Events of the past few years – from the stock market collapse to Madoff’s Ponzi scheme – have made trust a critical issue. Even with signs of an economic recovery underway, many family investors remain cautious. Rod Goldstein, our chairman and managing director, was asked by
Pitcairn, a leading multi-family office and advisor to families, what advice he would give to families considering new private equity investments.
In an article in Pitcairn’s Spring 2010 Update newsletter entitled Is Private Equity Drowning? Goldstein argued that, “despite economic waters of uncertain depths and unpredictable currents, private equity investment will survive and thrive.” But he stressed that families must develop trust in their investment managers and know specifically how their capital is being deployed.
He went on to suggest five things families should do before “taking the plunge.”
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Take nothing for granted. Don’t mistake famous brands and lists of eminent investors as unquestionable indicators of sustainability or value.
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Dissect the investment model. Understand the historical drivers of returns on equity, such as investment origination, focus on companies’ operations, use of leverage and market timing in securing investment exits. The drivers of a firm’s past success may not win in the new world of greater uncertainty and volatility.
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Assess the management, leadership and culture of the fund manager. Pick managers you trust. Make sure your trust is reinforced by the trust these managers enjoy from people whose judgment you respect. Learn all you need to about the manager’s motivation, ambition and interests; about governance and sharing of incentives; and about the firm’s commitment to its own perpetuation.
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Confirm that as an investor you are prepared for the lack of liquidity that defines private equity fund commitments.
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Make sure that the investment works for you, as a taxable investor. Check investment objectives, tax efficiency and fund terms carefully. Many fund structures are optimized for the benefit of tax-exempt endowments and pension funds, who are pre-tax IRR driven and whose tax objectives thus don’t mirror yours. Understand fund governance, including the makeup, role and mindset of the advisory board.
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Private equity was surely not the only asset class whose reputation was challenged these past few years. Moreover, it is probably safe to say that purely debt-driven private equity investing is a thing of the past. There has emerged from the recession a savvier class of family and individual investors. The result – positive in our view – is that every investment manager ought to be prepared for tougher questions, and have sound answers to them.
