‘We’re all on equal footing’: Private equity guru Erik Hirsch on working via Zoom, dealmaking in a crisis, and retaining a coveted culture

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I've enjoyed getting to know this edition's guest over the course of the past decade, when, as chief investment officer and then vice chairman of Hamilton Lane, he and I would trade notes on the colorful, ever-evolving private equity industry.

Erik Hirsch and I recently caught up to discuss his management, along with CEO Mario Giannini's, of the 400-strong global investment manager and adviser throughout the coronavirus pandemic. One thing that has always fascinated me about Hamilton Lane, headquartered near Philadelphia, is its culture: a discernible blend of ambition and humor; conference rooms named after iconic rock stars; the firm's own in-house band, The Hamiltones; and its track record of consistently being named one of the best places to work in investment management.

We also discussed the environment for private equity limited partners' allocation of capital and general partners' deployment of that capital, with unique challenges and opportunities arising amid the current uncertainty. Hamilton Lane managed $69 billion and advised on $434 billion in assets as of March 31.

Below are excerpts from the conversation.

When did the severity of the coronavirus dawn on you? How has it affected the nature of work at the firm?

It was when Hong Kong and parts of China began to really lock down — that was happening right around the Christmas holiday. We were watching it migrate and become more problematic across Asia. Having seen that, and having had to deal with taking down our Hong Kong office, then Seoul, then Tokyo, we were pretty quick to put a number of plans in place as we saw the potential for this coming to the U.S.

We're big tech folks, and fortunately we had made a huge push on technology within the firm, so the transition actually was surprisingly easy and very smooth. Any surprises came on the positive side. For example, we're really big users of Slack, and I would say that tool in particular is where we found some expected benefits but also a number of unexpected benefits. On the expected side, that was the easiest place for us to set up things like a virtual help desk — we quickly pivoted our IT team into a virtual help desk. What then came from that was people helping each other because that channel was populated. As people were seeing requests, if the IT team weren't able to get to it immediately, you saw co-workers jumping in to help.

The unexpected benefit is how interestingly employees have connected in ways that we just had not had happen before. A couple of Slack channels popped up around hobbies — people who are into gardening or people who are into, like, barbecuing or smoking meats, people who are into podcasts. And what you saw was employees who may not have had reason to interact directly with each other all of a sudden found themselves in a channel realizing that they both shared the same passion for something. So, we saw and have continued to see interesting connectivity across departments, across levels, across geographies.

The folks outside of headquarters are reporting that they've never felt more connected to the firm.

Because what they're saying is, hey, it's the first time that we're all on equal footing. Before, if I was in the satellite office, I'm always the guy on the phone, or I can't really see who's in the room, or I'm on the video screen. Now, with a Zoom environment, it's completely democratized. There is no side conversation in the conference room that you're not a part of.

I think that will cause us to make some changes on a permanent basis. Even when we're all back to work, I think you're going to be surprised at how many meetings are still taking place via Zoom. I can easily envision meetings where, even if some people are sitting in the same room together, they're still looking at Zoom on their iPads to better connect with the people not in the room.

How has communication from the top — you and the leadership team — changed or evolved?

What you miss is, in a normal world, you would have senior leaders walking the halls, popping by people's offices. You're sticking your head in going, "How's it going? How are you?" With the inability to do that, we've had to pivot.

Mario in particular, as CEO, has been very active. He quickly started a video series, "A Minute with Mario," which is weekly. It's both him giving a bit of a state of the union address around what's happening at the firm, what's happening with clients, what’s happening with the business, and then he's joined by guests. Those guests have been, for example, another office — one of the guests was one of our Asian offices that has returned to work, talking about what it's been like in their instance. He has featured some of the folks on the IT team. It's been a mix of education and entertainment. So, video has been very effective.

In addition to that, senior leaders around the firm are doing one-on-one Zoom calls with employees, and we are popping into different departments' Zoom meetings to talk more macro about what we're seeing in the markets or what's happening more broadly around the firm. Some of the departments have been hosting Zoom cocktail hours and have asked different senior folks to pop in as a guest.

The overall theme around communication right now is just huge frequency. People want to know that you're there, they want to know that you care, and they want to know that you're working to stay connected with them.

So much of your existing work, as well as the growth opportunity, is driven by in-person interaction with clients and prospects. How have you adapted as a result?

On some level, it’s probably too early to fully know. Part of the challenge is, how quickly do the clients pivot and where do they pivot?

