A New Era for Private Equity and Venture Capital
October 07, 2021
The Private Equity and Venture Capital industries find themselves at a critical juncture. On one hand, institutional investors, pensions and endowments and high-net worth individuals are deploying large sums of capital to the asset classes. On the other, the looming potential for higher taxes and market uncertainty has some investors running for the hills. Both industries find themselves at a key moment in time amid the democratization of private markets, billions of dollars of dry powder on the sidelines waiting to be deployed, emerging technologies, the desire for ESG solutions and the raising of profiles of diverse and emerging managers. It’s an important, yet uncertain time, but one thing is for sure: investment managers need to find a way to thrive in it.
Steve Nelson: Sure. Thanks Bonnie. I think the first thing to say is this really represents one of the silver linings emerging from the pandemic experience. And by that, I mean that there's been a growing focus on, and a commitment to issues of stewardship generally, but specifically in the area of ESG and diversity equity and inclusion. And I think that's incredibly encouraging for the industry because it would have been all too easy to imagine a scenario where these issues might've been pushed aside in favor of prioritizing tactical responses to the pandemic. And that would have been understandable, but this push for a deeper dialogue, creative solutions, it's coming not just from LPs, not just from GPs, but the community as a whole. And I think that includes the professional services firms that are active in our space as well. So, it's really been a community effort. And I think that's both critically important and also reason to be optimistic about the progress that we might be able to make here in relatively short order. And on specifically how our LPs taking up these issues, they're addressing it on multiple levels.
So, they're looking at this within the confines of their own organizations, for sure, at the GP organizations, in which they invest as well, and at the portfolio company level. And that obviously introduces some complexity, but I think it's worth keeping in view that this isn't something that can only be taken up through one lens. And how is it impacting the ILPA work? Well, I think its simplest way to say is that it's featuring prominently both ESG and DE&I on our strategic agenda. And that cuts across our efforts on behalf of LPs content, education, advocacy. And examples specifically that are probably worth mentioning. We have a diversity in action initiative, which launched late last year, somewhere in the range of 30 or so signatories that over a period of just a few months has become a group of 200 LPs, GPS consultants that are getting together on a quarterly basis to discuss these issues. And we released the ESG assessment framework just this summer. So, I think you're likely to see much more from us on this front going forward.
Bonnie Sussman:Thank you, Steve. Hunter, we'll go over to you.
Hunter Carpenter:Yeah, sure. I think Steve is right. I mean, I think it starts with an awareness. And with awareness comes to perspective and I think you have to move into action on those things. And from a Redbird standpoint, it starts with your broader community, and then it goes into the community that you have at your workplace and the culture you have at your workplace. And for us, since the beginning in 2014, when Redbird was founded, we're founded in partnership of Ontario teachers. It's been somewhat of a bedrock for us. It's been something that at times they were leading the target and at times we were leading the target. And I think as you work together both with your LPs and then work internally amongst the GP and amongst the culture you're trying to build, if you don't have awareness, you can't make progress on it. And I think that for us, if we look sort of the arc of where we've come at Redbird, today 40% of our people are either diverse female or veterans. And that's something we're very proud of.
And I think two of our portfolio company CEOs are females. And so, it's not one thing, it's everything. And two, it's almost not an LP perspective or a GP perspective. To me, it goes to the perspective that we must have as humans on where we're going and what we want to be as we all live together in common humanity. As a father of a very diverse family with two adopted children who are African, it's somewhat unsettling to me when we talk about these things in the investor community as if they only apply to the investor community, because they are much broader issues that really should not just matter what industry we're in. Now, as industry leaders, we have to set the standard and we have to carry it forward and be an example, but it's not just an investor or a GP or LP issue. It's an everything issue. And my hope is that it goes across all of our lives wherever we are. So, I do think that as capital providers, we can lead and as leaders, we can make examples of doing the right things.
