PRINT THIS PAGE

Institutional investor profile: Philip S Paul, Chairman, Paul Capital Partners

Paul on the outlook for US early stage, on the lessons that GPs have learned over the last few years, on who is selling in the secondary market and on the impact of negative media coverage on the industry.

Established in 1991, Paul Capital Partners manages funds of funds and secondaries funds as well as running a fund that acquires healthcare royalty streams. The firm is the result of the acquisition of limited partnership interests from Hillman Ventures. With offices in California, New York, France and Switzerland, the firm has $900m under management through its two funds of funds vehicles. Its fund of funds investment focus is primarily on early-stage Silicon Valley venture capitalists, although it has a handful of commitments in European funds. Paul founded the firm and previously managed the direct and fund investments of Hillman Ventures.

What is the focus of your fund of funds activity?
‘Our funds of funds are focused on early-stage venture capital. It's a narrow focus and it has developed as a result of the relationships that we have had over the last three decades with the top tier venture capital funds.

‘Our fund investments are based primarily in Silicon Valley, and I would say that 90 per cent are US-based. The rest, which are based in Europe, are funds that we have built relationships through the secondary business.'

What is your outlook for the early-stage venture capital market?
‘We are very optimistic about early-stage venture capital - that is where our experience has been and that is where you fund the top-tier managers in the venture capital segment.

‘The whole industry, across all the segments, has been through a very difficult two to three years. But despite that, we believe that the sins of the past have been washed through the system. We're back to the point where valuations are reasonable, deal flow is outstanding, entrepreneurs and management are available. The climate is now back to normal - and that's exciting. People will look back on this time-frame and say that now was the time to be investing in early-stage venture.

‘No-one knows when the IPO market will open up, but things are turning more positive. The fact that the IPO market as an exit strategy isn't strong right now isn't that relevant if you have long-term horizons.'

How would you characterise this down-turn in relation to others you have been through?
‘I would say that this one is worse than previous ones I have seen. The excesses in the years 1999 and 2000 were so much worse. I've been through a number of cycles, but this one was unprecedented. Deals were getting done carelessly, the valuations were silly. The whole investment psychology became one of flipping - and that's not what this industry is about.

‘As a result, we will take longer to reach a recovery point. It is beginning now, however. As I attend venture capital board meetings these days, general partners talk candidly about the valuations they are carrying companies at and I can see that they have faced the realities of their mistakes. They are no longer talking about taking further drastic write-downs and they are still sanguine about when they will be able to turn around and exit their investments.

‘An indication that times are more normal is that fund sizes are creeping down to reasonable levels. Many GPs are talking about raising around half of their previous funds and, in some cases, much less. Another corollary to that is that GPs are taking a very thoughtful and deliberate pace in their investment pace. There is no rush any longer to beat other firms to a deal.'

Do you think that firms have genuinely learned a lesson from this?
‘There are always going to be cycles, but I think they have learned lessons. When I hear how candid discussions are among GPs, I can really see it. They know that they have made mistakes and they will be very careful about not making the same ones again. They don't want to get burned as badly as they have been over the last few years. Having said that, there will always be exceptions.'

And what about your secondaries portfolio?
‘We like to target secondaries opportunities that are not subject to auction. We like to target those in which we can work out a creative deal structure so that it is a win-win situation for both buyer and seller. That means that we generally avoid huge portfolio sales or, if we do get involved, we attempt to acquire categories of assets.

‘There is an enormous amount of assets for sale. We are seeing deal flow across the board and a lot of it is confidential. We are seeing assets of financial institutions up for sale and we're also seeing a lot of deal flow from corporations, plus endowments and universities that are trying to correct their overall allocations. We are talking confidentially to a number of institutions that don't want it known that they are getting out of private equity, but they need to sell of parts of their portfolios.

‘We are also seeing public pension funds looking to reduce the numbers of GPs in their portfolios. The downturn has caused all institutions to rethink their strategies. Many have learned that they shouldn't spread their investments across a broad range of GP relationships; they now believe they need to be more focused.

‘There is a bigger deal flow in the secondary business than there has ever been in the past.'

How much has increased competition in the secondaries market affected you?
‘The increased competition has certainly affected the market as a whole. There are now a significant number of players - vastly more than when we set up. There is also far more money in the market. Secondaries used to be very inefficient, but that is becoming less so as the competition increases. The other thing to say is that just as we have become more sophisticated in our approach, so have our competitors. There are some smart competitors out there and I think that's the sign of a healthy market.'

Do you think that there is too much money in the market?
‘I don't think there is too much just yet. The reason I say that is because the deal flow right now is staggering. And I don't see it slacking any time soon. So, while there is a lot of money, there are a lot more transactions out there to be done.'

What do you look for in a manager?
‘We look at track record - not only that of the firm but, more importantly, that of the individuals. We look at each person's participation in a fund, the deals they have done, the value they have created in individual businesses. But remember that we tend to invest with people that we know well already and so we will tend to have a lot of the information we need before a fund comes to market.'

Does that mean you wouldn't look at first-time funds?
‘The only way that we will look at new funds is if it is a spin-out from a group that we know well and have a lot of respect for. We see these as a great opportunity for us. But otherwise, we don't look for new firms to add to our portfolio. That's not our mission.'

What is the biggest mistake that you've ever made?
‘We have made mistakes in acquiring direct investment portfolios. The problems occurred because we underestimated the amount of time and capital that these developing companies would need. Hopefully, we have learned our lesson from that.

‘It's a difficult thing to judge, though. You really have to triangulate with investors in your due diligence process, since they have been in the investments longer and have a historical background. It's very important to tap into their knowledge rather than looking at as a new investment and coming to your own judgment.

‘We have also made one or two mistakes getting involved in auctions and we simply won't do that any more. We believe now that it takes much more sophistication than an auction process allows to do a successful secondary deal.'

What irritates you about the market?
‘On the funds of funds side, we have found it irritating over the years to cope with the arrogance of some general partners. It takes a big ego to be a good general partner. But it is very irritating when those egos run amok and aren't open to suggestions or other inputs.'

What is the biggest issue that the market faces?
‘I would say that the biggest issue at the moment is that firms are continuing to suffer through difficulties caused by past actions. The headlines - which is what the general public sees - are going to continue to be negative for the venture capital industry. We just have to bear up under what we know is going to be a continuing stream of negative media reports. This is all despite the fact that the current environment is actually very positive for venture capital. We all just have to continue thinking over the longer term.'

How do you think that the market will change in the future?
‘I think that the market will change in three ways. The first is that the market will face up to the fact that serious mistakes were made and that lessons need to be learned. These lessons are already in evidence in a slower investment pace - that is a very positive change.

‘Secondly, and related to my first point, is that the amount of money that is thrown at the industry will be less than we saw in the late 1990s. The industry has learned that there is a limit to the amount of money that can be deployed sensibly in early-stage opportunities. There may not be a definable limit, but we know that it was too much in 1999 and 2000.

‘And thirdly, on the exit side of things, the private equity and investment banking communities will need to be very careful about when to take nascent enterprises public. I think the broader industry has learnt a lesson there - everyone from the lawyers, to the firms, and the investment bankers.'

Copyright © 2003 AltAssets