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Institutional investor profile: Rafael Astruc, Partner, and Rob Voeks, Managing Director, Private Advisors

Astruc and Voeks on the definition of proprietary deal flow, on the opportunities and threats in the US mid-market, on buzzwords and operational experience and on the increasing importance of value-add.

Private Advisors was set up in January 1997 by Rafael Astruc and Chief Investment Officer of the $1bn University of Richmond endowment fund Lou Moelchert. The firm is based in Richmond, Virginia and currently has $1.4bn under management through several alternative investment funds of funds, of which two-thirds is invested in hedge funds and a third in private equity funds. It is in the process of closing on approximately $100m for its second fund of funds targeting the lower end of the US mid-market. The target size of Private Advisors Small Company Buyout Fund II is $250 MM. Astruc was previously a mergers and acquisitions advisor for regional investment bank Matrix Capital Markets Group. Voeks joined the firm in 2000 also from Matrix.

What type of investments do you look for?
Astruc: ‘Our focus in private equity is entirely on US mid-market buy-outs at the lower end. We define that as companies with an enterprise value of less than $150m. The majority of the transactions in this space are less than $100m. That translates to fund sizes of $80m to $500m.'

Why do you focus specifically on this area of the market?
Astruc: ‘The reason we focus on this area has to do with the value orientation of Private Advisors. This part of the market is significantly less efficient than larger buy-outs primarily because there is much less capital focused on smaller deals. As a result, according to several Independent sources, long-term returns are 500-700 basis points per year higher than larger transactions. We want to create niche products that are significantly differentiated from our fund of funds competitors. The other reason, of course, is that this area fits perfectly with our backgrounds.'

Voek: ‘From a direct experience perspective, since we both worked in the market from the transaction side, we were able to observe a lot of the inefficiencies at the smaller end of the market. Consequently, we saw that there were tremendous opportunities for investing in this space.'

Astruc: ‘It's a good point. When I was at Matrix, I had a reasonable amount of success investing in several of these management buy-outs alongside private equity sponsors. I found that we were able to purchase companies with a strong management team, led by a strong equity sponsor, brand name products, consistent profitability, all for a very low multiple. That proved to me that you could make significant returns in that sector of the business.

‘That experience, and the networks we have built up as a result, give us an edge when we come to committing to a fund. If we tried to invest with a large buy-out fund, say, we wouldn't have that edge. We also believe that we don't add any value for our limited partners if we simply invest in these larger funds. They already know about these funds and they could commit to them themselves if they wanted to. We're not necessarily selling access to our limited partners, we are selling them manager selection in an area they may not know so well and we're also selling portfolio management. It takes a lot of time and effort to build up a diversified portfolio of funds in this space and we believe we have an edge in evaluating the partnerships.'

How would you characterise investor appetite for this part of the market?
Voeks: ‘What amazes me is that, just five years ago, if you had a $250m buy-out fund, you wouldn't get the time of day at a placement agent. Now, placement agents are actively looking at that end of the market and are representing these firms. That is an opportunity and a threat for us.

‘The opportunity for us is that institutional limited partners may see these groups and believe that they should be investing and yet they may not have the resources or contacts to conduct thorough due diligence on them. We can do that because it is our job and because we have these networks to draw on.'

Astruc: ‘It is potentially a threat for us because the placement agents are so good at getting the crowd in. Partnerships that may have previously had difficulty getting funding because no-one really knew about them are sometimes now ending up oversubscribed or are admitting investors on terms that we don't believe to be favourable. We have seen some groups that have great management teams and that we would be happy to back if it weren't for that fact that we feel they have raised too much money and have set terms that don't completely align their interests with those of the limited partners.'

How do you source opportunities?
Voeks: ‘If we start from the top, we have identified 425 partnerships that operate in the lower end of the mid-market. We have developed this as our proprietary database. ‘We are pretty sure that we see all the PPMs across our desk, but where we really generate deal flow is through our networks and through our previous experience. We have calculated that, in 75 per cent of instances, we were aware that a fund was coming out to market before we received a PPM.'

Astruc: ‘We are extremely proactive in terms of contacting fund managers well in advance of their fundraising. That way, we are not only able to ascertain whether the fund fits in our space, but also whether or not we are interested in their fund at a very early stage. This means that we are able to negotiate terms and that we are able to take an advisory board seat, despite the fact that we are not always the largest investor in a fund.'

