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Institutional Investor Profile: Catherine Lewis, Founding Partner, Proventure

Catherine Lewis on the stages of Proventure's investment selection process and her experience with GPs. Lewis co-founded Proventure in 1998 because she and her colleagues felt that there was a gap in the market to raise a fund of funds from institutional investors - mainly in Finland and Scandinavia - that would focus on investing in small and mid-sized funds. The founders developed a concept for a fund of funds that could deliver a unique service to investors and result in high returns. Proventure is located in Schaffhausen (Switzerland) and in Helsinki and has five partners: Lewis, Turo Levänen, Ulla Niemelä, Ari Jauho and Samuli Sipilä.

Lewis has been in private equity for 18 years. In 1987 she joined Venture Economics, then went on to Cinven in London before moving to the European Venture Capital Association in Brussels, where she was head of marketing for four years. Lewis also worked for Sofipa and ABN AMRO Capital Investments in Italy, before founding Proventure in 1998.

What exactly is Proventure's strategy?

'The investment strategy is to invest in small to medium-sized funds, that is funds raising between €100m and €500m. Our bite size is €10-20m. In Europe historically the best returns have come from funds with that size. We avoid the large buy-out funds and the auctions market.

As a fund of funds we are looking for a broad diversification across sectors. Although we do consider sector-specific funds, investing with them would be the exception rather than the rule.

Most of our buy-out managers are looking to put together portfolios consisting of up to ten companies and they would be in various industry sectors. The sectors are to some extent a function of the market they are operating in. For example, in the UK market there is not such a great manufacturing base, which means that the emphasis in the UK tends to be on business and consumer services. If you are investing in a fund in continental Europe, specifically Germany or Italy, you will see more industrial sectors represented within a portfolio. Overall we are looking for a mix of all those sectors.

From its beginning the focus of the firm has been Western Europe. I think, going forward we will eventually define Europe as the new Europe but for the foreseeable future we expect to make the majority of our investments in Western Europe.

We tend to be concentrated on the more mature private equity markets in Europe: UK, Germany and France. However, we invest across Europe and have completed investments in nine different European countries to date. We aim at a geographic diversification but we do not have any pre-set targets as far as allocation is concerned.'

How many funds of funds have you raised to date?

'Proventure has two funds of funds under management and also manages three separate accounts on behalf of institutional clients. Currently we have €1bn of capital under management.

Proventure has raised two funds of funds, The First European Fund Investments and European Fund Investments II with circa €200m of committed capital. When we reach the threshold of 75 per cent of capital committed by the second fund of funds we will start pre-marketing a new fund, which will probably happen later this year. We expect the new fund to be larger, in the area of €250m.

The main difference between the first two funds and the fund that we are going to launch is that the first two funds did a small element of venture. We have now decided to separate out venture and buy-out fund investing, and our next fund of funds will be purely focused on investing in mid-market buy-out funds in Europe. Later on in the day we may launch a separate venture fund of funds. This is in alignment with our clients' current requirement for either pure buy-out or pure venture vehicles. They prefer to define their own buy-out/venture allocation internally. They appreciate that buy-out and venture investing are impacted by very different drivers and cycles so both theoretically and practically it does not make sense to combine these into one portfolio.

We have 20 funds in the first fund's portfolio and we are still building the portfolio for the second fund of funds, and we expect to have 15 to 20 general partners represented here when the portfolio is complete. If you add our separate accounts, we have invested with 60 different general partners to date.'

How does your investment process work?

'Our deal sourcing might be a bit different compared with our competitors. We spend a lot of time "on the road", trying to seek out opportunities. This is a very vibrant market and new players are coming to market all the time. We are interested in finding out - country by country - who is coming into the market, who is already in the market, and who are the best performing in their respective markets. Proventure also has good contacts with the intermediaries and placement agents. Deals also come in through our "open-door policy", which means, we are happy to see anybody who wants to visit us as long as their strategy is broadly within what we do with our funds of funds and our separate accounts.

In terms of the process, any fund that is out fundraising and wants to raise money from us is asked to complete a short questionnaire which they can download directly from our website. That questionnaire then generates automatically for us internally what we call a quick-scan report, and it is that first-scan report that we use as the basis for our first screening in our pipeline meetings, which we hold about once a month.

Many potential investments get screened out at this stage, and we categorise why we reject proposals. The reasons for rejection could be management (the level of experience within the management team is considered as insufficient), strategy (we do not believe that the investment strategy is appropriate at this time in that market, or perhaps there has been strategy drift within the firm), terms and conditions (we like to see fairly standard market terms and conditions, and they should not differ from that too much), performance (past track record has to hit minimum hurdles for us before we would take a proposal to the next stage).

If the proposal still looks interesting, our next step is for one of the partners to meet the team - either at their or our offices. Once we have had that meeting, the partners decide in the next pipeline meeting whether to go into full due diligence. If we do go into full due diligence we allocate two partners for the commercial due diligence and one of our partners, Ulla Niemelä, always does the legal due diligence in-house. Effectively, we have three partners working side by side on each and every proposal as we progress through the due diligence process. The shortest time this process can take is a month but that is really pushing it. It can, in the other extreme, take up to a year, if that is coinciding with a fund getting its first closing together. The typical range is between three and six months.

