PRINT THIS PAGE

Institutional investor profile: Fabrice Lepeltier, Partner, SG Asset Management

Lepeltier on the importance of in-depth industry knowledge, on the relationship between limited and general partners, on why limited partners should talk more to each other, on not-so-smart money and on the drawbacks of investing in independent groups.

SG Asset Management, based in Paris, is the investment arm of French bank Société Generale. Its private equity division manages direct investments and so far, has one fund of funds with E150m under management. It is currently structuring a second fund of funds with a target of between E400m and E500m. Lepeltier is responsible for monitoring direct investments and for managing SGAM's fund of funds. He was previously manager in the corporate finance arm of Andersen France and before that, worked in internal audit at Société Generale.

What type of investments do you look for?
‘Our current fund of funds is invested mainly in early-stage venture capital funds, with a focus on IT and with some in life sciences and healthcare. We thought of it mainly as a business development tool. So we invested in limited partnerships, partly to cater for specific interests of investors and partly as a way of creating a VC community and to help our direct investment arm with their deal flow. To date, we have invested in 14 funds. Four of these are in the US, the rest are all over Europe: in Spain, Italy, The Netherlands, the UK and we have a core fund investment activity in France to help us generate co-investment opportunities.

‘We are now in the process of structuring a second fund of funds. Our investment strategy with that will be wider in that we won't focus purely on venture capital fund investments. We would like to invest in some venture capital, but we will also commit to buy-out funds, LBOs, turnarounds, etc. It will be a global fund of funds, so we will add Asia to the regions in which we invest. We will be working alongside TCW (Trust Company of the West in LA) on this. We acquired TCW last year and so there is room for some cross-fertilisation between the two groups. We would like to ensure that we are also well diversified by vintage year. This is very important when you consider that the funds have a ten-year lifespan. We will have no less than three vintage years in that fund of funds and we will also look at secondaries to help ensure that we get that level of diversification. Our target for the fund is around E400m or E500m and our tentative plans are to start fund-raising at the end of 2002 and to start investing in mid-2003.

‘In our type of organisation, the fund of funds is like a backbone. I meet many teams, many management companies, many funds. I am in a position to have a very good knowledge of the industry, so I can pass on that knowledge to our teams here. So, for example, if I find out about an IT fund, for example, I can share the information with our direct team and they may even be a co-investor for one of our direct investments. Our rationale is this: we want to serve our investors in the fund of funds, but we can also use the data that we gather to help us on our direct side. This creates value for our direct investments. So we have to have fund of funds skills, but we also have to be corporate financiers, to think of the mergers and acquisitions opportunities that may exist in each of our fund investment portfolio companies. We are very proactive and hands-on.'

Do you invest in first-time funds?
‘Yes. In fact, we invested in several first-time funds from our first fund of funds. They had a good strategy and they fit with our aim of boosting our local French deal flow. They invested in small, entrepreneurial businesses and had a good network through their connections with universities and research institutes.

‘You do have to look at first-time funds differently because the managers may be very naïve about the private equity world. But I see this as part of my role. We will invest in first-time funds if they have a good knowledge of the industry or technical expertise. It's up to us to ensure that they have a good understanding of the whole picture. I can work with this type of fund to ensure that they have the right systems and structures in place. New funds are similar to a start-up - they expect smart money from investors. I try to deliver smart money in that I can give them advice, I can introduce them to my contacts. It's a two-way relationship.'

How do you find out about good investments?
‘As a part of Société Generale, we have a good brand recognition in the wider financial community as well as in the private equity world. We have a global network, which means that we have a good level of deal flow in our direct investing business or in our fund of funds. I get sent hundreds of prospectuses, I receive e-mails and phone calls every day from funds looking for investors. I travel extensively, I meet hundreds of teams and so I think that I have a good network. We have no problems with deal flow.'

What do you look for in a private equity manager?
‘We like teams that have an in-depth knowledge of the industry they are investing in. I don't want financial managers; I want industry people. If some members of the team have a financial background, that's fine - there is plenty of reporting to do, after all. But I want to see industry experts. That is especially important in the areas that we focus on. You need industry expertise to invest in biotech, in IT and in telecoms. We're looking for ten to 20 years' experience in the major names, such as Intel, IBM, etc. But it's not just experience. We look for people who have a vision of what will happen over the coming years.

‘I look for people who have already shown a consistent track record. The overall track record, even if it's a good one, is not a recipe for success in the future. I see so many funds that have a good track record, but when you look more closely, you see that it is the result of one investment - the rest haven't done well. I always want to see a good representation of a fund's successes and failures. I'm not interested in one-hit wonders. You have to look at the failures as well as the successes. You have to find out why investments have failed - I always ask general partners. I need to benchmark a fund's investments against our own direct investments.

‘The other important thing is the way in which they view their relationship with investors. I always ask managers how they believe that the relationship should be between general and limited partner. It's an open question. I want to hear what their experience has been in managing the relationship. I want them to show me some transparency. I want them to show me their capacity to answer my phone calls and my queries. I want to be hands-on and proactive and have the door constantly open. Of course, they can tell me anything, but they need to demonstrate to me that they are organised in a way that enables them to answer any questions I may have. I look for general partners who are comfortable with this and have incorporated this level of investor involvement into their philosophy.'

