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Institutional Investor Profile: Catherine Lewis, Founding Partner, Proventure

Lewis on why Western Europe is the place to be, on the difficulties of fundraising, on the tightening of capital, on why many funds of funds will disappear and on the way in which many investors will lose money in private equity.

Set up at the end of 1998, Proventure is a private equity fund of funds advisor based in Switzerland and Finland. Its first fund closed at E110m and the firm is currently raising its second, European Fund Investments II, which is targeting E200m. Before co-founding Proventure, Lewis was at ABN Amro Capital Investments in Italy. She has also worked for Italian firm Sofipa, Cinven, EVCA and Venture Economics. She has 15 years' private equity experience.

What type of investments do you tend to look for?
‘We have a highly focused strategy. We are a niche fund of funds. We invest in small to mid-sized funds that raise between E100m and E500m and that have managers located in Western Europe. We don't look at Israeli managers, we don't look at Central and Eastern Europe and we don't look at US managers. We are very focused on Western Europe.

‘The reason for that is partly because our investors have quite well developed in-house private equity programmes, so they don't need our help to identify the larger buy-out players. They all know who Cinven, BC Partners or CVC are. They can go to those funds themselves. So we wanted to get down to the lower strata to an area in which the market is much less transparent. We can go down to a country-by-country level to dig out high quality opportunities that wouldn't have been presented to our investors. We are our investors' eyes, ears and legs in Europe. We can find opportunities that they might not be able to find for themselves and run around after those opportunities.

‘Our first fund has 17 fund investments and in our next fund, we aim to have between 15 and 20 fund investments - all in Europe. We reckon that the total universe of fund managers in Europe is about 800. There are probably 500 that fall within our criteria and from those, we have to pick four or five funds on an annual basis over the next five years. So we feel that there is enough opportunity in Western Europe without having to look elsewhere.

‘We also feel that in our chosen sectors - mid-market buy-outs and venture capital - the returns in Western Europe will be much more interesting than those in the US over the next few years. In buy-outs, there is still a lot of restructuring to be done. That process has already been completed in the US. You don't find many fragmented industries in there these days. In Europe, companies that our managers are looking at are finding that they have to expand to survive. It's a matter of expand today with professional help, or be swallowed tomorrow. There is a lot of impetus for these companies to take themselves to the next stage.

‘On the venture side, even though we agree that there are fewer highly qualified venture capitalists in Europe compared to the US, we do feel that there is excellent technology here, that there is a growing number of experienced venture capitalists in Europe and there is less competition overall. We feel that that combination means the opportunities in Europe will be much more interesting. We think that what happened in 1998, 1999 and 2000 was a bit of a false dawn for technology investing in Europe. In fact, we stayed out of the venture technology offerings in that period because we felt that it was too much, too soon. We thought that a lot of the groups coming into the market didn't have sufficient exit experience. But we have identified around 25 high quality venture funds in Europe and we want to get maybe five to seven of these into our portfolio over the next five years. So there is less opportunity generally, but there are high quality managers out there.'

How are your investments split?
‘Currently, we have 17 fund investments managed by 16 fund managers. Of that, 60 per cent is later stage and 40 per cent is venture. In terms of numbers, we have seven venture funds, two generalist funds and eight buy-out funds. Our second fund is likely to have a similar split by stage.

‘We haven't set a fixed allocation between venture and buy-out, although we believe that the portfolio should contain a mix of opportunities. We haven't set a geographic allocation, either. We don't go on a country-by-country basis and find the best fund in, say, the UK. We look at what is on the table everywhere in Europe and we go where we think the best opportunity is. Having said that, we have managers located in eight different European countries in our first portfolio. I think that we naturally get a good geographic diversification.'

What about direct investments?
‘We are able to invest up to ten per cent of the fund in direct investments. We can co-invest alongside our investee funds. That would typically be with buy-out funds rather than with venture funds because we look for companies that will come through to exit and provide a return in three to four years. The whole idea is to leverage the returns of the fund as a whole by selectively picking a number of direct opportunities. We won't invest if we can't find opportunities that fit our criteria and investment horizons.

‘We also do secondary purchases, up to ten per cent of the fund. And again, if we don't see the right opportunities in terms of discounts, then we won't invest. We have certain parameters that we set internally before we will make a direct or a secondary investment.'

What is your appetite for first-time funds?
‘If you look at the funds that we have committed to so far, many of them tend to be second or third-generation funds. That's because the founding partners are still heavily involved with the funds and the people that made the firm's track record are still there. We are less comfortable with more established groups that have become more institutional in their approach. They may have a very successful past track record, but it's not clear who will actually be making the investments in the new fund.

‘We will invest in first-time funds, but not first-time venture capitalists. If it's a spin-out situation, then we will consider it. If it's a group of people who have worked together within another institution, then we're very happy to look at the fund. We need to see some kind of track record and we need evidence of exit experience.'

What do you look for in a private equity manager?
‘We look for different things in venture and buy-out funds. On the buy-out side, we typically look at domestic plays. We look for managers that are very well entrenched in their local market with very developed networks with business leaders and entrepreneurs. That hopefully results in good quality, proprietary deal flow. We don't like funds that always go to auction. Some deals will, of course, go to auction, but we're not talking about the type of auction organised by the big investment banks.

