Beyond the J-curve - Managing a Portfolio of Venture Capital and Private Equity Funds


ListofBoxesxv
Acknowledgementsxvii
Disclaimerxviii
PARTIPRIVATEEQUITYENVIRONMENT 1
1Introduction3
1.1Routesintoprivateequity3
1.2Thelimitedpartner’sviewpoint4
1.3Thechallengeofventurecapitalfundvaluation4
1.4Hardfiguresorgutinstinct?5
1.5Managingwithfuzzyfigures5
1.6Makingthegrades5
1.7Outline7
2PrivateEquityMarket9
2.1Fundsasintermediaries10
2.2Theproblemofpredictingsuccess15
2.2.1Cansuccessberepeated?15
2.2.2Whatissuccess?17
2.2.3Toleranceforfailure18
2.3Broadsegmentationofinvestmentuniverse18
2.3.1Institutionalqualityfunds18
2.3.2Newcomers21
2.4Privateequitymarketdynamics22
2.4.1Boom-and-bustcycles22
2.4.2Therelationshipbetweenlimitedandgeneralpartners23
2.4.3Lifecycleoflimitedandgeneralpartnerrelationship24
2.5Conclusion26
3PrivateEquityFundStructure27
3.1Keyfeatures29
3.1.1Corporategovernance30
3.1.2Investmentobjectives,fundtermandfundsize31
3.1.3Managementfeesandexpenses31
3.1.4Carriedinterest32
3.1.5Preferredreturnorhurdlerate33
3.1.6Generalpartners’contribution34
3.1.7Keypersonprovision35
3.1.8Terminationanddivorce36
3.1.9Distributionwaterfall37
3.2Conflictsofinterest38
3.3Findingthebalance38
4BuyoutandVentureCapitalFundDifferences41
4.1Valuation43
4.2Businessmodel44
4.3Dealstructuring45
4.4Roleofgeneralpartners45
5Funds-of-funds47
5.1Structure47
5.2Valueadded48
5.2.1Diversification49
5.2.2Resources49
5.2.3Selectionskills50
5.2.4Incentives50
5.3Costs51
5.4Privateequityinvestmentprogramme52
5.4.1Funding53
5.4.2Managementfeesandprofitsharing53
5.4.3Investmentactivities54
Appendix5A54
PARTIIINVESTMENTPROCESS 57
6InvestmentProcess59
6.1Keyperformancedrivers59
6.1.1Fundmanagerselection60
6.1.2Managementofdiversification60
6.1.3Commitmentmanagement60
6.2Processdescription61
6.2.1Portfolioobjectives61
6.2.2Portfoliodesign62
6.2.3Liquiditymanagementandvaluation63
6.2.4Monitoring64
6.2.5Actionandimplementation64
6.3Riskmanagement65
6.3.1Risk-measurementframework65
6.3.2Riskcontrol65
6.3.3Riskmitigation67
6.4Tacklinguncertainty68
6.4.1Reducinguncertainty69
6.4.2Strategiesunderuncertainty69
7RiskFramework73
7.1Marketvalue75
7.2Marketorcreditrisk?77
7.2.1Marketrisk77
7.2.2Creditrisk77
7.3Conclusion78
Appendix7A:Incorporatingprivateequityintothetraditional
VaRframework79
7A.1VaRcalculationbasedonreportedfinancialdata79
7A.2Marking-to-model80
8PortfolioDesign81
8.1Portfoliodesignframework81
8.1.1Modernportfoliotheory81
8.1.2“Naïve”allocation83
8.2Portfolioconstructiontechniques83
8.2.1Bottom-upapproach84
8.2.2Top-downapproach84
8.2.3Mixedapproach85
8.2.4Portfoliomonitoring87
8.3Risk–returnmanagementapproaches88
8.3.1Core–satelliteapproach88
8.3.2Diversification90
9CaseStudy95
9.1Lookingfortheoptimalprogrammesize95
9.1.1Data96
9.1.2Themodel97
9.1.3Results98
9.1.4Extension100
9.1.5Conclusion102
9.2Overcomingentrybarriers:long-termstrategies104
9.2.1Data104
9.2.2Modelling105
9.2.3Results106
9.2.4Conclusion106
Appendix9A:Formulae111
Appendix9B:Skewnessandkurtosis112
Appendix9C:Expectedutility113
12.2.3Otherrelativebenchmarks169
12.2.4Absolutebenchmarks169
12.3Portfoliooffunds170
12.3.1Performancemeasures170
12.3.2Benchmarks171
13APrototypeInternalGradingSystem173
13.1Gradingofprivateequityfunds173
13.2TheNAVisnotenough174
13.3Existingapproaches176
13.3.1Fundratingbyexternalagencies176
13.3.2InternalVCfundassessmentapproaches178