Voeks: ‘We also take an unusual approach to sourcing opportunities in that we will attend trade shows for, say, business brokers. The interesting point about that is that these trade shows are not targeted at institutional investors and so we will usually be the only ones there. Other than that, we use the traditional sources, such as trade publications, endowments and foundations we have good relationships with, competitors we have respect for, investment bankers, etc.'

Your past experience would suggest that you make co-investments…
Astruc: ‘Yes, we make co-investments. We invest up to ten per cent of our fund this way. But we are very selective about the investments that we choose. We generally work with equity sponsors that we have had some kind of business relationship with in the past. One thing that we insist on is that it is a meaningful position for that private equity sponsor. That way, we know that the firm is going to spend an adequate amount of time and energy on the transaction going forward. Other than that, we would look for a brand name, consistent profitability, recession-resistance, opportunities for growth, conservative capital structure, defensible market position, diversified customer base, a very reasonable multiple. It's very difficult to find opportunities like these and to access them. But we have done a few of these.'

And what about secondary positions in funds?
Voeks: ‘We do look at secondaries. We have submitted bids on a few, but we are not going to pay up in what we consider to be a very heated secondary market at the moment. Where we have a relationship with a GP and where it is a quiet sale, we would be interested. But we are not going to get involved in situations that are 50 to 70 per cent paid-in, five years of maturity on the fund - that portion of the secondary market is very efficient right now. There are enough players out there circling this area and new firms. Many are even getting investment bankers involved.'

What do you look for in a private equity fund manager?
Astruc: ‘In our core positions, we'd be looking for managers that have been together as a team for five to ten years successfully executing their strategy over that time. We also look for managers that have already made significant realisations in their portfolio. We like to see some kind of edge, operating expertise, some methodology to increase earnings across the life of the investment - that is becoming increasingly important.'

Voeks: ‘The other point is that we keep a careful eye on how the team sources transactions. You hear the phrase “proprietary deal flow” bandied about all the time, everyone seems to have it when they are out raising money. So we'll go through their deal log, company by company, to see where they are sourcing their deals. That is the only way that we can see which of their deals really are proprietary. There has to be something unique about the partnership in the way in which it approaches this. There is a pyramid. If you are the only person involved in a deal, then that is purely proprietary. If you are in a beauty contest, then that is semi-proprietary. If you are getting a book from any of the bulge-bracket firms or the boutique M&A shops, then you have to have a really good story as to why that is proprietary.'

How do you judge a team's operating experience?
Voeks: ‘There is a lot that has to be learned by the private equity industry about how operational models work. Currently, there is not a “one size fits all” solution. You have the operating partner model, you have the executive counsel model, then there are the networks of 50 to 100 people that you can call on and then you can just call on a consultant. Firms can claim anywhere in that continuum that they have an operating model. It's our job to distinguish which people use this phrase as a buzzword and which actually do what they say. There are plenty of people who have common sense techniques for operations that work great. We are not going to penalise them just because they don't have a buzzword.'

Astruc: ‘There are a number of methodologies to fit that definition of having operating expertise, but at the end of the day, what we are looking at is how the expertise that they claim to have has been effected on portfolio companies. Have they executed by adding value at the company level? That's what it comes down to.'

What is the biggest mistake that you have made?
Astruc: ‘What kills managers is concentration and leverage. Our biggest mistake was to invest with a group that thought they were going to raise $500m, but ended up only raising $140m and then concentrated that portfolio in one company. The company then experienced difficulties. The good news was that the LP base took over the fund because we lost confidence in the GPs and managed to stabilise the asset. We will likely come out ahead when we sell it. The bad news is that it was problem that could have been avoided simply by not allowing them to invest based on anticipated capital being raised. Also, since we played a very active role taking over the partnership, we spent a tremendous amount of time and effort on it.'

How do you think that market will change over the future?
Voeks: ‘I think that, in the wider private equity market, the pendulum is swinging towards LPs to the extent that the market will establish terms that are better in the long run for both GPs and LPs. That process has been underway for the last couple of years and it will continue.'

Astruc: ‘On the investment side, the ability to add value at the portfolio level, beyond providing capital is going to be crucial to success in terms of generating attractive returns going forward.'

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