Mastering Private Equity – A conversation with Claudia Zeisberger

Private Equity (“PE”) is experiencing exceptional times with enormous growth. Capital committed to traditional funds, co-investments, separate accounts and directs are at an all-time high, but as asset valuations push steadily higher, PE funds are finding it tougher to find and close good deals at prices that will generate satisfactory returns. Few people know the industry as well as Claudia Zeisberger, Senior Affiliate Professor of Decision Sciences and Entrepreneurship & Family Enterprise at INSEAD, and the Founder and Academic Director of the school’s private equity centre (GPEI).

She recently published ‘Mastering Private Equity – Transformation via Venture Capital, Minority Investments & Buyouts’ as well the corresponding INSEAD case book ‘Private Equity in Action – Case Studies from Developed & Emerging Markets’. The first book provides an excellent PE overview putting venture capital (“VC”), growth equity and leveraged buyouts into context and describes several alternative PE investment strategies such as distressed investing and real estate. It looks at the investment processes, starting with deal sourcing, due diligence and target valuation before exploring deal pricing considerations and the actual structuring of PE deals. The book also includes a thorough coverage of transaction documentation. A section on managing PE investments looks into aspects such as corporate governance, securing management teams, driving operational value creation, all the way to a timely and profitable exit. Another chapter touches on responsible investments and how private equity can be a force for good. The book also describes the different stages of managing a PE fund from formation over fundraising, portfolio management, reporting to winding down of a fund. The final chapter takes a closer look at recent developments in the industry and the evolution of private equity with the authors exploring key themes that will shape private equity and venture capital in the future. All through “Mastering Private Equity” case studies, which are examined in detail in “Private Equity in Action”, bring the learning points to life.

PlanetCompliance spoke to Professor Zeisberger about the books, the impact of innovation on PE and Venture Capital, the future of fundraising and cryptocurrencies as well as what entrepreneurs need to bear in mind if they want to tap VC financing successfully.

PlanetCompliance: Claudia, what attracts you to Private Equity?

Claudia Zeisberger: I’ve been working in finance for over 30 years and was in one form or the other always close to alternative strategies. Why specifically move towards Private Equity? I have been in Asia and Emerging Markets for over 20 years now, where investing in Private Equity is simply unavoidable for investors targeting a globally diverse portfolio that reflects the macroeconomic growth in respective geographies. In emerging markets, public markets are often not very efficient and the returns from publicly listed companies may not reflect the actual growth that is happening on the ground. So institutional investors with a mandate to invest in emerging markets simply cannot ignore Private Equity; it is really the only way to gain exposure to the economy at large.

PlanetCompliance: Could you tell us about the current state of PE?

Claudia Zeisberger: PE has done extraordinarily well. Whether from a fundraising perspective, where funds were raised in record time, or whether one considers the amount of capital that has been returned to investors in the last 2 years, PE truly stands out. Now, will the good times continue to roll? That’s the question on investors’ mind and the answer is not obvious. Record sums of dry powder are sitting on the sidelines, waiting to be deployed, and this has in turn led to higher entry valuations.

Deals are being done at quite ambitious valuations, which raises questions about the long term returns in PE. The concerns are in particular about large capital inflows which are pushing up valuations, plus the pressure on the funds raised which will need to be deployed in the next 5 years. It will be interesting to see how the industry will tackle those challenges and continue to please investors which have gotten used to above average returns in the last 3 years.

PlanetCompliance: What role does innovation and digitalisation play for PE?

Claudia Zeisberger: Anyone invested in real businesses is concerned about the impact of innovation and digital is these days the first talking point. Private Equity firms, which have traditionally worked closely with their investee companies to improve their operations, will need to build new competencies with regard to digital. What’s interesting here is that we have seen conversations emerge between buy-out funds and venture funds who deal directly with these disruptors.

There is a concern about digitalisation and innovation and how it will affect businesses. PE funds will need to ensure the capabilities within their teams are up to the challenge.

PlanetCompliance: Is Private Equity as opposed to other parts of the financial industry less affected by innovative technologies?

Claudia Zeisberger: PE portfolio companies are of course affected by innovative and disruptive technologies; PE itself though not as much. At the outset PE investors still need to look at real businesses, do due diligence and then execute the deal – not much has changed. Nevertheless, managing these deals towards a successful exit will in future require additional capabilities that may not have been necessary ten years ago. So while the trading rooms of banks and hedge funds have changed significantly in the last 20 (just consider the electronic trading platforms), the business of PE has at first glance not changed as much. Nowadays you have electronic data rooms etc, and the capabilities needed to improve the business of one’s portfolio companies might have changed, but not so much the PE business as it is done.