Historically, we're all used to big conferences, we're used to onsite diligence visits, where they come, spend the day, and meet a bunch of people. Does that continue? Do they not make any decisions now because they can't do that? Do they recognize that they need to change and so they do?

Early indications are that the clients, just like you, just like me, are all adapting to a new reality. Again, in Asia, we're already seeing in-person meetings starting to resume. They're occurring slowly, and it's a different experience, but it's starting to return to some level of normality.

On some level, I think the clients and the prospects don't really have a choice but to pivot. They, just like all of us, need to keep making decisions. If they want to be deploying capital, they're going to need to make that decision in order to deploy capital.

What we have found in past downturns is that people tend to want more help rather than less help in times like this. You want more expertise, more resources, more perspective. So, we're optimistic that that bodes well for the business that we're in of being an advice provider.

Looking at the private equity industry, do you expect a further bifurcation between established firms and upstarts during this period?

I think it's certainly going to be harder for the latter category. There's just no question. If no one has heard of you before and you are about to launch a brand-new franchise, doing that in a world where nobody can meet you or no one can come check out your operations or perform operational due diligence for the first time — I don't think it's an insurmountable issue, but it's certainly going to be very hard. Or, said differently, there are going to be very few LPs that are equipped to handle that challenge or who, frankly, are going to want to handle that challenge.

So, I think for the bigger brands, life is going to be, on a relative basis, easier. Fundraising is continuing apace. We are still getting PPMs. Our fund investment team has been unbelievably busy. The volume around that has been surprisingly high, considering that most people believed it was going to drop to zero.

In speaking with and tracking big LPs around the world, what's your sense of how their appetite for private equity has changed, if at all, during this period?

It does vary. If we were talking a few months ago, we would be talking about the denominator effect, with the public markets having dropped significantly. And now, nobody's talking about the denominator effect, because portfolios are really only marginally down.

So, the answer on the client side is it depends on what kind of institution they are and what's happening to their own cash flow situation. It really depends on what's happening inside of their own existing portfolio. It depends on how new or not new they are to the asset class.

For the person who's got a big, mature portfolio with unfunded commitments, they're contributing to the dry powder. They might be saying, I've got a lot of dry powder, I'm going to get advantage of this market without having to do much of anything. That's different from the person who has just begun building their portfolio and has little to no exposure to anything.

On top of that, one thing that has been different this time around is that, in '08, you saw a lot more panic. Of course, that drop was much more significant, but also there was a lot less data around how private equity performs in a major downturn. Today you've got the benefit of having that data, and a lot of the LPs have been convinced that private equity actually does pretty well coming through periods of dislocation and volatility.

As a result, you also have people who are looking to lean in, because they believe that this is going to be a relatively more attractive place to be. Net-net-net-net-net, the data that we're seeing so far is more people looking to lean in on the asset class than not.

Zooming out to look at the public and private markets right now, as well as the economic recovery, what are you watching most closely?

Having been in the asset class for a long time, I would say that I've never felt a bigger disconnect between private equity mindset and public equity mindset.

You're hard-pressed to find a private equity GP today who thinks that the stock market is appropriately valued. I think they're looking at this and they cannot figure it out — they're dumbfounded. They keep waiting for the crash to come.

From their perspective, they're dealing with the carnage on a daily basis, up close and personal. They're seeing what's happening at their businesses, they're seeing the revenue impact, they're seeing the layoffs, they're seeing all of that. Then they wake up in the morning and see the Dow futures are up again. They're convinced that they're right and that it's going to come, it's going to drop — and they've been wrong.

The public equity guys sort of say, you private equity guys don't really get it. We're not looking at valuations at a moment in time. We operate in more of a discounted cash flow environment, and you've taken my discount rate down to almost zero because we've lowered interest rates so far. So, I have taken into account that there's a lot of carnage, but when the risk-free rate is close to zero, that's how the math works.

Those are just two really different worlds right now, because the mindsets are so different. So, it makes the dialogue with people really difficult, because both sides are convinced that they're right.

So, what are we looking at? We're hugely focused on data around reopening and what is actually happening on the ground. In particular, how quick is the consumer coming back or not?

The supply chain that people had historically been worried about — "historically" meaning a few months ago — was not nearly as disruptive as many people were projecting. We're not seeing a lot of pain around the international supply chain in particular. Goods are flowing from Asia. Asian factories are significantly ramping up capacity.

