Carried Interest – PEVC Conference Web-Magazine 2012

For a round-up of social media and press coverage, visit our Storify page for a collection of photos, videos, tweets, and news coverage of the event

Morning Keynote
The Leveraged Buyout
Strategic Venturing
Emerging Markets Investing
Private Equity in the Middle Market
Venture Capital Investing
The Changing Regulatory Environment
Afternoon Keynote


Jason Kelly - Private Equity Reporter for Bloomberg News

Joseph L. Rice III - Chairman and Co-founder of Clayton, Dubilier & Rice
David M. Rubenstein - Co-founder and Managing Director of The Carlyle Group

Consistent with prior years and aligned with the theme of this year’s conference, “Out of the Storm but Not Out of the Woods,” the morning keynote address started the conference with a retrospective discussion of private equity (PE), its evolution to date, and thoughts regarding the future.

Moderated by Jason Kelly, Private Equity Reporter for Bloomberg News, the dialogue between David M. Rubenstein, Co-founder and and Managing Director of The Carlyle Group, and Joseph L. Rice III , Chairman and and Co-founder of Clayton, Dubilier & Rice, addressed topics ranging from the growth of their respective careers and companies to contemporary issues such as tax legislation and shifting investor concerns.

Asked about how they found themselves in PE, Mr. Rubenstein and Mr. Rice recalled their beginning as lawyers, noting an evolutionary path involving a discovery of their true skills and interests. Mr. Rubenstein advised “you shouldn’t try to decide what you are going to do for the rest of your life when you are in business school.”

Exploring the “ethos” of their respective firms in more detail, Mr. Kelly prompted Mr. Rice to discuss his motivation to enter the business, and specifically with the individuals who helped start his firm. Mr. Rice replied that he started the firm with people “who spent their lives managing businesses as opposed to financing businesses,” explaining that although “it wasn’t readily apparent, you … intuitively felt that you were going to create something of value.”

Mr. Rubenstein then commented on a once smaller industry limited (in comparison to today) in its geographic reach, political attention, portion of contributed equity, and diversity of investors. By contrast, he explained, today “private equity is a global business [with] enormous amounts of money coming in from all parts of the world and people using much better techniques to enhance the value of the companies using less leverage… to do deals that are much more complicated.” Tying back to Mr. Rice’s comments around intuitive value creation, Mr. Rubenstein asserted that the essence of the business remains centered on value creation through alignment of incentives in a private setting that permits growth and efficiencies.

Mr. Kelly then asked whether they could start their businesses in today’s economy, returning the conversation to an evolutionary theme. Mr. Rubenstein stated that “people who want to be their own bosses … are likely to start businesses,” while Mr. Rice tempered the discussion by saying “I don’t honestly think that the wind is at any entrepreneur’s back in our business as it was when we got started.” Mr. Rubenstein then lifted the mood by joking that “the great growth business is private equity conferences, as there are more of them than private equity firms.”

On the topic of qualities necessary to succeed in PE, Mr. Rubenstein and Mr. Rice agreed that their requirements have not changed over time. In addition to hard-working team players with an entrepreneurial mindset, they emphasized ethics, communication skills and personality as critical factors for success. Mr. Rubenstein also added that as PE firms grow internationally, the diversity of their employee base continues to expand.

In response to questions about the differentiation between Wall Street and PE, Mr. Rice distinguished the two saying “our business we think of as a principle business and … Wall Street, by and large, an agency business … I think that is an entirely different mindset.” Mr. Rubenstein added that the level of mutual understanding between the Washington D.C. (political) and Wall Street (financial) sectors has diminished and continues to worsen. He then proceeded to say “we have learned that just getting good rates of return is not enough because so many other factors in society want to take into account what you are doing.” Both Mr. Rubenstein and Mr. Rice highlighted that a major challenge for PE in the future will be successfully communicating the industry as an engine for value creation, not destruction.

In a similar category, Mr. Kelly initiated discussion around the recently popularized topic of carried interest. Mr. Rice suggested a pessimistic view on the future of carried interest, suggesting a potential convergence to income tax rates. Mr. Rubenstein cautioned the bigger problem in the US is our national debt predicting, adding that predicting Washington is difficult and immediate changes are unlikely. Prior to comprehensive reform, he states, “we have to recognize that if we change the industry and laws, we will affect more than just the private equity and the buyout people.”