PlanetCompliance: The rise of ICOs that is being used in the tech start-up sector is probably less an issue for Private Equity, but commentators have gone as far as to call it the death of Venture Capital. What are your thoughts on these new forms of fundraising?

Claudia Zeisberger: ICOs are indeed new and will need to prove themselves as a worth-while fundraising tool for start-up entrepreneurs. Let’s consider two distinct situations: First, an ICO without having raised VC-capital in earlier rounds; in which case ICOs appear to be a straight competition to early stage VCs. Nevertheless, entrepreneurs should be crystal clear about their desire from this fundraising exercise: funding only OR funding plus access to an experienced team of venture investors, their knowledge, network & advice during board meetings. This reminds me of similar discussions founders have had for years, on the preference for early VC funding over an extended period of bootstrapping. In both situations the optimal choice depends very much on the experience of the entrepreneur and his plans for the road ahead.

Secondly, assume the startup haas already raised money from VCs in an earlier round and is now contemplating an ICO. This raises a number of questions: what kind of impact will an ICO have on my board dynamics; do my VCs agree? And, it will immediately raise concerns from VCs with regards to a future exit. How should those tokens, sold during an ICO be managed when it comes to an IPO or even a trade sale to a strategic investor? At this point, we don’t have any evidence yet on best practices.

So, for ICOs to become a real competitive concern for VCs, we need to understand the impact & consequences of ICO funding on the future access to other capital market avenues for the company. We don’t necessarily need more regulation, but we need clarity in terms of process, we need clarity in terms of how ICOs can help companies achieve an exit in future whether it is an IPO or an acquisition. Paraphrasing Mark Twain, I suggest that rumours of the death of VC have been greatly exaggerated.

PlanetCompliance: With the current frenzy around Bitcoin and cryptocurrencies, what do you think then? Is it a good investment both in the short and in the long term?

Claudia Zeisberger: To assess whether it is a good long term investment, we simply do not have enough data given that cryptos have been around only for a relatively short time. In ten years from now we will look back at 2017 and consider one out of two outcomes: either, how could we have ever questioned that this could become mainstream; or we may say: how crazy were we to think that this was something we should invest in for the long term? Which outcome it will be is anyone’s guess. Nevertheless, regulators, central banks and possibly countries may have an opportunity to influence the outcome. Let’s see when the first country will allow its taxes to be paid in a crypto currency; this would have impact on the at present very low liquidity. I don’t know whether we will go all crypto; I rather think that cryptos will develop into a new asset class and analternative to the fiat currencies. In any case, these are exciting times; one does not often have the opportunity to take a ringside seat to observe a new asset class being introduced to the financial markets.

PlanetCompliance: Taking one step back, one of the problems that ICOs seem to solve for tech start-ups is the problem of access to early-stage funding as VC investors often receive hundreds of pitches per week and many entrepreneurs complain that if you don’t have any personal contacts, it can be close to impossible to get in touch. What would you recommend to them and is there a secret short cut?

Claudia Zeisberger: As a first time entrepreneur getting access to VCs unfortunately requires a bit of footwork; entrepreneurs are well advised to make themselves smart about the VC ecosystem. First, no VC is alike. All are focused on certain industries, geographies, technologies (or no-tech). It is therefore really important for entrepreneurs to find those venture funds that have a high likelihood to look at their pitch and may be excited about their business idea. No point pitching a tech start-up to a fund that has a mandate for consumer related products only. No point approaching late-stage VC for seed funding; etc … Quite often entrepreneurs don’t understand the venture space, and come away frustrated, having wasted crucial time in pitching to the wrong funds.

Funds have a clear mandate, which is to some extent dictated by the promise/ pitch to their investors. So, if I’m a tech-focused venture fund, I cannot invest in non-tech start-ups as I would be in breach of my mandate. Targeting those venture funds that are really aligned with what my business is trying to achieve is crucial. I hear it from venture funds all the time that they get approached by entrepreneurs and have to say, “Look, I like you’re business, but you’re at the stage that I’m not investing in or I have no idea what you’re talking about, this is not an industry I look at”. It’s a big frustration for the VCs as well and they wish that entrepreneurs would do their homework a little bit better.