Avoiding the Pitfalls: Invest in Skills for Deal Evaluation

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This article is sponsored by The Wharton School.

Venture and private equity investment are important components of the portfolios of sovereign wealth funds (SWFs). However, access to these asset classes has come with hefty management fees. For SWFs, there are several advantages to direct investment in venture and private equity deals. Direct investment allows more control over the timing of actual investments. It also allows the SWFs to have more flexibility in their portfolio construction. And most importantly, there are significant savings on management and performance fees.

SWF managers need to be adept at analyzing whether their returns will beat the realized return (after fees) offered by venture capital and private equity firms. Unfortunately, ample evidence has shown that this can be very challenging for many SWFs making direct investments. The sources of these challenges vary across venture capital and private equity deals.

To date, SWFs’ investments still lag behind the performance of private equity firms. This brings us to the issue of know-how.

Venture investments often require a judgment call on the management team, because of a lack of tangible assets and reliable market data, and a paucity of concrete information about how the company will perform. Furthermore, in recent years, venture investments frequently suffer from what is known as the winner’s curse. If a deal becomes available to SWF managers, it is likely that it has already been turned down by many sophisticated venture funds. To “win” these deals may actually damage (or “curse”) an SWF portfolio.

In contrast, SWFs have relatively more access to deal flow in private equity deals. Fund managers are able to evaluate these investments at a higher level through information gathering and commercial due diligence.

To date, SWFs’ investments still lag behind the performance of private equity firms. This brings us to the issue of know-how. Is it possible for SWFs to hire the right personnel or train their staff so that they can mimic the general partners who lead private equity firms on sourcing and commercial due diligence? What are the best practices used by leading general partners when they source deals? What are the return drivers as private equity firms evaluate deals in their search for value creation?

Wharton’s new four-day executive education program for industry professionals, Private Equity: Investing and Creating Value, provides a highly focused program to address these issues. “Sovereign wealth fund managers will receive training on due diligence, how to structure a private equity deal, and how to think like private equity firms,” says Wharton Private Equity Professor Bilge Yilmaz. “This will give them an advantage when partnering or even competing with private equity firms. We hope that SWFs will see this program as a smart investment.”

“This is a unique opportunity to make an investment in your skills,” adds Yilmaz. “You will tap into the expertise of some of the top senior partners in leading investment organizations, who will not only share the latest trends, but also evaluate deals that participants put together. You will learn how they add and create value, and how the private equity business model varies as a result of regulations and market forces in different countries and regions. SWF managers in particular, as they increasingly move toward direct investments, need this kind of knowledge now.”

 
 
 
 


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