. PE firm’s venture and growth equity investments, admits he share of venture capital investment worldwide shrank to 54 often uses a familiar four-letter profanity when he hears percent from 90 percent.1 someone disparage private investing. “We’re not trying to cut It’s A Global Battle For Investment Funds jobs; we’re trying to create things,” he asserts. IVCA Viewpoint has devoted the past three reports to “This innovation arms race is a virtuous competition where the illuminating what private investing in private companies byproducts are new technologies that improve the way we live, nurtures and achieves. Their titles say it best: “Private Equity, new jobs and economic opportunities, greater productivity and Public Good,” “I Am a Private Equity Investor” and “Partnering greater economic growth,” Scott Kupor, managing partner at for Growth.” Still, the defamation persists too frequently. VC firm Andreessen Horowitz, told the Senate Committee on This report strives to show, not just tell, how PE and VC Small Business and Entrepreneurship in July. firms make a real difference for the private companies they As for PE firms, they are laser-focused on creating value invest in. Through case studies, filled with rich detail that through actions that will improve operations and spur growth. help relate how the investors and the private companies they They conduct rigorous analysis, put the right management invest in grow and prosper while adding -- not slashing jobs team in place, and identify and monitor the critical metrics -- and, yes, how the investors also benefit while strengthening for driving value. Even public companies acknowledge they their companies. can learn powerful lessons from how PE firms employ real What’s a counterpart? Think how British restaurateur and and sustainable operating and productivity improvements TV personality Gordon Ramsay saves struggling restaurants at their portfolio companies. And during a window of 3-10 on ”Kitchen Nightmares“ and horrid lodgings in “Hotel Hell.” years, usually. What’s especially worrisome is this reality: The move It’s All About Growth to impose more regulations on private investing is reshaping Of course, VC and PE firms differ. VC firms finance startups the investment landscape, locally and globally. Disruption and entrepreneurs in hopes that over a number of years, ensues. And as profit margins tighten, private investment usually 5 to 10, the startups will blossom and, eventually, lure firms must center even more on operational superiority to a buyer or go public. PE firms typically invest in relatively achieve their investment objectives. mature companies, aiming to grow them and later exit -- again The following case studies make clear that for private for seven years on average -- at a profit. investments to succeed, PE and VC firms and their portfolio Still, growth constitutes PE and VC firms’ overriding companies concentrate on how to improve their companies mission. They each play a vital role -- VC in the entrepreneurial so, yes, they can exit at a profit to willing buyers or investors. ecosystem and PE in building effective and efficient companies It’s time to stop demonizing the private investment through an engrained platform for change. For PE, especially. community. What critics fail to grasp is that in today’s global 1 nvca.org investment landscape, other countries are directly competing IVCA VI EWPOINT | 2016 1 THE ART+SCIENCE OF INVESTING IN PRIVATE COMPANIES What We Do, How We Do It When I was incoming IVCA chairman, I expected that my 18-month term would be an “active” time. It certainly has been. Being that active voice on behalf of our members has been essential at a time when the state’s financial strife persists and when a sustained misconception continues to be held by some about the investment objectives of private equity and venture capital firms. Bob Fealy This explains our association’s vigor in advocating for our industry to legislators, government IVCA Chairman officials and the public at large. It also explains why this Viewpoint focuses on dispelling the myths Founding Managing Director, around PE investments by telling specific stories that illuminate the art + science of private investing Limerick Investments in private companies. In short, PE is about growth and adding value, not “greed” and slashing jobs, as the rhetoric might suggest. As I began my chairmanship, I listed four principal areas of focus, and I want to give you a progress report on each of them because it underscores what IVCA firms and their members have achieved toward our vital objectives: Engage. In supporting an entrepreneurial spirit in Illinois, we continue to meet with state legislators and government officials in Springfield and elsewhere in an effort to promote a better understanding about private company investments in the state. We made our voice heard on a number of fronts, comments and it played a critical part in the Illinois Treasurer’s new $222 million Illinois Growth & Innovation Fund, which will support Illinois-based VC and PE firms over the next six years. Our opposition to a bill that would disadvantage Illinois public pension funds led its co-sponsor to establish a task force, that includes IVCA representation, to consider the bill’s ramifications; no action was taken on it in the recent session. Thanks to our IVCA Political Action Committee, we raised a record $105,000 to support our legislative activities. Many thanks go out to Lee Mitchell, Chair of the IVCA Political Action Committee, and Campaign Co-chairs Darren Snyder of Prairie Capital and Jim Tenbroek of Growth Catalyst Partners for their exceptional efforts. Enlarge. We have worked to grow our membership, particularly among large family investment ivca chairman’s chairman’s ivca offices in Chicago and Illinois, many of which have direct investment strategies in addition to investing in PE and VC funds. They can benefit from our programming and from networking professionally and socially at our events. Existing IVCA members will gain from better understanding the strategies these groups employ in making their investment decisions. Expand. The association has been involved actively in increasing diversity in our industry, especially among African Americans and Hispanic Americans, and Executive Director Maura O’Hara continues to drive this essential effort. Educate. IVCA sponsored educational programs and luncheons in the past year on topics ranging from private equity valuation and mitigating reputational risk, to negotiating roll-over equity and clos- ing a growth financing round.