Bonnie Sussman:Thank you. Thank you. So, PV, I want to turn the tables to you right now. So, with increased awareness and appetite from investors, how is Cota Capital implementing ESG and DEI priorities?
PV Boccasam: We come at it from a technology lens and we say, what are the right things to do right around not just ESG, but also DEI, right? And our ability to... Our job is, in Big G on the governance side, we... So, someone asked me the other day, with the QSBS, regulatory changes happen where the significant wealth is generated in the VC private equity industry, which is based on QSBS which is qualified, small business stock gets changed, would it change? Would there be less investments? And I just don't believe it, right? We don't make investments in companies to avoid tax laws. That's not what we do, right? We're here about creating the next billion-dollar trillion-dollar enterprise. And so, governance for us is a core part of what we do. So, tax laws, all new regulatory changes that's happening around it is a core part of what we do. On the social factors side, like we talked about, right?
The S part of the ESG is fundamental to how our technology firms are going to have to create a special focus on. You may have recently heard, we were talking about it earlier on here with Hunter and Steve, Facebook knew exactly what it was doing when it bought WhatsApp, right? And they knew how addictive WhatsApp was going to be. If you still continue to battle that to the young impressionable teenagers, it doesn't matter what ESG initiatives that you have within your company, your actions directly reflect that, right? As my colleagues has mentioned. And we think that the impact of technology, we have a lot of investments in the bio and the energy sector. So, the direct involvement around how technology impacts climate change, UN efforts around us, we are investing in portfolio companies that make a strong case for how their technology and their practices are going to align with ESG initiatives. Not just doing by LPs requirements, but our ability to show that in action is really important for us as well.
Bonnie Sussman: Thank you, PV. So, my next question I want to give that to Steve. Steve, how are the ESG and DEI initiatives tracked and measured by investors?
Steve Nelson: Yeah, the honest answer, I think, there is with difficulty. And I mean that both from the LP and the GP perspective, and this is a place where no one is at fault, we're just all finding our way together and in real time. I would say, I think it starts with establishing objectives. And in many cases, these are still coming into focus and, or being refined. So, what are we seeking to achieve? And then we can start to have that conversation about what are we measuring and what metrics are we going to use to ultimately make that assessment? And I think that's part of the reason why you see LPs today looking not just for data, but to understand the policies that GPs have in place that they can rely on over time to help ground and guide those efforts as it relates to ESG and DE&I.
And I would just underline the point that those two things have to continue to come together. And there needs to be a shared appreciation for the fact that we are on a journey, and there are going to be starts and stops along the way. What really matters is that there's a rich and robust dialogue that's in place that is going to get us to a point where we can feel good about the frameworks that we're using and the metrics that we're reporting on. But definitions really matter with these issues. And data can be difficult to collect, obviously. And the reality is that I think this complicates and frustrates efforts, even for those with the best of intentions. But we are, I would say, unequivocally on a one-way street here and ESG and DE&I are no longer ad-ons or an afterthought in any way for LPs and many organizations, maybe most organizations are now taking these factors into consideration as a part of their investment decision and really a core decision point for any investment decisions.
So, you're going to see more of these questions feature in due diligence, questionnaires, and data templates, and the like. That information exchange needs to continue to become a more consistent and more meaningful, and again, that is a two-way street. LPs need to help GPs provide that right information, need to be clear about what they're asking for and why. And hopefully that leads us to a place where we can establish a standard set of metrics. It really does represent a precondition, I think, for the industry to move forward in any meaningful way here. Encouragingly, there are some initiatives that are already in flight that do bring together that GP and LP perspective. You can see some of those compromises happening in real time. You can also see folks acknowledging that perfect is going to be the enemy of the good here.
And I think what we'll find is those industry led solutions are going to be the best possible outcome for us, as opposed to a rigid regulatory mandate being posted, which will happen. If we, as an industry, aren't able to move this thing forward with pace. So, I think you only continue to see more discussion, more data. The hope is that we don't end up at the end of this with 15 competing frameworks and a whole range of definitions and solutions that don't track across markets or across strategies. That sort of tangle will be a major impediment for all involved.
