Trends in First-time Fund Management in Asia Pacific

Contents

1. EXECUTIVE SUMMARY 3

2. METHODOLOGY 5

3. INTRODUCTION: ASIA PACIFIC PE INDUSTRY 6

4. SURVEY FINDINGS 7

Key Success Factors 8

Fundraising 9

Asia Pacific Geographical Aspects 10

Challenges 11

5. CONCLUSION 12

This report was prepared by Austin Arensberg (MBA Class of December 2013) in the

second half of 2013 under the supervision of Claudia Zeisberger, Academic Director

of the Global Private Equity Initiative (GPEI) and Professor of Decision Sciences and

Entrepreneurship and Family Enterprises at INSEAD, and Michael Prahl, Executive

Director of the GPEI.

3

1. Executive Summary

This report focuses on first-time fund managers in the Asia Pacific region. Based on

surveys with Private Equity and Venture Capital (PE/VC) professionals in the region,

it outlines the hurdles first-time fund managers face while fundraising and deal

sourcing, and puts forward strategies to successfully overcome these obstacles.

The current capital raising environment is a challenging one. Industry body EMPEA

reported that in the January to June 2013 period, private equity funds in emerging

markets (among which Asia Pacific is typically the leading region for fundraising, at

63 percent of total funds raised in 2012) had raised only $10.8 billion, down 52

percent from the corresponding period in 2012 and compared to a full-year total of

$40 billion raised in 2012.1

Amidst this difficult fundraising environment, first-time fund managers face

additional hurdles. In 2013, these managers raised only 7% of all private equity

capital,2 a significant drop from the 11% recorded in 2012 and the lowest share on

record.

The difficulty in raising capital is also reflected in the small fund size – nearly 75% of

newly raised funds were $100 million or less, whereas only 5% of newly raised funds

were of such a small size in the past 3 years. To add to the woes, the average time to

reach final close has also been increasing.

In addition to these fundraising challenges, first-time fund managers also face

performance issues. A preliminary finding in 20133 by Professor Josh Lerner from

Harvard Business School highlights the relative underperformance of the first fund

raised by a given fund family, as compared to the family’s subsequent funds.

1 Reuters 2 That’s globally not Asia specific, see Preqin, Private Equity Spotlight February 2014. 3 Venture Capital, Private Equity, and the Financing of Entrepreneurship Josh Lerner (Author), Ann Leamon (Author), Felda Hardymon (Author).

4

Given these circumstances, there is an important need to understand the dynamics

specific to first-time fund managers. Various questions arise: What are the

challenges that they face and what causes their funds’ underperformance? Are there

unique issues in the Asia Pacific region that hinder or improve their chances for

success? What lessons can be drawn from past experience?

In order to address these questions, we conducted over 20 interviews with PE/VC

professionals in Asia. We found that many first-time funds are experiencing difficulty

across the private equity value chain, from deal sourcing to portfolio management

and exit.

The lack of sophisticated broker networks in Asia affects first-time fund managers

more than their established competitors, and puts them at a significant disadvantage

in deal sourcing. Furthermore, first-time fund managers are typically only able to

participate in deals with transactions sizes below $250M, a highly competitive

bracket. This competition places upward pressure on deal valuations, and adversely

affects fund performance. The highly variable regulatory environment across

different countries in the region and the lack of exit opportunities add to the

difficulties faced by these fund managers.

Various lessons learned and helpful strategies can be culled from our survey results.

First-time fund managers need to objectively assess their skill set and determine

whether they are able to create a niche appreciated by LPs in this fundraising

environment. Creating multiple exit avenues as well as demonstrating a track record

that is specific to the region and/or a given sector will be beneficial. Specifically in

the Asian market, firms need to increasingly focus on building teams that have

operational expertise so that they can provide meaningful value to their portfolio

investments and build confidence amongst company promoters. Given the

increased competition and small deal sizes, having the right balance of local talent

and functional experts will significantly enhance a team’s ability to perform.

5

2. Methodology

We conducted interviews to answer

the following questions: what are

the key trends among first-time

fund managers operating in Asia

Pacific, and what are the necessary

requirements and factors to

consider when raising the first fund?

Over 20 interviews were conducted

with first-time fund managers and

private equity professionals with experience working and observing first-time fund

managers in the Asia Pacific region. The telephone interviews were unstructured

and were conducted over 20-60 minutes.

