February 22, 2010 Orange County Business Journal

2010 Excellence in Entrepreneurship

Dan Lubeck, managing director, Solis Capital Partners, was nominated for this prestigious award. The award honors the entrepreneurial spirit through vision, execution and business accomplishments.

January 2010

Private Equity Investing for High Net Worth Families and Individuals: The Time is Now

Post-boom markets, like the current one, often yield the best investment opportunities.

By Dan Lubeck
Founder & Managing Director
Solis Capital Partners

Over the next several years, the opportunity for wealth creation in private equity should be significant, particularly for high net worth families and individuals.

Although there is uncertainty regarding the current U.S. market and the timing of its recovery, investment professionals are anticipating attractive investment opportunities over the next several years. Typically, recovery periods yield more attractive purchase valuations for platform and growth investments. This is particularly true for smaller, middle-market companies (annual revenues of up to approximately $200 million). As the opportunities in this sector improve, so should the performance of the private equity funds that target those opportunities (NBER Working Paper 9807), and that have the requisite skills and experience to create value with companies in that size range.

The smaller private equity funds ($50 million to $250 million) typically are those investing in smaller, middle-market companies. Accordingly, the top-performing funds going forward will not be involved in mega-buyouts, but rather special situations and small- to medium-sized transactions (Almeida Capital survey). Equally important, the most successful of those funds not only will purchase well, but also will operate well. Those funds will have the infrastructure and expertise needed to support and grow their portfolio companies.

The good news for high net worth families and individuals is that the smaller funds typically welcome them as investors (Preqin Survey 2010). These funds also are more likely to have the experience and processes needed to meet the unique reporting and relational demands of high net worth investors. Accordingly, we believe that now is a good time for these investors to create or increase their allocation to appropriate private equity opportunities. The following are a few key issues to consider.


Ability to Add Value

The most successful private equity funds today will do more than bring capital and financial engineering expertise to their investments (Choosing the Right Private Equity Investments for Your Family Office). These funds will create value through selecting and supporting effective leadership, strategic guidance, enterprise improvement, sales and marketing improvement, and shared resources. As such, when evaluating a fund investment, be sure that these practices and disciplines are part of the fund’s strategy discussion, and that they actually have done and are doing what they say. Funds that implement this strategy must have: (i) members of their team and/or other available resources with the requisite expertise and experience, (ii) processes that strategically and, if appropriate, tactically support the portfolio company leadership, and (iii) reporting and communication methods to assure compliance. An easy test of this is to talk with one or two of the fund’s current portfolio company leaders.

Track Record

Of paramount concern is how the fund has performed in the past. The best performing funds likely will be managed by teams that have invested together through at least one entire economic cycle with good results throughout. Also, the “Siamese twin” issues of valuation discipline and appropriate use of debt need be considered. One of the most tempting and dangerous mistakes funds make is paying high multiples for portfolio companies and then using high leverage to chase returns. This works only when companies grow at a significant pace without mishap. If the required growth doesn’t happen, then the fund and portfolio company are fighting merely to avoid loss rather than create return. This is happening today in the portfolios of a significant number of funds that were established in the mid to late 2000s. During this period, the leverage ratios of private equity transactions reached as high as 90%, compared to the more typical 50%-60%. For example, during 1997 – 2008, leveraged buy outs of all types averaged 7.4x EBITDA. But in 2007, leverage-fueled transactions drove that average up 30% to 9.6x EBITDA, with 20% of the transactions at multiples of 13x or higher (, December 14, 2009). Thus, when examining a fund’s track record, look for consistent, appropriate valuation multiples and use of leverage.

Adherence to Strategy

Funds that consistently perform well over long periods of time most often adhere to the same strategy. Fund managers should be able to explain their strategies simply and succinctly, and those strategies should be intuitive and appealing. When considering a fund investment, validate that its investments are consistent with its stated strategies.

Payment and Fee Structures

Two basic philosophies should define a fund’s fee and payment structure. First, the investors’ interests should be paramount. For example, the investor should receive a return of their capital plus a minimum return on their capital before the fund managers begin to share in the created value. Second, there should be an alignment of interests between the investors and the fund managers. This is accomplished in a number of ways. For example, fund managers should be significant investors in their own fund (and not with non-recourse loans from banks). Also, fund managers should create their personal wealth from creating wealth for their investors, not from fees. Fees should be transparent and equitably shared with investors. Another alignment structure that some funds use is tying their carried interest percentage to investment performance. The specifics can vary greatly, but an appropriately structured fund will adhere to these basic philosophies.

Ability to Meet the Investors’ Needs

As fund raising is getting more difficult with traditional institutional investors, more funds are pursuing investment from high net worth families and individuals. These types of investors often have different communication and service requirements than institutional investors. Thus, be certain that any fund you are considering has the experience and infrastructure to meet these requirements. If a fund doesn’t have experience investing for high net worth families and individuals, extra diligence should be devoted to be sure that expectations of all parties are clear and can be met.

The Private Equity Opportunity

Private equity is an accepted and important part of a diversified investment strategy. Deciding what type of private equity investment(s) and how large an allocation will vary by investor. For high net worth families and individuals, now is an opportune time to invest in private equity funds that invest in smaller, middle-market companies, and that have experience meeting the unique needs of the high net worth investor.

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