by Oliver Aldridge and Lucas Rimmer
Foreword
The following interview was held with Alexander Savin, founder of Chrome Capital.
The following answers were not recorded word for word and have been adapted and shortened to suit the BSPEClub format.
What is your process when starting a fund? What does it look like from concept to execution?
There are three to four main elements, the first is the idea. The PE space is usually crowded in most markets. If you just try to do what everyone else is doing, normally, you will not do very well or receive great returns for your investors. First and foremost, you should come up with an interesting idea, investing in a particular geography which is not busy and a strategy to which you can add value.
Secondly, a team is important. PE firms are usually founded and run by one individual and sometimes by a few. They form a partnership and hire a team to find, manage, process and execute deals. This makes the team extremely important and the culture of the team is equally important. There is huge competition for talent nowadays, especially in developed markets such as the US and Europe. It is very hard to pull together a strong team, from the top of the team down to the more junior members. With regards to the starting team, where you still have nothing you can offer them, finding the right people that are motivated to go with you on the journey is a tricky objective.
Investors are the third and most challenging component. Most of the money is found with large financial institutions, be it pension funds, insurance companies or sovereign wealth funds. There is a lot of money globally to invest in PE but they all want to invest in well established teams and businesses with good track records. Raising first time funds from these institutions is very hard, nearly impossible. Usually you start with raising money from friends, family and some high-net-worth individuals who like you, the team and the strategy. Then you start to gradually build your experience and track record and afterwards approach institutions. Normally raising the first fund is by far the most difficult exercise, a multi-month process which is very challenging.
Once these 3 elements are in place, you go and look for deals. You start looking for the deals during your fundraise, in fact, because you want to tell investors about the deals that you want to fund. They understand that you might not buy-out all of the potential deals that you present but at least there is something specific they can look at. Once all of these elements are together, it is enough to get things going. It takes many months, sometimes years, to get all of these together, but it is how you start a PE fund.
After you complete the first fund and have completed these steps, is it usually an easier task to open subsequent funds?
One of the most critical things an investor looks at is your track record and your history, which is probably wrong because history is not always a good predictor as to how you will do in the future. Most institutions need to base their decisions on something, and that something is usually the track record of the management. Once you have a track-record, which is good of course, it can lead to raising funds more easily.
Are there a lot of recurring investors in funds?
Usually you try to build subsequent funds on the basis of your previous investors. Actually, for new investors to come into your subsequent fund, they look very carefully at how many investors in previous funds re-committed their investments. They are considered as insiders and know how well the GP works. In normal markets, you would expect more than 50% of your previous funds LPs to recommit, sometimes it’s much more (closer to 80-100%), and sometimes it’s lower. Usually there is a ladder effect to the nature of funds; each subsequent fund tends to get larger and larger in the amount of funds raised and deployed.
What is at the forefront of your investment approach? What do you look for to evaluate whether a business can create growth value in a fund’s timeline?
Evaluating businesses and deals is at the core of investment business and ultimately the rest of what we discussed is just the means to the end; if you don’t know how to execute good deals it will be hard to build a successful PE firm. Each firm has their own process for evaluating deals. Usually they include creating a pipeline of deals that come in and filter them, as usually with PE deals there are a lot more ideas and deals proposed rather than the amount of deals carried out and followed through. There has to be a way of narrowing this process down. Ultimately, your team prepares the deals and presents them to an investment committee, which makes a decision. In most funds, the deal team prepares an investment memo and there are certain things which go into this memo that differs from fund to fund. Fundamentally, there will almost always be analysis of the market where the deal is taking place, analysis of industry trends and analysis of the company itself, forecasts and analysis of the management of the company and of course, the valuation of the company. This all gets presented to the investment committee and based on the information presented, and comparing it to the funds strategy and other investments being made by the fund, the committee makes a decision. Ultimately, if you speak to any senior investment professional, the biggest criteria is your “gut feeling”. All of the numbers and analysis is super important and of course you read all of this in detail and process it, but usually the deal team would not put forward a sub-par deal and so they have already thought through most of the technical aspects of it. How does one select from all the deals where the data indicates it is good standing regarding industry, management etc? This is ultimately the judgement that you have to make as a PE professional. I think it will be quite some time before AI can take this decision instead of people. It is not always easy to formalise this. It comes with experience and “gut feel”.
Is your investment focus on the management team or on the goods and services provided? If there was a good product or service but a poor management team would you acquire a controlling stake and change the management or do you prefer to go through with deals where the management will stay put?
There are some PE businesses whose model is to do exactly that (acquire complete or majority control of firms and change the management as they like the good/service being offered). They have their own batch of managers who come in and improve the management. Normally, when minority stakes are taken, you are “backing an entrepreneur” (which is usually heard in VC not in PE as much) and then, by definition, you sometimes are not investing in the business but more so in the leader of the business and believe in their abilities to improve shareholder value in the long term regardless of the current standing of the business. Usually if you take a minority investment, it is a mistake to invest in a firm where you do not like the management team, as you do not usually have power to replace it. If you buy a majority stake and have thought about how to improve the management team, this is more normal.
What are the conflicts of interest you might experience when acquiring a significant minority stake in a firm?
You run two main risks when acquiring a significant minority stake. Firstly, your fellow investors have different visions and push a separate narrative to management. However, this shouldn’t be an issue because you would observe their strategy beforehand and would attempt to avoid any conflict. Secondly, and more likely, is conflict with founders or the management team. For example, you may back the founders but realise it was a mistake because of their vision or not being able to manage a company as it grows. You might not have the ability to change the team or not easily exit the deal and this is where losses may be incurred. Minority stakes are riskier for these reasons as you have less control over the direction of the company.
What is most rewarding about working as a Private Equity investor?
I would say working with super talented and highly intellectual entrepreneurs is probably the most rewarding part. There are people with amazing energy, ideas and visions of creating things that have never existed before. These things might not happen everyday but when they do they are huge – and they are fantastic. The other thing is your results are measurable, so you can easily see whether you have done well or not and so can your investors. This, of course, is a good feeling as well.
What is your advice for students hoping to start a career in Private Equity?
You have to look at it from a short term and long term perspective. For the short term, generally people will work in banking or consulting for a few years prior to joining a PE firm. Do not be discouraged if you don’t make it into the industry straight out of university. But it should be said that working for PE is a good training ground in that it encompasses aspects of Investment Banking and Consulting.
Long term to be good at this, you need to have a unique set of skills which is incredibly rare. So it is easier to be a great banker or consultant as opposed to a private equity individual just because you need to combine many skills with different sectors at a very high level. On top of that, you need good interpersonal skills and you have to have good investment judgement. As a 20 year old, don’t set yourself a goal of becoming the next Henry Kravis because it may just not be for you, give it a go, see where it goes but don’t be surprised if it doesn’t work out. It is hard to know when you are only 20 if you can make it in the long term.
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