Nearing the end of the morning keynote, Mr. Kelly asked Mr. Rubenstein and Mr. Rice about changes in the relationship between Limited and General Partners. Both Mr. Rice and Mr. Rubenstein acknowledge that investors are increasingly interested in more than returns. However, they also noted that as part of recent economic downturns, the industry has a renewed appreciation for PE’s ability to generate returns above the public markets through proper investment management and incentives.

Prompted by a question from the audience regarding emerging markets, Mr. Rubenstein and Mr. Rice assessed areas of opportunity for PE. They predicted that PE would increase its investments and presence in emerging markets, as they present attractive growth alternatives to U.S. investments. The challenge, as Mr. Rice noted, “Implementing in… those countries is a challenge,” continuing that “it is difficult to find people who are as experienced as the people we are used to having represent us” and “it is unclear sometimes, what the rule of law is, if there is a rule of law.” Mr. Rubenstein confirmed this challenge, revealing his firm’s strategy is to “hire local people to invest in local countries.”

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Gwyneth Ketterer ‘91 – Adjunct Professor, Columbia Business School
Jeffrey Barber ‘01 - Managing Director, TA Associates
Christopher Behrens - Managing Director, CCMP Capital
Andrew O’Brien ‘90 - Managing Director and Co-Head of Global Debt Capital Markets, J.P. Morgan
Rick Perkal - Senior Managing Director, Irving Place Capital
Kirk Radke - Partner, Kirkland & Ellis LLP

The morning session delved right into the question that seemed to be on everyone’s mind, what is the status of today’s Leverage Buyout (LBO) environment? Moderated by Gwyneth Ketterer 91, adjunct professor at Columbia Business School, the distinguished group of panelists offered their viewpoints on the health of the deal market from their respective industry angles. The common theme of the day suggested the market is slowly improving but is not close to the levels seen in the boom years prior to the credit crisis.

Christopher Behrens, Managing Director at CCMP Capital, provided a backdrop for the discussion in noting that the deal market was bifurcated. “The bifurcation of deals getting done is both based on size and quality. We aren’t seeing as many multi-billion dollar closings but the middle market is active for good companies.” Providing a viewpoint from the sponsors’ perspective, Rick Perkal, Senior Managing Director at Irving Place Capital, commented “it’s not as frothy of a deal market as you might expect given many sponsors need to raise money soon and the potential for carried interest tax implications.”

The availability of credit, or, in other words, the willingness of banks to lend money to finance transactions is a vital element for an active buyout market. This is particularly true for mega deals–typically those above $5 billion–which depend on billions in debt financing. Sharing his view from the capital markets side of LBO transactions, Andy O’Brien ‘91, Managing Director and Co-Head of Global Debt Capital Markets at J.P. Morgan, said “the capital markets are open and financing is available, but not as extensive as before. Things have changed since the credit crisis.” Mr. O’Brien added specifics on typical capital structures for transactions in the market “the institutional loan market is active but is mixed with high yield tranches and deals require a higher percentage of equity.”

North America and Europe are considered mature private equity (PE) markets, but issues currently plaguing Europe have impacted the LBO market there. “The U.S. deal market is beginning to come back but less so in Europe because of the current economic issues” said Kirk Radke, Partner at law firm Kirkland & Ellis LLP.

One of the major topics of the day seemed to center around the ability of PE firms to “add value” to their investments. Nowadays, PE firms must convince owners, board members and shareholders that they offer more than just capital. “Firms are focusing on their ability to help grow revenue vs. just cutting costs” said Mr. Behrens. “Exit multiples are typically more robust when value has been created through top line growth vs. cost cutting. This is key discussion point when we are looking at making investments.” In the last few years PE firms have smartened to the notion that sellers are often looking for more than just money. In a growth equity scenario where an owner is looking to take on an investment partner, valuation may take a back seat to picking the firm best positioned to help the company achieve its goals. “We are seeing more creative deals getting done with firms using their expertise to better position themselves” said Rick Perkal. “An example of that is Golden Gate Capital’s investment in apparel retailer Pacific Sun.”