Bonnie Sussman: Thank you. So, perfect is the enemy of good. I am taking that line because I love it. So, Hunter, how was Redbird Capital tracking and measuring ESG and DEI initiatives, the GP perspective?
Hunter Carpenter:So, I would second what Steve said, perfect is the enemy of good. And this is an evolution. I've been doing this almost 20 years and certainly 15 years ago, we were not having these kinds of conversations. So, I think the evolution maybe needs to be accelerated, but at least we have begun the journey. I need to think about Redbird from a dedicated... From a Redbird, how do we approaching it, and how do we track and measure it? We have a dedicated deal team that focuses on ESG and DE&I across the portfolio. So, whether that's in underwriting or whether that's ongoing, we have three to four individuals in the firm who that is their job, include one partner to ensure that that overlay is across the portfolio.
And then certainly for our more ESG sensitive businesses that may be a natural resource oriented, each company prepares sustainability reports and we track things on a very granular basis on metrics that can be measured such as greenhouse gas reductions and whatnot. So, there are fine-tuned stats that we can closely monitor. We do that. As Steve said, it's hard sometimes to define everything and to track everything as we're on this. So, what we try to do is really focus on the good and not worry about being perfect, frankly, because I think as we have these conversations with LPs right now, it is a conversation it's not a... It's harder to do a scorecard because as PV said, what belies underneath the scorecard, maybe the actions are different. So, what we're trying to do is make sure that our overall philosophy is driven by the journey where we want to be on versus, maybe just pure statistics here and there.
Bonnie Sussman:Thank you everyone for your perspective on ESG and DEI. Let's now turn over to investment sector. So, coming out of the pandemic, which sectors do you think will be the recipient of significant PE or VC capital over the next 12 to 18 months? PV, I'll start with you.
PV Boccasam: Oh, thank you. As we chatted earlier, we are a US-based B2B enterprise technology investment firm. The fundamental belief is that our businesses are going to be digitally powered. And the digital transformation has almost accelerated at warp speed post-COVID. And the digital transformation that we've been talking about for 10 years literally happened in 10 weeks. And so, a big part of our delivery, of how we think about investments are areas where the context of not only the shifting geopolitical issues, especially as it relates to the China and Europe and kind of the post-COVID complexities really have driven a new way of thinking about our specific investments.
So, one area that I would highlight is we think there's going to be a rebirth or renaissance of the semiconductor industry here, because we have a very severe chip shortage in this country. And we relied on just one main source to get access to silicon-based chips. So, we think we need to dig our head out of the sand and head back into Silicone, as I said, and start creating foundries and start making chips in the United States. And we talked about AI. AI systems, not being embedded inside of chips now, so we can do faster processing, faster voice recognition, faster visual recognition and so on. So, it's a fundamental game changer for us to think about just a simple thing of bringing semiconductor, manufacturing the design back out to the United States.
Bonnie Sussman: Thank you, PV. Hunter, I would like to ask you the same question.
Hunter Carpenter:I certainly think that the pandemic both created dislocation and acceleration as PV said. And I think that if you look at one of the Redbird's core sectors, which is sports and the ecosystem of sports. We made a number of investments over the last 12 months in the sports sector that maybe I would say most of those were accelerated because of the pandemic and really the opportunity for growth. So, it wasn't so much rescue as it was enabling growth at a quicker pace than maybe what it was contemplated as the underlying industry and underlying trends transform quicker than maybe what was anticipated.
So, I think the sports ecosystem, which is a big part of what Redbird does really had a lot of interesting things happen and present a lot of investment opportunities that had been in the hopper, if you will. Deals take time, but maybe accelerated the opportunity. So, I would say that's one. And then certainly on the telecommunication side and the digital transformation as well. I think that there are a host of opportunities there that we've invested in and we'll continue to see as the world just migrates at a quicker pace. So, the proliferation of ones and zeros is going to continue and as PV said, whether it's infrastructure or applications, both are needed to solve problems.