Throughout our research, we measured

the percentage mentions on particular

topics and logged the frequency of

keywords used.4

Potential sampling bias exists due to the high

number of INSEAD alumni in the pool. Where

possible, first-time fund managers were

contacted; however, the pool was broadened

early in our research process to include other

PE/VC professionals to ensure a comprehensive

perspective.

4 Quotes were transcribed from notes and, where required, particles were paraphrased to make structured sentences.

Dow Jones + Preqin +

S&P Capital IQ Asia Pacific PE Associations

INSEAD Alumni Linkedin Groups +

iConnect in Asia Email requests sent out

Interviewees 300+200+

80+100+

20

20 interviewees identified / screened from numerous resources,

databases, industry associations, and alumni associations

China: · Venture Funds

· VC · PE

· Fund Service industry

India: · VC

· PE · Fund Service industry

England: · Fund of Funds

Singapore: · PE

· VC

Indonesia: · PE

20 interviews conducted over 4 weeks across range of disciplines

Vietnam: · PE

41%

47%35%24%

18%

82%59%

PErespondents

VCrespondents

ASEAN-basedrespondents

China-basedrespondents

India-basedrespondents

INSEADalumnirespondents

Workinginfirst- mefund

6

3. Introduction: Asia Pacific PE Industry

A difficult decade in the Asia Pacific private equity industry underscores and further

complicates many of the challenges faced by first-time fund managers in the region,

as identifying and executing profitable portfolio investments has been difficult for

even the best performing funds. The following graphs and commentary provide

additional insight into the challenges faced by regional private equity investors.5

Reduced activity in M&A markets – private

equity-backed and otherwise – has

compounded the investment and exit

environment for first-time funds. Not only is

private equity dry powder in the region at an

all-time high – estimated at more than $150

billion as of year-end 2013 6 – significant

unrealized value remains tied up in regional

funds raised between 2004 and 2009.

The difficult environment for private equity

investors in Asia Pacific is also reflected in

the returns for funds raised over the last

decade. Whereas median IRRs for regional

funds raised between 1999 and 2003 ranged

from 14.3% to 26.8%, funds raised between

2004 and 2009 generated median IRRs

ranging from only 5.7% to 8.4%.

5 In the course of this research it was discovered through database searching and interviews with research services (including ThomsonOne, Preqin, MergerMarket, and S&P Capital IQ) that no service currently provides first-time fund management tracking and performance. Tracking is instead conducted on the firm level. As tracking this data is outside the scope of this study the author has provided generalized proxy data here as reference only. 6 Preqin

7

4. Survey Findings

The interview questions and their responses can be bundled into four broad

thematic categories that were utilized for data classification and trend analysis.

Keysuccessfactorsinfirst-

mefundmanagement

Lessonsinfundraising

Challengesforfirst- mefundmanagers

AsiaPacificgeographic

considera ons

2

34

1

8

Key Success Factors

According to the PE/VC professionals in our

survey, the ability to generate deal flow is a

strong predictor of success for first-time funds in

the Asia Pacific. As one Chinese interviewee

noted “at the end of the day it’s all about

proprietary access” to deals. This is in stark

contrast to more developed markets where

existing pipelines are often facilitated through

more sophisticated broker networks and increasingly online marketplaces. Another

VC fund manager based in India stated that “deal sourcing is a huge problem,”

partly because there are simply “too many GPs in the country,” resulting in

competition for the same deal sizes.

Another often cited success factor was

the ability to navigate the challenging

regulatory environments found in

many countries in the Asia Pacific. All

but one Indian respondent in the

survey mentioned that this as a key

competency. As one PE Manager in

India noted, “GPs from abroad need to have worked in India to understand the local

conditions. Knowing how the regulatory framework operates and how business

functions is the biggest value add.”

9

Fundraising

Fundraising for first-time fund managers is a vital skill. Throughout the interview

process, we noted references on the need for “track record” that were nuanced in a

variety of forms. One associate at a Vietnam PE

fund said that fund managers need track records

that extend to the fund’s locale and sector, “this

might mean having native language abilities and

ties to the region or having a track record in

those markets.” Having a track record also

seemed the key constraint for many aspiring

fund managers.