Continuing on the topic, Professor Ketterer asked about the specific strategies that firms have undertaken to better position themselves as value-add investors. “We have made key hires whose main responsibility is to support the operations of our portfolio companies”, said Mr. Perkal. “For example, last year we hired Michael Feiner, previously a professor at Columbia Business School, to focus on “human capital”. Mr. Feiner works with our portfolio company management teams to implement best practices and to help them think strategically about human resources.” Mr. Perkal continued, “We made another key operational hire that is focused on helping our portfolio companies develop their e-commerce platforms.”

Mr. Behrens added “today limited partners are demanding a closer look at how private equity firms have created value in their investments. Realizing revenue and earnings growth is critical in demonstrating that a sponsor has added value through their involvement.”

PE firms are often criticized for over-leveraging, which can lead to financial duress in hard times. However, the recent economic downturn proved that many PE backed companies did a better job of weathering the storm. Mr. Radke commented, “The board room of a public company or family business does not have the same energy as one owned or influenced by a private equity firm. This was really brought to light in the 2008 to 2009 period when private equity owned companies were able to quickly react to the recession and survive the downturn. PE firms gather a tremendous amount of data and expertise across their investment portfolio and impart that to their portfolio companies.”

Professor Ketterer moved to the ever important question of the fundraising environment for buyout firms. According to Mr. Radke, “2012 is going to be huge year in fundraising as many firms will be coming to market. The fundraising environment is better than people might think–LP portfolios are healthier and are getting capital returns. LPs don’t have as many options where they believe they can get solid returns on such large amounts of capital, so they will be inclined to continue investing in PE.”

Mr. Perkal commented on the increasing discernment among LPs when choosing PE firms. “LPs are now asking a lot more questions. They want to know if a firm is sticking with their original investment thesis. They want to see continuity in both investment thesis and track record. PE firms who have not performed well will likely have to reduce the size of their next fund, good performers will have the option of raising more money.” Referring to the development of the Institutional Limited Partners Association (ILPA), an organization dedicated to advancing the interests of PE limited partners, Mr. Behrens said, “The ILPA is a great resource for LP discussions and learning how they look at their investment values, co-investment opportunities, etc. It hasn’t always been there and is a function of a maturing industry.”

The last topic of the session focused on the importance of having the right managers running a PE-backed company. A question from the audience brought to attention the fact that being a portfolio company CEO can be lucrative, but far from easy. It is essentially a high stakes balancing act in that CEOs are expected to meaningfully grow revenue while maintaining or reducing costs, often under the pressure of debt and under the close vigilance of demanding and occasionally impatient PE investors. Given these pressures, it is no wonder PE firms like to work with managers who have succeeded under this regime before. Confirming this notion, Mr. Perkal said “we do like working with CEOs that we have prior experience with. Their experience in communication with private equity firms helps a ton. But it doesn’t necessarily make them a better CEO.” The rest of the panel agreed with Mr. Perkal’s thoughts, but interestingly nobody confirmed that portfolio company CEO compensations packages had increased despite the increase in competition for proven CEOs.

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Philip Wickham - CEO, The Kauffman Center
Andrew Cleland - Partner, Comcast Ventures
Taylor Davidson – Senior Associate, kbs+p Ventures
Scott Levine – Managing Director, Time Warner Investments
Andrew Siegel – Senior Vice President Strategy and Corporate Development, Advance Publications

Corporations as venture capitalists? You bet. Philip Wickham, CEO of The Kauffman Center challenged the room with exactly that. The bet: Who would take a $1000 challenge to name more than 10 corporations who invested in venture last year? With no takers, Mr. Wickham informed the room that there are over 500 corporations actively involved in venture investments.

With a wealth of experience in a variety of corporate venture investments, Mr. Wickham and the panel quickly demonstrated their unique perspectives and position within the “zoo” as Mr. Wickham refers to the corporate strategic environment. Building on the analogy, he says that “you have to figure out which section of the zoo you are in,” with respect to the varied approaches to strategic, financial, core business objectives and approaches to venture investments.

Taylor Davidson, Senior Associate at kbs+p Ventures explains his company’s position as having formed the venture function as a means to assist in the development of the core ad agency kbs. Focused on investments which contribute to the primary business, Todd and his firm strictly target early cycle companies as a follow-on investor.