The piece that we are focused on is: What does spend look like? There are some early signs that are encouraging. Home sales have been encouraging, to see that starting to really rebound. There's been some interesting data around automotive sales. The retail data has actually been pretty encouraging, how quickly people have pivoted to online. On the flip side, obviously travel statistics, dining statistics — those are discouraging. So, processing all of that data is what we're focused on.

Given how resilient the public market comps have been, do you expect deals to continue getting more creative? PIPE deals, minority investments, growth-equity transactions, and the like?

I think we will see a lot more of that, yes, for a variety of reasons.

If you're a GP who believes the world is about to crater, you think you're overpaying if you do a deal today. So, there's going to need to be an acceptance. Either they're going to be right and we'll see the market correct, and then that will be the new normal. Or they're not correct, and the public markets are going to continue staying around these levels, in which case they're going to have to recalibrate their own mindset around what is value.

So, that hasn't happened yet. You add on top of that just the sheer logistics of trying to buy a business in a remote environment where you can't walk the factory floor and meet with management. So, I don't think it's surprising that we're not seeing traditional buyout deals.

I have to say, there's also an interesting debate that's starting, which is: What is an acceptable rate of return to be underwriting to in this environment?

It's early, but this is going to be a really, really important topic for both GPs and LPs.

Camp A says: I should be looking for huge downside protection in a world of uncertainty, and with a risk-free rate as low as it is, I think an appropriate equity rate of return is something like 13-14%.

Camp B says: Hey, in a world of uncertainty, if I'm not making 30% rates of return and two or three times my money, why would I put capital at risk?

Neither is an irrational view! But those are two wildly different approaches to sourcing deals and pricing assets. I think it's important, as you're talking to fund managers, to figure out which of those two camps they're in, because what we're finding is it's a pretty stark divide.

And it's creating odd behavior. If you're in camp B, there's not enough distress right now for you to find a bunch of deals that are going to generate a 30+% rate of return. So, you're sitting on dry powder. By the way, you're also likely the person who's saying, the sky is about to fall, the public market has it wrong, the wave is coming, just hang on. But you're sitting and waiting.

Meanwhile the camp A people are saying, look, I think the equity markets are going to be pretty soft for a while. Risk-free rates are close to zero. If I'm putting up a 13% rate of return with great downside protection, I'm going to be a hero to my clients, so I'm spending money right now.

Hamilton Lane has been in such a growth mode during the past decade that I've followed the firm: new offices, global hiring, your IPO in 2017. Have you put any expansion plans on hold during this period?

We've not. We have welcomed our undergraduate analyst class this summer. We have hired throughout the past four months. We want those folks, we are sticking by that, and we want them to come.

What's tricky is how to make sure you culturally integrate new employees in a world where they don't get to walk around and meet people. We're spending real time on that. It's incumbent on managers to spend extra time with those employees, making sure that they're feeling a part of the firm, and helping them build their network.

We are continuing to be cautiously optimistic, but we're not changing. We still see a road to growth. We, frankly, want to continue to push on our leadership position. Environments like this really start to widen out the gap if you do it the right way. That's where our heads are.

What does a return to work look like for Hamilton Lane?

We've had flexible, work-from-home arrangements as part of the firm for quite some time. Now, I wouldn't say that a huge portion of the firm availed themselves of that option, but the option has been there and there certainly are a number of people who do it regularly.

I certainly believe that this has been a big, eyes-wide-open experience for managers who have historically been more skeptical of flexible work arrangements.

I think those managers are realizing, OK, there are actually better ways to approach this. They are seeing some really good productivity statistics. So, I do believe the frequency of that is going to rise.

I suspect that firms like ours, which can very easily and successfully continue to operate in a remote environment, will be toward the back end of that flow back to the office, not the front end. Some of our geographic locations make it easier or harder. Our New York location would be one of the harder ones; our London location as well. As employees are understandably concerned about mass transit, what's top of mind for us is how we physically get people to offices in practical and expedited ways.

You pride yourselves on Hamilton Lane's culture, which has repeatedly been rewarded with best-place-to-work honors. How do you retain that while working from home?

It takes effort! Mario has got to keep filming those updates. We have a little Hamilton Lane band, and we're continuing to make music, each of us recording our piece and then stringing it together to share in Slack. Departments are continuing to do their Zoom happy hours.

That stuff takes time, and it takes work, but it's important. If you don't do it, you lose culture. You lose what you've worked really hard to build.

We've been telling managers, look, we've always spent time on culture, we just now have to do it in a very different way. We can't solve the problem by having an offsite, which we've always done, or by getting together for drinks after work.

You have to put that same time and effort that you would have into solving it in different and new ways.