Background of first-time fund

managers varied widely. In

developed markets, first-time funds

frequently spin-off from established

firms with an attributable track

record. In Asia, most talent is from

investment banking, consulting or

MNCs, as these historically

represented the most attractive career paths. While these paths offer some

experience, there is little front-end transaction expertise.

Raising money as a first-time fund manager often requires showcasing investing

ability in one particular sector; as a result, fund mandates can be restrictive and

reduce a manager’s flexibility to develop a regional or industry-agnostic approach.

As one ASEAN fund Manager noted “LPs will often force you to be sector-specific,

but we felt it was important to maintain our flexibility.”

10

One interviewee who is currently raising a pan-ASEAN fund noted “it has taken us 18

months to get to first close and we thought it would take only 6.” As this comment

highlights, first-time fund managers must factor significant buffers into their

fundraising forecasts in this demanding environment. An interviewee based in

Singapore observed that teams need to have all of their diligence documentation

ready as “you are always fundraising.” Another Vietnam-based manager noted that

GPs seeking support from placement agents are often forced “to pay upwards of 5%

of capital raised. Therefore, having good direct relationships with LPs increases

access to potential commitments and avoids costly third parties.”

Asia Pacific Geographical Aspects

Local talent was cited by numerous interviewees as a vital predictor for success.

“Partners should have spent at least ten years living and working in the region.”

Others went further: one Chinese manager noted that

GPs from abroad – even Chinese nationals - were

often viewed with suspicion by entrepreneurs: “there

is a large cultural difference; they often find it difficult

to work with the more localized entrepreneurs.”

Another Chinese manager noted “… family

connections are really important in China. They can

bring proprietary access to certain

projects; hiring sons or daughters of

famous top tier government officials

can help.” Functional skills and risk

controls coupled with rigorous

quantitative analysis were

anecdotally shown to not be

rewarded as much as strong

relationship.

11

Operational skills were also not highlighted as a key skill impacting overall success.

However, one interviewee mentioned, “One critical problem with Asian GPs now is

that they are typically bankers. It is very difficult to persuade someone who has run a

business in their family for 50 years that they should undertake a change to their

factory when it comes from a banker.”

Challenges

The most common refrain noted for challenges by

far was the lack of exit opportunities. Chinese and

Indian interviewees were particularly aware of this

issue, as one fund of funds LP who invests in

emerging markets noted, “That’s really where

private equity in Asia has suffered, when the

momentum dies, they are stuck.” He continued

stating, “We need PIPEs sometimes for this reason,

LPs don’t like it but we need to maintain liquidity.” A Chinese national fund manager

noted, “The IPO process has been almost completely frozen for a year – a manager

must come up with new exit methods.”

One M&A professional in one of

China’s largest advisory firms cited,

“there are now increasingly more

secondaries entering the market that

may provide liquidity.” The key

takeaway was that private equity in

Asia is still to some degree a

momentum business, especially as a

common investment strategy is to focus on growth equity which, by its nature, must

rely less on operational improvements and alpha generation than strong market

conditions and exit opportunities.

12

5. Conclusion

Survey Results: Critical Factors for Success

First-time fund managers utilize local networks to generate strong deal flow;

Fundraising centers on showcasing track record; there is no substitute;

Lack of exit opportunities will continue to hurt first-time fund managers and

cause consolidation; and

Teams in Asia Pacific are short of local talent and operational skill sets.

These surveys were validated through general and industry research, industry

publications and performance database statistics. Professionals seeking to raise

funds need to be realistic on goals, focus on their track record, generate good deal

flow, create multiple avenues for exit and build complimentary, local, expert teams.

Implications

First-time fund managers need to constantly assess their own skill set and determine

whether their particular value-add sets them apart and creates what one manager

called a “unique niche” in the fundraising environment. Fundraising should only be

initiated if the manager is strongly convinced that a cornerstone investor is on

board, otherwise the expenses of maintaining a rigorous fundraising schedule can

be too much for a small team.

In Asia, firms need to increasingly focus on building teams that have operational

expertise and that can provide meaningful changes in control and non-control

investments. Momentum and growth equity are out of favor as current market

conditions have all but eliminated many chances for profitable exits. As the markets

become increasingly competitive, sourcing local talent that can both secure deal

flow and provide strong transaction execution will significantly improve a team’s

performance.