‘We look for managers that are really able to add value post-investment. Everyone says that they do that, but very few actually do. So we talk to managers that a team has backed in the past to get an idea of what a firm or a particular person brought to the company. Apart from the quantitative checks that we have to do, we also want to understand how the managers behave and what value they bring. We don't just check one deal, we talk to a whole list of companies.

‘On top of that, our managers have to have a lot of exit experience. Everyone says that investing money is the easy part - I don't think that it is especially easy - but getting out is very challenging. So we look for managers with a long list of realised investments that show they can exit in a variety of ways.

‘On the venture side, it's rather different. We look very closely at the technological capabilities of the managers. That doesn't mean that all the venture capitalists have to be technology specialists, but we like to see financial experience mixed with scientific experience. So we'll look for people who have PhDs or technology company backgrounds. We also like our venture managers to have international networks, even if they are operating only in one country. They don't have to have offices in the US and Asia, but it helps if they do. They have to be able to demonstrate to us that they know enough about what is happening internationally. That's much more critical on the venture side than on the buy-out side. But again, value-added and exit experience are key.'

What puts you off an investment?
‘We will never invest in a one-man show no matter how fabulous that person is. It's too risky because that person could disappear for whatever reason. We only invest in teams. We see some very interesting proposals from teams that include one very high-profile individual, but we won't invest in them. We also see teams that present themselves as being broad and democratic, but when you look at the carried interest, there are only one or two people who receive any substantial share of that. We don't like that either. We like to see evidence that a firm has thought about what is going to happen in the future in terms of succession.

‘Less of a problem now, but something that we used to come across quite regularly was that fund sizes were often ridiculous for the type of investments they planned to make. So we'd see people with great track records in investing, say, E100m over five year suddenly wanting to raise E500m. I think that problem is less acute now and there are a lot of very good fund managers who can't get funding. That's a pity. These are managers who, under normal market conditions, would get funding.

‘There are a lot of details in the legals that would put us off. There are certain elements that have to be in there, such as key man clauses. We usually have to go back to general partners to get amendments and if a manager refuses on the grounds that other investors haven't asked for the changes, then we won't go ahead. This is a very risky business anyway and we need to be sure that we are protected. We want the legals up to scratch and we have actually lost a few potential investments that way. But we won't proceed if we are not comfortable with what we're getting into.'

What is the biggest mistake you've ever made?
‘All our partners are from the fund management community and our strengths lie in investment analysis. What we're not so strong on is fundraising. Our biggest mistake was that we stopped after we had raised our first fund. We have a very good relationship with our existing investors, but we didn't spend time going out to meet potential new investors for our next fund. The mistake that we made was to have an on-off fundraising process. We raised our first fund in three months and that gave us the impression, wrongly, that fundraising was easy. But we have learnt now that this is a business with two aspects: investing and fundraising. We're trying now to have a more continuous fundraising effort.'

What are the main barriers to private equity investing?
‘I think the barriers depend on where an investor wants to be. If an investor is happy to achieve index-style returns, then they have a lot of options. They can invest with the large funds of funds or they can invest with large pan-European offerings. But if they are really focused on returns, then we believe that they are going to have to get down to the level that we invest. It's very difficult and it's time-consuming. Investors typically have only a small proportion of their total assets allocated to private equity and they generally don't have the time to devote to travelling and finding the best local teams.'

What is the biggest issue in the private equity market?
‘Yesterday, I would have said that the biggest issue in the industry was fund sizes. But today, I'd say that the issue is the tightening of capital. There are a lot of good fund managers that aren't getting funded and by extension, there are a lot of good companies not getting backed. If you go back three years, everything in the technology space was great and now everything in the technology space is terrible. I think that the truth lies somewhere in between. Many venture portfolio companies are not going to survive in the current environment. That will change - we're just seeing an over-reaction to an excessively hyped market at the moment. It will take time for it to change, especially if you judge it by what is happening in the public markets. But I hope that we will see a return to normality over the next two to three years.'

How do you think that the industry will change in the future?
‘There will be some kind of shake-out. The number of firms in existence will decrease. It won't happen quickly because most firms raise funds that have a ten-year life. Over the medium term, you will see fewer new people coming into the industry for the first time because the conditions aren't right for them to raise a first fund. Some of the people who raised their first funds over the last three years will raise one fund and that is it. That's not a bad thing. If you look at EVCA data in terms of funds raised, investments made and total number of firms, there was always an implicit assumption that the fact that these figures were increasing was a good thing. I don't think it is. I know that the amount raised in Europe is only a quarter of that raised in the US and that the GDP is roughly the same between the two regions, but Europe doesn't have any many opportunities as the US.

‘There have also been a lot of funds of funds coming into the market. We were the first fund of funds in the Nordic region when we set up. It's amazing to see how things have changed now. A lot of the newer funds of funds have been institutionally sponsored. Institutions have a nasty habit of changing their mind about private equity when things aren't going well. Private equity is typically an add-on for them rather than a core part of their strategy. A lot of these institutionally funded funds of funds have great distribution powers, but many of the people running them don't have a great deal of private equity experience. So I'm not sure that there will be a commitment over the long term from these groups and many will disappear. It's also worth noting that what we're going through now has the same feeling as the last recession a decade ago. People were saying the same things then and doing the same things. A lot of people were piling into private equity when times were good. When the environment changed, a lot of people piled back out again. That's a surefire way of losing money in the asset class.

‘Funds of funds are the fastest-growing area of the market - I just hope that most of them live up to their promises.'

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