Should PE and VC Join Forces?

@BurtonLee recently posted this interesting FT Article which is hinting on some of the things I have been talking to a few close friends recently: Titans turns attention to Silicon Valley. Private equity wants to enter venture capital territory of tech investing.

"We have missed the boat on tech investing,” says the co-founder of one of the major US private equity firms. “All the power is moving to Silicon Valley.”

As it turns out, few people have the ability to have a deep understanding of both the PE and VC world. People have either one or the other.

If, like me, you had an opportunity to dab into both worlds, it would become pretty quickly apparent that PE firms have historically been focused on more traditional (read non tech) businesses that usually cash flow sooner and also have more stable (read non exponential) growth curves. PE firms would then apply financial engineering and (not often enough maybe) operational expertise to leverage that same cash flow and maximize ROI. More than creating new value, PE firms tend to squeeze equity value creation out of existing assets, by increasing debt on businesses and optimizing cash flow. In 2007, leverage went almost completely away, having a sobering effect on the PE industry but the last 7 years of cheap credit/money, supported by the US Monetary Policy, has once again boosted the leverage ratio to 5-6x EBITDA multiples... Irresistible appeal of cheap money when you are a financiers and pressure for banks to put it to work.

As indicated in the FT article, the swelling of dry powder available to PE/Buy-Out firms (~$4Tr AUM) as well as the number of firms (~6K) is resulting in an extremely competitive landscape where PE firms are desperate for deals and scavenging every corner of the globe for worthwhile "existing" companies to buy or invest in... Lately, there isn't a week that goes by where I do not receive an email from "XYZ" PE firm asking me to refer a >$5M EBITDA companies, etc...

I think it is worth mentioning the difference between Buy-Out and Growth Financing strategies..one buys a company, provide liquidity to the founders/shareholders and with or without their help, drive further growth to sell it again in a few years or IPO it (sometimes after taking it private to do all the necessary restructuring away from the public eyes) vs. growth financing, which usually provide acceleration capital to scale operations, expand in other verticals or geographies and sometimes provide (partial) liquidity for early investors or founders.

The later definitely overlaps with late stage venture investment funds in term of strategy but the historical divide has usually been the "sectors" in which each would play. Growth Equity/PE fund would usually get involved in traditional (read non tech) industries while Late Stage VC/Growth Funds would mostly focused on Tech stuff.

It is obvious that today, companies like AirBnB, Uber, Palantir and others are disrupting traditional industries (PE's historical private hunting grounds) and this is what is concerning them. Technology is not a sector, it is an enabler and thus will transform all sectors, providing VCs with an unprecedented opportunity to go after the PE's lunch.

The challenge is that most PE firms have limited access (read relationships), or credibility (expertise/ value-add beyond their cash), when it comes to helping tech companies scale.

It is then natural to start seeing a growing interest of cash rich PE firms looking "upstream" toward VC firms that have built reputation, expertise and deal flow with technology companies. With late stage rounds in the hundreds of millions, these "unicorns" start to become meaningful at the scale of the PE firms and can move the needle in their fund.

It is also interesting to me that some PE firms have historically been a bit more "global" in their modus operandi and thus could play a very interesting relay for international growth of VC portfolio companies when times come to scale quickly across the globe and prevent the Rocket Internet guys to copycat you. But that would mean that your VC partnership is thinking beyond its city borders..not an obvious one in what has been mostly a cottage industry.

One of the main challenges I see in this odd marriage between PE & VC is that, in general, their respective DNA could not be more opposite. One is seen as a Wall St ex-consultant/Investment banker by one, while the other is seen as a presumptuous #SOB that thinks his revenue-less portfolio companies are worth $Bn of dollars.

But cooperation does not have to take the form of a buy-out and partnerships as well as co-investment can be a great start.