13.3.3Comparisonofapproaches180
13.4Newapproachtointernalfund-gradingsystem180
13.4.1Gradingformalisation180
13.4.2Expectedperformancegrades181
13.5Summary—NAV-andgrading-basedvaluation188
13.6Conclusion189
Appendix13A189
14FundManagerSelectionProcess193
14.1Relevanceoffundmanagerselection193
14.2Whyduediligence?194
14.2.1Duediligenceasarequirementforprudentinvestors194
14.2.2Duediligenceasabasisforbetterinvestmentdecisions195
14.3Theduediligenceprocess195
14.3.1Limitations195
14.3.2Duediligencequestionnaires196
14.4Fundmanagerselectionprocess197
14.4.1Determinationofthe“wishlist”197
14.4.2Dealsourcing198
14.4.3Screening198
14.4.4Meettheteam198
14.4.5Evaluation199
14.4.6In-depthduediligence200
14.5Decisionandcommitment201
Appendix14A:Illustrativeduediligencequestionnaire—venture
capitalfunds202
15QualitativeFundScoring219
15.1Scoringapproach219
15.2Scoringdimensions221
15.2.1Managementteamskills221
15.2.2Managementteamstability224
15.2.3Managementteammotivation225
15.2.4Fundstrategy227
15.2.5Fundstructure229
15.2.6Externalvalidation230
15.2.7Overallfit231
16Grading-basedEconomicModel233
16.1Approach233
16.2Internalageadjustment237
16.3PrivateequityfundIRRprojections238
16.4Expectedportfolioreturns239
16.5Discussion241
16.5.1Verificationofapproach241
16.5.2Relianceonassumptions242
16.6Conclusion242
Appendix16A242
16A.1Identifyingbottomfunds243
16A.2Identifyingtopfunds243
Appendix16B245
Appendix16C:Grading-basedprivateequityfundvaluation—howfair
ismyvaluation?248
16C.1TherevisedIAS39248
16C.2Valuationmodel(mark-to-model)251
17PrivateEquityFundDiscountRate253
17.1Thecapitalassetpricingmodel253
17.1.1Risk-freerate254
17.1.2Equityriskpremium254
17.1.3Beta256
17.2Privateequityfundbetas257
17.2.1Estimationbasedonquotedcomparable257
17.2.2Alternativestothe“standard”regressionbetas261
17.3Thealternativestothecapitalassetpricingmodel264
17.3.1Theopportunitycostofcapital265
17.3.2Thehistoricalperformance265
17.4Summaryandconclusion266
PARTIVMANAGEMENTTOOLS 269
18Monitoring271
18.1Approachtomonitoring272
18.1.1Monitoringaspartofacontrolsystem272
18.1.2Thetrade-offs273
18.2Themonitoringobjectives273
18.2.1Protectingdownside274
18.2.2Creatingvalue276
18.3Informationgathering276
18.3.1Standardmonitoring279
18.3.2Specificmonitoring281
18.4Evaluation282
18.5Actions285
19CaseStudy:SavingYourInvestments—ApproachestoRestructuring287
19.1Thevalleyoftears288
19.2Thereporttotheboard289
19.3Thetermsoftherestructuring291
19.4Epilogue293
Appendix19A:Investmentproposal293
Appendix19B:Trackrecord294
19B.1Greenlight1294
19B.2Greenlightbuyout295
20SecondaryTransactions297
20.1Sellersandtheirmotivations297
20.2Buyersandtheirmotivations299
20.3Secondarymarketprices300
20.3.1Factorsforvaluation303
20.3.2Top-downanalysis304
20.3.3Bottom-upanalysis306
20.3.4Comparables307
20.4Transactionalissues307
20.5Thefundmanagerperspective308
PARTVEMBRACINGUNCERTAINTY 311
21DeviatingfromTopFunds313
21.1Strategicinvestments313
21.2Policyobjectives314
22RealOptions319
22.1Realoptionsinprivateequity319
22.2Realoptionanalysis321
22.3Anexpandedstrategyanddecisionframework322
22.3.1Decisionframework322
22.3.2Strategyframework322
Appendix22A:Arealoptionexample324
23BeyondtheJ-curve327
23.1Somedoitbetter327
23.2Deadlysins327
23.3Structureinsteadof“gutinstinct”328
23.4Patienceisavirtue328
23.5Turningwaterintowine329
Glossary331
Bibliography341
Abbreviations351
Index 353