Bonnie Sussman:Thank you. So, PV, speaking of deal activity, we saw that healthcare and technology have been very popular. What's the sector that no one is talking about?
PV Boccasam:Like I mentioned earlier, I think semiconductor is probably the one that people overlooked. The second one, I would add what I would call addictive manufacturing, or kind of what's properly known as kind of 3D printing. It's something that, again, coming back to the supply chain and parts and materials issue, there's tremendous amount of research, as well as technology innovation that's happening in material science in the United States. So, it's new ways of creating sort of value in the clothes that we wear, right? That are more environmentally friendly, to materials that reduce the use of plastics, for example, and so on. So, material science is another, I think, really cool growth area.
Bonnie Sussman:Thank you, PV. It has been reported that there is a record high of $950 billion of dry powder in north America, which created a very competitive deal environment. How can a co-investment partner support ongoing operations and value creation? Steve, I'll start with you on this one.
Steve Nelson: Sure. And I'll defer to Hunter on sort of the specifics of what a general partner is looking for in that co-investment partner. But, maybe just in more general terms, it's worth saying that the appetite for co-investment opportunities from LPs remains very strong. That has not been dented at all by the past year and a half. And I think that's both because of the potential to enhance returns, but it does have to be said that part of the effort there is to reduce overall fees as well. So, I think one of the challenges that we've seen amongst LPs that are looking to do more on the co-investment space is how to retool and/or add to their investment teams in ways that allow for a different sort of diligence process, the compressed timelines that are often in place.
So how do you build out specific skillsets that are going to allow you to do this type of investing even more effectively? The other point, which I think is occasionally lost in the conversation is, you have to ensure that that overarching governance structure can support the decision-making that's required. That that mechanism is in place. And that's often different requires some sort of modification evolution in order for the governance structure to really be there for the investment process to take hold. I would also say that most of the LPs that are really participating in co-investments in a strategic way are looking to be more than just providers of capital. And so, they would like to be a value-added partner. They look to their networks, which might be additive in a particular situation.
Perhaps their portfolio includes the possibility of really sort of leveraging existing investments to help support a new investment. And in some cases there's real domain expertise. That's resident with an LP, whether through the individuals that are involved in the investment and, or sort of the broader organization and its history and other activities. And so obviously, LPs come in a variety of shapes, sizes, and types, but it's certainly the case that there are some LPs that are far more than just providers of capital. And I think more and more are looking to figure out how can they be a genuine value-added partner to the GPs that they're engaging with?
Bonnie Sussman:Hunter, I think Steve called your name for your perspective on this. So, let's get your opinion.
Hunter Carpenter:I think Steve's right. Some of it comes down to how's the LP equipped. Do they have the team, or are they accustomed to be an allocators of capital versus working on a deal and underwriting one particular investment on a compressed timeline with pressure where frankly, you don't know the answer? If you knew the answer, you would be seeing into the future. So being comfortable only having 80% of something, to me, that's the biggest difference between when someone sits as an allocator, they're underwriting the manager, they're looking at their past performance, the philosophy that they sink on what their investment strategy is versus when you're underwriting a deal and having to make judgements on the fly with less than perfect information. So, there are two different skillsets. And I think what we appreciate with some of our co-investors, and we've had an awful lot of co-investment over the last seven years and are fine. The first one is the hardest with a co-investor. And once you get one done and you've walked the road before 2, 3, 4, 5, are much easier. And so, I can recall our first co-investment, it was very difficult and we thought, "Why are we doing this? We should never do this again." But over time, some of our larger co-investment partners, we really have figured out the right cadence. And so, I think the first one's always the hardest. And then you begin to figure out and have the right cadence together as you walk the road. But what we enjoy the most is, when someone comes at it from a true investor mindset, they're willing to dive into the data room. They're not looking just to read a report. They realize that you may read a report, but then you have to start making judgements around the investment. And that's what we really appreciate.