By contrast, Scott Levine, Managing Director at Time Warner Investments, discusses a more leading edge technology approach whereby the company attempts to “peer around the corner” for “next generation services and technologies” more as a supplement to their core business.

Offering a third perspective, Andrew Cleland, Comcast Ventures, reveals that “the first lens we take is to look at a any deal from a financial perspective” with partners motivated to invest in great financial returns which Comcast views as a default mechanism for selecting successful and, thereby, strategic investments.

In contrast to their varying investment approaches, investment leads and sourcing was a point of agreement amongst the panelists, as all stated that relationships and working contacts play a significant role in determining the opportunities businesses realize in terms of making the initial contact. As Mr. Cleland explains, the process is as straightforward as finding people they like, meeting them and getting their proposal versus “random email submissions to the email box” which have a yield of only 10%.

Adding to the importance of relationships, Mr. Wickham explains that initial introductions and due diligence processes serve a function beyond gathering of metrics and static data. According to Mr. Wickham, the first meetings provide a testing ground where the corporate venture group gains insight into the entrepreneur’s ability to sell and build relationships, a quality which is critical to future success of the investment.

Another area of agreement amongst the panelists is the variable approach to target investment company culture. A bit surprisingly, the culture hurdles are formed less around fitting within the parent organization but more focused on the ability of the two organizations to adapt to one another. In fact, according to Mr. Levine, sometimes obtaining a new culture is part of the selection criteria.

While it is easy to see corporate venture investing as a two-way street with regard to benefits, it is of paramount importance that the strategic investor and entrepreneur establish open communications regarding the specific areas of synergy and expectations regarding their relationship, both short and long term. One specific consideration proposed by the panel is for entrepreneurs to not approach corporate venture as an exit strategy. A relationship with a corporate venture partner could not only limit IPO options, but also risk lower valuations as a result of flaws exposed through a working relationship. Offering an example of the recommendation for longer-term vision, Andrew Siegel, Senior Vice President Strategy and Corporate Development at Advance Publications, stated that he “take[s] a 20 year view” when looking at investment opportunities and looks to “build generations” of value.

With an eye toward the future, the panel agreed that trends toward increasing entrepreneurship and availability of corporate funding leave corporate venturing well positioned for the long term. However, the specific areas of investment and disruptive themes revealed a final distinction between the panelists and their investment outlook. The list of challenges driving future growth included the impact of ongoing globalization, capturing revenue associated device-driven behaviors, potential for homogeneity of media and applications, metrics optimization, and cloud-driven solutions.

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18th Annual Conference February 3 2012

Paul Tierney Jr. – Adjunct Professor, Columbia Business School
Mukul Gulati ‘05 - Managing Director, Zephyr Management LP
Karyn Koiffman - Partner, Kirkland & Ellis LLP
Thando Mhlambiso ‘92 - Director, Allan Gray
Sebastian Villa ‘04 - Partner, Southern Cross

The Emerging Markets Investing panel featured an impressive representation from the different hyped markets around the world: Mukul Gulati ’05 from India, Karyn Koiffman from Brazil, Thando Mhlambiso’92 from South Africa and Sebastian Villa’04 from Argentina. While each part of the world has a unique set of circumstances and different business, cultural and political environments, the key idea that repeated throughout the session was that the big opportunities lie now in the emerging middle class, and not necessarily in national infrastructure projects anymore. As the standard of living increases, more people enter the middle class and begin spending money – in consumer goods and retail, for example.

But a growing middle class is not enough; the local government policies and support are also a key factor in making successful investments. Mr. Villa mentioned Argentina as an example for a potentially attractive market that his fund has not invested in over the past eight years since there is no rule of law. Mr. Gulati shared his insight on projects requiring Indian government support and / or approval: avoiding them, and focusing instead on domestic demand driven opportunities. Mr. Mhlambiso, on the other hand, gave the South African government as a great example for supporting the local market, leading to a stable South-African LBO market over the past years.

