Kellogg Conference Notebook: Notes from LP and PE Future Panels

The following was written by Joel Stanwood, a 2nd year MBA at the Kellogg Graduate School of Management. Joel has worked with two private equity growth-oriented funds, focusing on consumer products and healthcare/financial/business services. Prior to Kellogg, Joel served in strategic, operational, and general management roles at Siemens, was recruited into the firm’s international management development program and is certified as a Lean Six Sigma Black Belt.

Headlines from the “Limited Partner Perspective” Panel

• Brett Gordon, Managing Director, HarbourVest Partners LLC
• Jonathan Harris (KSM ’99), President, Alternative Investment Management
• Ross Posner (KSM ’92), Director of Private Equity Group, Allstate Investments
• Shawn Wischmeier (KSM ’02), Chief Investment Officer, Indiana Public Employees Retirement Fund
• Andrew McDonough (Moderator), Partner, Co-Chair Private Equity Practice, Winston & Strawn LLP

* There will be a confluence of fund-raising activity in the back half of the year, as funds who pushed out 2009 launches meet those who had originally planned to begin fundraising in 2010

* Watch for a bifurcation of “winners/losers” as LPs decide where to allocate

* Distressed investing will benefit from the business cycle for a while yet

* Watch the general partners who are skilled at growth recaps outperform their peers

* The Volcker Rule will create a significant buy opportunity in the secondary market

* The balance of power will shift to LPs – watch for changes in partnership agreements (e.g. key man clauses)

* Although LPs are watching management fees closely, there will be little pressure on the 2-20 arrangement in the lower middle market

Headlines from “An Industry in Transition: What the Last 24 Months Mean for the Future of Private Equity”

• David Chapin, Strategic Development Partner, Ropes & Gray
• Ross Gatlin (KSM ’93), CEO & Managing Partner, Prophet Equity
• William “Bill” V. Glastris, Jr. (KSM ’84, NU ‘82), Founding Principal, Prospect Partners
• Kelvin Walker (KSM ’86), Partner, 21st Century Group LLC
• Andrew Ross Sorkin (Moderator), Author, Too Big To Fail; Chief Mergers & Acquisitions Reporter, The New York Times

* Before the crisis, general partners boasted about their “velocity of capital deployment” – how did the industry lose focus on the key metric of absolute returns to investors (net of fees)?

* On the Volcker Rule: Financial institutions should be encouraged to keep investments on their balance sheet, which would then drive prudent behavior and high-quality investments

* Investors in the lower middle market still have little access to senior debt; they have been innovative in closing deals in 2009 (e.g. financing using seller notes)

* The lower end of the middle market still offers the most opportunity for alpha/value creation in terms of market inefficiencies and dislocations

* Prophet Equity recently closed an oversubscribed inaugural fund by solving five key dysfunctions in the private equity landscape; below are the firm’s structural differentiators:

1. Promotes operating experience within the general partnership to allow for superior operational due diligence prior to close and improved probability of investment success
2. Guarantees a commitment to the lower middle market by placing a hard cap of $250mm on Fund I and also committing to a hard cap on future Fund II
3. Distributes carried interest to everyone in the firm, which focuses the entire team on delivering alpha vs. beta management
4. Lives by a set of 10 Operating Principles which promote win-win partnerships with investors, management teams, and within the investment team
5. Principals commit a large dollar investment to ensure alignment of incentives with the Limited Partners