Bonnie Sussman:We're going to switch over to technology now. So, PV, we'll start with you. How have PE or VC firms been transformed by technology in recent years, and which parts of the businesses do you see being changed by technology in the next few years?
PV Boccasam: A lot of ways the private equity and the venture capital world, in some sense like the cobbler's kid with children with no shoes, would we invest in technology all day long? And I see my colleagues here shaking their heads. But it's about to get shaken up quite dramatically. We see add one end of the spectrum, some really incredible firms like EQT and Tiger that basically use data and data science and large quantities of data science engineers that compute data. Literally across the past 20 years company and company performance, as well as all the funding that's happening in our industry today. And algorithms and systems are now telling them which ones they should prioritize first, and which one has the highest chance for getting to a billion dollars in revenues. So, everything is driven today through better data, better information, better analytics, and therefore better decisions.
Algorithmic trading and things that leverage kind of high compute has been very common in the hedge fund world. They've been using technology for years now, but the private equity world is truly a wash in data. There's one thing that we have is data and company performance. Less so perhaps in the private side, but that's changing as well. And so, even venture debt providers today can literally write you a $5 million check within 30 minutes with companies just uploading their financials. And you can make decisions on getting a $5 million credit if you like, because they've got algorithms built into these systems today. So, while we invest in leading edge and cutting-edge sort of technologies, the private equity firms are now becoming incredibly sophisticated as well in how they do their data collection, their curation, the data analytics, as well as the position making that powers them. So, we're fundamentally being disrupted in very unique ways that's going to hopefully sustain the industry.
Bonnie Sussman:Thank you. Now, Steve, your opinion on this topic?
Steve Nelson:Yeah, I'll take just a slightly different tact on this. And I would agree with everything that PV has just shared. And maybe from the, from the LP perspective, they see the technology that's being developed and deployed by the portfolio companies in their private markets portfolio. To PV's point, how that's unlocking efficiencies, enabling growth, creating amazing value. And then they look at the technology that they rely on internally, and to be diplomatic, can't help but see just a massive gap in terms of agility, sophistication, etc. And we actually ran, ILPA ran a targeted LP technology survey last year and the results, unfortunately, weren't a huge surprise. So only a quarter of the LPs that responded were satisfied with their current technology tools and the vast majority reported that manual interventions, legacy data, and systems integration, and just their internal capacity to evaluate new solutions were primary pain points.
And those have been around now for a while. So that leap from just being able to do things a little bit easier to everything that PV rightfully points to in terms of massive analytical capacity and what that can do for decision-making, it still feels a long way off for most LPs. I would say on the flip side of that coin however, obviously technology has been a tremendous equalizer for the industry over the past couple of years, and everything related to that shift a 10-week shift that PV mentioned of moving to virtual interactions and remote operations. And that could have brought us to a screeching halt, but in many ways, I think that is both up to the game for LPs in terms of how they manage their operations internally, but also improved the LP GP dynamic.
So, folks being more accessible, more touch points, information sharing that's been even better. More robust, higher quality and more folks being able to be brought into those conversations on both sides. That bodes well for the industry as a whole. So, we've had a number of professionals, and again, I know this holds true across the GP LP spectrum, that have been able to participate in different ways earlier in their career has gotten that exposure, learned some lessons. And that that experience will be, I think, really valuable and put to good use here for years to come. So, technology from the portfolio standpoint, incredible opportunity set from the internal operating perspective, a massive pain point. And looking ahead to the future from an organizational development perspective, lots of reasons to be optimistic.
Bonnie Sussman:Thank you, Steve. So that concludes all our questions, Hunter, Steve, PV, thank you so much for taking some time out of your busy schedules to share your views with us. And thank you for joining us today at the PE VC panel.
Transcribed by Rev.com