Mr. Mhlambiso agreed that while LBOs tend to rely more on financial engineering, when investing in creating new assets, the importance of operational skills dramatically increases. This is part of the why he believes in bringing managers to the team from outside of South Africa. Ms. Koiffman added that in Brazil, since the country has been developing rapidly over only the past few years, often one of their greatest challenges is finding the right team with the appropriate operational experience. In India, according to Mr. Gulati, “finding growth is not the problem – growth is everywhere”; but he said that growth stops when the entrepreneur hits that level when business processes are needed, when structured operations are required for the company to succeed – and that is an important part of the work required from him in any investment. Mr. Villa said that his fund actually has its own internal resources to guide the different management teams with ERP, audit functions, etc.

Finally, when asked whether private equity (PE) is still a good business, the panelists agreed that while good, large investment opportunities have become much harder to find. It does not necessarily mean that there are not excellent investments that generate exceptional returns, but they just might be of a smaller size, in new industries, and require more operational skills with great corporate governance.

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Alex Chi – Managing Director, Goldman Sachs Financial Sponsor Coverage Group
Justin Hillenbrand – Partner, Monomoy Capital Partners
Seth Hollander - Partner, Kohlberg & Company
Paul Levy - Founding Partner, JLL Partners
Christopher Manning – Partner and Member of the Executive Committee, Trilantic Capital Partners
Mitchell Presser - Founding Partner, Paine & Partners

In an environment of ongoing volatility, robust financing markets, industry consolidation and regulatory reform, the private equity (PE) firms focused on the middle market investments face an interesting combination of challenges and opportunities.

The first paradox addressed by the panel concerns the deal activity and competition. As he explains the transition from “value-oriented generalists” to specialists in the food and agriculture business, Mitchell Presser, Founding Partner of Paine & Partners, explains that in a market where access to capital is an insufficient criteria for success, all companies must differentiate themselves in order to maintain profitability.

Along the theme of generalist versus specialist, Christopher Manning, Partner and Member of the Executive Committee at Trilantic Capital Partners, agrees that, to demonstrate and communicate value to investors requires a high level of specialization. His firm achieves this specialization through a combination of internal expertise and external resources such as consultants, advisors, and bankers. An alternate approach to specialization, as proposed by Seth Hollander, Partner at Kohlberg & Company, is to take a “general specialist” approach, whereby the firm invests in a variety of industries, but selects specific sub-sectors within those industries on which to focus. This strategy allows for Seth and his team to react quickly as an expert on specific deals.

Adding to the competitive pressure, an excess amount of “dry powder” in the collective PE reserves has the potential to attract from large cap interest in what are traditionally middle market deals. When asked by the moderator, Alex Chi, Managing Director of Goldman Sachs Financial Sponsor Coverage Group, about whether this type of competitive threat puts firms of his size at any disadvantage, Paul Levy, Founding Partner of JLL Partners, asserted that “we are not that concerned” citing that the economics provide a natural barrier to ongoing threats from large cap companies. Simply put, a large cap fund doesn’t realize enough return from a mid-cap investment to significantly impact the performance of the fund. Further dismissing the large-cap threat, Mr. Levy highlights personality and social acuity as a noteworthy component of his firm’s value proposition and competitive advantage.

From a financing perspective, the panel confirmed what we largely already knew with respect to the tremendously low rates available depending on type of loan (ABL, fund backed, cashflow, etc.) and position within the debt structure (senior/junior, secured/unsecured, etc.). Mr. Presser added that the U.S. banks are bidding each other down to the point where the cost of capital no longer has material impact on the realized return of an investment. “If your businesses can’t make money when they have access to 3-4% capital, you better take a closer look at the business.”

On the topic of business performance, middle market PE firms, under competitive pressure, are increasingly attentive to true value creation by way of operational improvements. Offering an example, Justin Hillenbrand, Partner at Monomoy Capital Partners, explains that his firm has structured an operations team comprised mostly of former Toyota employees. Monomoy further leverages the Toyota resources through a quarterly “bootcamp” training program to educate portfolio company managers and supervisors on the principles of lean manufacturing. While some may consider the Monomoy model to be extreme, it may serve as an indicator of the direction of PE as returns on investment become less financially dependent, requiring significantly more operational investment.

Lastly, and consistent with messages from the morning keynote, the panel discussed current challenges faced by PE. The discussion centered around recent debates on carried interest, true value creation, and increasingly sophisticated & demanding limited partners. Specifically, the panel mentioned that current carried interest rates may be difficult to maintain as they are increasingly challenged by the government and investors. In this context, the group emphasized that private equity must continue to communicate its position as a value creating industry.