What's the biggest issue in the private equity industry?
‘As a fund of funds player, I see so many funds that I see the huge disparity between the best and the worst practice everyday. The key word for me is transparency. You have to have regular contact with the fund you have invested in and they have to report back to you. You need to get the right information. It's not complex. We have the EVCA guidelines and I try to get everyone to comply with them because I have to comply with them. We use them as an internal standard and I have to show my shareholders that we are compliant. Funds are often pretty receptive if we have an issue. We had an investment in a US fund, for example, and we found that its reporting wasn't satisfactory for our needs. So we talked to the managers, asked them to understand my needs better and showed them the EVCA guidelines. They have since adopted these reporting standards and things have really improved.

‘The other big issue is that funds of funds are a disparate group. Fund investors need to get together to discuss problems. We all share similar problems and concerns in areas such as reporting and the restructuring process - we are going through some restructuring of investee funds. If you are invested in a company, you have to meet regularly with your fellow investors to discuss the business. Funds of funds should be doing the same thing. I should know my peers, my co-investors. If you ask for a quarterly report from a fund that normally reports twice a year and you are the only one asking, you won't get that far. The more investors you have asking for improvements, the more you will see them happening. But the fund of funds industry is still relatively immature in Europe. I know my peers in Paris - we have set up an informal network to share ideas and concerns - but I don't know that many investors throughout Europe. On the Continent, funds of funds are used to working on their own and negotiating unilaterally. But now that we have some serious issues to sort out, we should all be talking much, much more to get them sorted out. It would mean that we could be much more proactive.

‘One of the big issues that we need to sort out is the restructuring of the VC industry. We need to sort out our views on what should happen if, for example, one of our funds is going through difficult times and it has called 20 per cent of the capital, but still has 80 per cent to deploy. We should be getting together to stem the crisis and talk to the management. Together, we would stand more of a chance of capping the fund at 40 per cent of committed capital to help refinance the companies worth continuing with. This type of process is hard. You have to know the other co-investors and agree with them. You need to get, say, an 80 per cent agreement to liquidate the fund or to cap it.'

Are you seeing a lot of restructuring among venture capital funds?
‘We haven't been in the position where we have needed to liquidate a fund as yet, although there have been a number of instances reported in the press. However, we are talking to general partners about restructuring their funds. One of our funds, for example, is going through this. But the general partners have taken a very pragmatic and sensible course in this. They had a medium to long-term view. They had already launched their fund but realised that the environment had changed since they had started raising. They kept us informed and we have agreed to a restructuring. They realise that they have to keep their investors happy - not just their existing investors, but they know that they have to show to new investors that they may wish to attract in a future fund that they reacted in the right way. One of the reasons that they have been so responsive is that they are semi-captive and so have had some pressure from their main sponsoring organisation.

‘We have another fund in our portfolio that we would like to do the same and we are in discussions with the other investors about what the best course of action will be. I would like to liquidate the fund because its strategy is no longer valid, the portfolio is not performing and the investments do not match the original strategy outlined in the PPM. The team is also way too dependent on the management fee. But what leverage do we have with this very independent group if we can't get agreement with the other investors?

‘I think that is one of the advantages of investing in funds that have a main sponsor. Totally independent funds can be good in that they have the freedom to invest according to their own predetermined strategy. But when things go wrong, it can be very helpful to have one large investor in the fund so that you can easily gather together the 80 per cent majority and get agreements - the general partners are much more receptive to investor pressure because their professional lives depend on it. That is much harder with an independent fund. Overall, I'd say that independence is good, but not too much.'

What has been your biggest mistake?
‘I've only been running this fund of funds for 14 months and so I haven't really made any big mistakes yet.

‘I suppose one big mistake might be not considering a key legal point until the last minute. This can cause big problems because you find that, at the very end of the process, there is a deal-breaking clause. I am very keen on getting the tax and legal due diligence - you may find right at the end of the investment process that there are some incompatibilities between our requirements and the fund's legals. Private equity is becoming more and more complex. Sure, you have the “plain vanilla” type of product, but the industry is also trying to develop hybrid products that include some hedge funds, and you may find that causes stumbling blocks at the end, even if every other aspect of the team is good and the fund's strategy fits exactly what you are looking for. A fund of funds is a process, a methodology and that requires you to be supremely organised.'

How do you think that the private equity market will change in the future?
‘It has already changed to a certain extent - the more proactive, operational funds are maintaining a closer dialogue with their investors and are providing greater transparency.

‘There has been a lot of criticism about venture capital firms. People have said that they have not acted professionally, that they did not have the right structures in place. But I think that the blame lies in part at the doors of investors. They gave money blindly. They did not get involved. It was not smart money. It was a case of new investors giving money to new, inexperienced teams and as a result, the expected prosperity hasn't been delivered.

‘I'm not sure that this experience will have matured the market much, either. All this has only happened over the last few years - it will take much longer for people to become more experienced with private equity. This is a specific market, with specific problems. There is no organised market, there is no transparency, there is no index, there is no benchmark. The major trends that everyone should wish for are increased transparency, more organisation, the development of benchmarks validated by independent organisations. Every year, certain organisations publish studies telling us about the IRRs achieved, the amounts invested, etc. But we just don't know what methodology they use. That's not a valid benchmark. Look what happened with Calpers. When it published the actual performance of funds, it created trouble. The private equity industry in Europe is going through growing pains. What is lacking now is a kind of organised move towards maturity. We won't have that until we have transparency and benchmarks.

‘Again, I don't think that we will achieve this unless investors talk to each other. The private equity market is made up of very independent people with independent minds and that is a bit of a problem. By working together, funds of funds have a key role to play in pushing for increased professionalism and maturity in the market. All parts of the private equity market can benefit from this. It's a win-win strategy.'

Copyright © 2002 AltAssets