Once we are substantially into due diligence, we have a two-stage approval process which is documented by the preliminary investment recommendation, which is presented by the partner assigned to lead the due diligence to the investment team at the pipeline meeting. Once passed this screening, a final investment recommendation is prepared and an investment committee called to discuss the full results of the due diligence process. If the final investment recommendation is approved by all the partners, then we finalise the legals with the underlying funds and take up references. The level of reference-taking depends on how well-known a particular manager is to us. References obviously play a particularly strong role when we invest with managers that we have not invested with before. In the process, most managers will send you a list of referees but that is not necessarily who we contact. We speak to all the investee companies in a fund and we talk to people in that country. We use our own network to verify what the managers tell us about themselves. On some rare occasions, when we deal with a new manager for example, we use a specialised consultant to do very in-depth reference checking.'

What does your post-investment process involve?

'As a fund of funds, essentially we have to do all the work upfront. However, monitoring is an important part of the service that we provide to investors. We monitor our funds through their quarterly reporting, attending their AGMs and meeting with them face to face (at least once a year). In some cases we sit on the Advisory Board or Investment Committee of the fund.

Our aim is to capture as much detail as possible in the pre-investment, due diligence and the post-investment processes. The information we gather is fed into our proprietary database, which we use for benchmarking proposals and for assessing the progress of the funds post investing. We can see if a fund is going to plan, below plan or above plan - and there are certain actions required depending on the status.'

How many investments do you intend to make over the next 12 months?

'Probably between five and eight with an average investment of €15m.'

Are you interested in first-time funds?

'We do first-time funds but not first-time teams. Investing with first-time fund managers is different and the main issue you are going to have is track record validation. You often need to find a way into the old captive organisation to verify the track record that is being presented and check that it is the complete track record for those managers. This can sometimes prove controversial. We have not noticed any difference in the performance of the first-time funds with which we have been investing compared with the other funds so far. The main difference is in the due diligence process, which usually takes longer for first-time funds.'

What are the main qualities you look for in a good GP?

'The number one criterion is very specific private equity experience. We like to see, even if it is a first-time fund, a team that has been in the industry for a number of years and that has been through more than one cycle.

A GP's strategy has to match with the market opportunity, and it has to be a strategy that they have successfully implemented in the past. There may be some tweaks to the strategy to adapt it to the current market environment and opportunities but no major changes. To make that concrete, if a GP has been very successful investing €150m and then wants to raise €500m we would be very concerned as it implies either changes to the organisation, more people, or changes to the investment strategy, larger deals, or changes to the portfolio composition, larger portfolio, or a combination of all of the above. All of these factors change the dynamics of the offering and increase the level of risk.

Track record and performance is very important. It is not the only thing we want to see, and good past track record does not always translate into good future track record but there is more of a chance that a past good fund will perform well in the future than a past bad one. We do a lot of work upfront to see how that fund has performed versus piers in the market using our own proprietary benchmarks database.'

What would you say are the main developments in the private equity business at the moment?

'The amount of capital currently being invested in private equity together with the level of debt is a major concern. A lot of the capital is concentrated at the large end, though, and that is not where our focus is. However, it has to have a knock-on effect on access, liquidity and competition in the market. Of course, the private equity market is always becoming more competitive which will - all things being equal - reduce returns going forward as the market becomes less imperfect. Having said that, we believe that we have both a strategic response and structural solutions for this.

Besides the amount of capital coming into the asset class, the persistent lack of transparency is a major issue. There has to be some kind of trade-off between protecting portfolio companies'' interests and providing sufficient information to LPs. We believe that our reporting to our clients strikes a good balance.'

How do you feel about the European venture capital market?

'The issue that we have with the European venture capital market is one of volume. When you look at the US there are maybe 100-150 high-quality managers to choose from, whereas in Europe we have identified only 20. When you have such a limited universe to draw from, and not all 20 funds are out fundraising at the same time, it is quite challenging to put together a whole fund of funds for that. That is why we are holding back a little bit to see how the market develops. We believe that this will come as the venture industry matures in Europe. The question is one of how quickly can this happen in a truly sustainable way.'

What advice would you give to new private equity investors?

'Invest consistently and think long-term. That is the only way to make money in this business. Unless you can be investing in this asset class for 20 years, do not bother because it is impossible to time the market. Vintage is significant in terms of its impact on returns, which you only see retrospectively. The macro market environment is also significant and although it is usually possible to grasp the likely positive or negative consequences of the current investment environment in real time, it will take several years before the full impact filters through into better or worse returns. Therefore trying to step in when you think is a good time, following a period of good returns for the industry for example, or stepping out when you think times are bad, when stock markets are illiquid for example, has often proved to be quite disastrous for some investors in this asset class.'

As a long-term player, what are your observations of the private equity business?

'There does not always have to be a direct relationship between the quality of the offering and the image of that team in the market. Sometimes you hear amazing things about certain groups but when you take a closer look major issues arise. And just occasionally you can still come across a group that is almost totally unknown outside of its home market but which has a terrific track record that has been acquired by virtue of skill and hard work and virtually no marketing spend.'

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