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Dawn Barber – Co-Founder, NY Tech Meetup
Habib Kairouz ‘90 - Managing Partner, Rho Ventures
Daniel Schultz - Co-founder and Managing Director, DFJ Gotham Ventures
Laura Sachar ‘91 - Founding General Partner, StarVest Partners
Neil Suslak ‘86 - Founding Managing Partner, Braemar Energy

The standing-room-only audience for the Venture Capital Investing panel was an indicator of the growing excitement around the venture capital (VC) industry, particularly in New York. Panel moderator Dawn Barber, Co-Founder of NY Tech Meetup, opened the discussion by asking a question that surely half the room was hoping to get answered: what is the best path to breaking into VC?

“There are several different paths to getting to the partner level at VC firm, said Laura Sachar ’91, Founding General Partner at NYC-based StarVest Partners. “For more senior positions, operational and entrepreneurial backgrounds are a good segue. But more junior folks often come in from investment banking and consulting programs.”

Daniel Schultz, Co-Founder and Managing Director of DFJ Gotham Ventures, added: “we like people who have experience at start-ups. It shows they have the right DNA and are accustomed to the entrepreneurial environment.”

Neil Suslak ’86, Founding Managing Partner at energy-focused Braemar Energy, said “we do like people with energy experience but we also recognize that other technologies touch the energy business and so we focus more on a technical background than energy specifically. However, there is no proven formula to become a successful VC–its more about having that life experience that gives you an edge.”

The conversation shifted to the topic of investment exits. The recent headlines detailing the successful IPOs of VC-backed companies such as Zynga, Groupon and LinkedIn have drawn much attention. Every venture capitalist hopes that their next investment will turn into the next big IPO success. However, the reality is that most investments don’t turn out that way. “When I first started in the business, exits were 80% through IPOs and 20% via acquisition. Now it’s the opposite, with 90% of exits coming through M&A,” said Habib Kairouz ‘90, Managing Partner of Rho Ventures. “Groupon, Zynga and Facebook are definitely outliers. We invest in companies that often don’t generate revenue yet. By the time they reach the $750 million market cap level, a good chuck of time has passed and we have likely exited already.” Ms. Sachar added, “It takes time these days, usually ten years or more, for companies to reach IPO size. You don’t want to go public with a company that has a market cap below $500 million.”

VC firms are always at the forefront of technology and entrepreneurship. Hoping to get some insight into the next big idea, Mr. Barber asked the panelists which disruptive opportunities were on the horizon. Mr. Suslak commented on the challenges faced in energy, “disruption can be challenging in an industry that is dominated by a few big players. In the utility business for example, having slow moving capacity is essential to the business and thus disruption through fast-moving technology is tougher to implement or discover.”

“The word disruption is sometimes a little overused. It simply means that there is an exogenous factor that is going to change the rules of the game, noted Mr. Kairouz. “For example, in the 1990s online user-generated content was disruptive to the print business. Today, we think there are opportunities in theme-specific networks. For example, I use Facebook for family and friends and Twitter and LinkedIn for business. However, when I’m watching the Superbowl, there isn’t a specific median to talk about it in real-time.”

Mr. Schultz made a pitch for companies that can capture and monetize consumer choices and actions. “We have barely scratched the surface of how to leverage our own behavioral and choice-based data. There is an opportunity to monetize it by selling it to corporations that put a high value on that data.”

Highlighting opportunities in the retail sector, Mr. Sachar believes e-commerce and mobility are significantly changing the game in retail. “Traditional retailers are trying to figure out how to use mobile applications to better connect with consumers. We like investing in the expansion stage and look for management teams that have the ability to execute on a big market opportunity.”

Ms. Barber transitioned the discussion to the budding venture community in Columbia’s backyard of New York City. As a major organizer of technology events around the city through NY Tech Meetup, Mr. Barber has had a front seat to the revival of entrepreneurship in New York. A new wave of NYC-founded start-ups primarily in media, social networks and retail has revived the NYC ecosystem often referred to as “Silicon Alley.”

