“How does a Private Equity or Venture Capital Fund really function?”

Few days ago, on Tuesday, I had presented to you an interview of Mr Gavin Ryan, an expert in Private Equity and Venture Capital Funds. As far as I understood from your feedback, this subject was really interesting for you, as the official information about this segment is really limited.

This is why I decided to address to Mr Ryan again, summing some of your questions and adding some new ones. This domain is really interesting and I think that it worths to know more about it.

This is why I decided to be media partner and support the first seminar about all these. In the last weekend of March Mr Ryan comes to Bucharest, in order to provide us a seminar for everything we need to know.

The second interview of Mr Ryan:

Ilias Papageorgiadis: What is the role of private equity and venture capital (Private equity & Venture Capital) investments for the country’s economy?

Gavin Ryan: It is estimated that in the UK, private equity funded companies account for one million jobs. In Central and Eastern Europe private equity has developed greatly from its small beginnings 10-15 years ago. Private equity can help promising medium sized local companies to grow into larger companies. Private equity therefore is an alternative source of capital for company growth; and those private equity companies that successfully grow represent an alternative model to foreign multinationals and local oligarchic type groups.

Ilias Papageorgiadis: Can you compare the Private Equity & Venture Capital market and investments in EU and in Romania (EU emerging markets)?

Gavin Ryan: Private Equity markets in developed EU countries are highly specialized. Different funds will focus on relatively narrow geographies, or sectors or life cycles of companies. Eastern European funds are more generalist funds, although in recent years there has been some specialization between venture funds and expansion capital funds. Still, most Private Equity in Eastern Europe is expansion capital.

Ilias Papageorgiadis: How the Private Equity & Venture Capital contributes for a company’s development process?

Gavin Ryan: An entrepreneur looking to expand his company needs a source of long term capital, in order to expand in a way that is financially stable. The two sources are long term debt and/or private equity. Many entrepreneurs prefer debt because they do not have to give up ownership in their company. However, this is not always viable and therefore private equity represents a source of equity capital for a company. Often the private equity manager is also able to bring knowledge and experience, apart from just the capital, which a bank does not have.

Ilias Papageorgiadis: Please explain in short the working process (operations) at a Venture Capital fund?

Gavin Ryan: A fund manager goes to investors and persuades them to put money in a future fund which he will manage. If he succeeds, he then seeks out investment opportunities in his market. He makes and number of investments over a period of say, 3-4 years. The manager sits on the board of the investee companies and supports their operations. After some more time, the fund manager sells his ownership in the companies he invested in, hopefully at a profit. From these monies he pays back his investors and keeps a proportion, usually 20%, as his reward.

Ilias Papageorgiadis: Which evaluation and financial engineering techniques and methods are used the most when valuing a Private Equity investment opportunity?

Gavin Ryan: Private Equity funds use a range of techniques which will depend upon the type of company he is looking at. The most common is discounted cash flow; the other main method is applying a multiple to an earnings figure, such as Earnings before Interest, Depreciation and Amortization (EBITDA). The manager will also use some empirical techniques specific to a sector, like for example value per hectoliter of production, in the case of a brewery.

Ilias Papageorgiadis: How company owners can use the Venture Capital to finance their firms?

Gavin Ryan: In two ways: Firstly, they will have fresh equity capital which will allow them to make new investments and finance the working capital needs for expansion. Secondly, if they have a good fund manager as partner, this person will be a good source of support and new ideas for the company.

Ilias Papageorgiadis: How important is the complete company due diligence and the documentation related with it?

Gavin Ryan: All Private Equity funds perform due diligence as part of their investment process. There is no investment without due diligence. Knowing how to do due diligence well and cost effectively requires experience. But it all boils down to the fact: would you buy a used car without opening the bonnet?

Ilias Papageorgiadis: In short, what are the main fundamentals when managing a Private Equity fund portfolio?

Gavin Ryan: The fund manager should balance having the empathy with the management to support the operations, with the need for control which in some cases can mean changing management. The main areas in which a Private Equity manager helps are helping with acquisitions, financings, hiring of senior staff, international expansion and generally all the extraordinary operations of a company's life.

Ilias Papageorgiadis: What is the strategic investors’ role for the investment climate in emerging markets?

Gavin Ryan: Strategic investors and Private Equity investors are the two sources of long term Foreign Direct Investment in an emerging market. Strategic investors have more specific sector knowledge than Private Equity funds, for obvious reasons. Private Equity funds have the versatility to manage different sectors in their portfolio. So both types of investors have complementary roles in any emerging market.

Ilias Papageorgiadis: How the Private Equity and Venture Capital differ from the business angels’ role in financing the company’s development and growth?

Gavin Ryan: Private Equity and Venture Capital is institutional money. The due diligence and investment process is more rigorous, on the other hand their time horizon is longer and they are ready to wait. Business angels invest more based upon the personal relationship which makes it easier initially, but if things do not go as expected they can get agitated sooner. Often there expectations have not been managed sufficiently by the entrepreneur.

Ilias Papageorgiadis: Do you think that there is direct connection between the level of development of a country’s stock market and the Private Equity & Venture Capital market in that same country?

Gavin Ryan: There is no evidence the two are strongly correlated. In SEE, this is not the case at all. Most CEE Private Equity funds do not look to the stock market as a credible exit route (with the exception possibly of Poland). The development of stock markets is related to other factors, such as the development of local institutional investors and good regulation. So for many companies, Private Equity investment is an alternative to an undeveloped stock market.

Ilias Papageorgiadis: What makes a fund manager successful?

Gavin Ryan: The most strong indicator for a private equity fund manager is his track record of previous private equity investments he has made. If these have mostly been successful, this is a strong indicator of future success, providing the fund manager makes investments which can draw upon his previous experience in some way.

Ilias Papageorgiadis: What professional qualities, personal virtues and experience should the successful manager possess?

Gavin Ryan: The required qualities are a strong financial analytical discipline, combined with a good judgement of the value of managers. A good fund manager must balance his sympathy and understanding of the needs of company management, with a certain skepticism of some of the claims and ideas that they may make in order to attract funding. A good manager should exercise a strong financial discipline to analyse an investment.