“Mayor Bloomberg has done a great job of championing entrepreneurs and start-ups,” said Mr. Schultz. Looking around at the packed conference room, Mr. Kairouz observed, “ten years ago this room would have been half empty, mostly with people that failed to get traditional jobs on Wall Street. The dot com bubble spurred the first wave of start-up companies, but now we are in the second wave of growth and many of those companies are based here in the city.”

Ms. Sachar added, “New York has the advantage of having some of the most important industries located here. This provides a vibrant platform for new companies. In last few years we’ve realized that we didn’t need to get on planes to meet start-up companies because many more are now starting right here in New York.”

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Donna M. Hitscherich ‘90 &nd,dash; Senior Lecturer Finance and Economics and Director of the Private Equity Program, Columbia Business School
David Baum - Partner, Alston & Bird
Mark Hallock ‘82 - Managing Director, Jefferies & Co.
Nicholas Panos ‘08 - Senior Special Counsel M&A Office, SEC Corporation Finance Division
Scott Zimmerman - Partner Financial Services Office, Ernst & Young LLP

The Changing Regulatory Environment panel, moderated by the director of Columbia Business School Private Equity Program Professor Donna M. Hitscherich, tried to answer what are the costs to the private equity (PE) and venture capital (VC) funds associated with the new regulations, and why.

David Baum, Partner at Alston & Bird LLP, started off by explaining the new regulations: under the Dodd-Frank act, the registration requirements under the Investment Advisers Act have been extended to the advisers of private funds. This eliminates the exemption to advisers to private funds with less than 15 clients. Registration with the SEC is due by March this year (2012), and includes an annual registration fee, compliance plans, code of ethics and reporting of security holdings, appointment of chief compliance officer, and the adaption of insider trading rules (including the misuse of non-public information). While no specific price was attached to this list of requirements, they easily accumulate to thousands of dollars annually.

Nicholas Panos’08, Senior Special Counsel at the SEC Corporation Finance Division, reinforced that the SEC’s mission is to protect investors and facilitate information. He presented the numerous benefits of the requirement for compliance: the competition will get better, as only the good firms that comply with the regulations will remain in the market; investments will increase, as investors will feel safer and will have a higher certainty in the quality of their investments; and globally, investors from all around the globe will feel more confident in putting their money into US projects. Furthermore, the U.S. has been the global PE leader for decades, and it is only natural that other nations will follow suit with the new regulatory standards.

Mark Hallock ’82, Managing Director of Jefferies & Co. and Scott Zimmerman, Partner of Financial Services Office at Ernst &Young LLP, together with Mr. Panos and Mr. Baum, have agreed that this will become the standard and another mechanism to attract the best investors. As a fund moves up the ladder of sophisticated investors, they will ask more about whether the fund has all the compliance practices in place – and this makes the associated costs almost irrelevant, as it becomes the standard.

Interestingly, smaller funds (SEC has its own differentiation between VCs and PEs) below $100M are not required to register with the SEC (although some state regulations may apply); however, the smaller funds are not exempted from filing with the SEC – including such information as potential conflicts of interests, etc. Compliance information, as well as other predetermined information, will be available for to the public. This is the new standard now, and sooner firms will embrace the change – the better.

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18th Annual Conference February 3 2012

Timothy C. Draper - Managing Director and Founder, Draper Fisher Jurvetson

Attempting to write Tim Draper’s afternoon keynote address is doomed to fail, as one of the most memorable moments of the entire conference was his live singing. One youtube video is worth more than 1,000 words.
DFJ's Tim Draper - "The Riskmaster"

Throughout the entire speech, Mr. Draper encouraged entrepreneurs to go out and make this world a better place. He started off by taking us on an international tour, from India, to Singapore, China, Ukraine, Estonia, Russia, and Egypt. It was a fascinating cultural, national and financial tour, as he shared with us the success – and failure stories – at each country. The flat world we live in has increased the number of entrepreneurs to potentially 7 billion people, and interestingly enough, different countries compete on becoming a more attractive base for ventures and innovation. Mr. Draper’s belief is that one of the main reason for the failure of entrepreneurs is the government and the competitive / regulatory environment it creates (for example, Sarbanes-Oxley Act made it incredibly expensive for companies to go public, so investment banks do not research small companies, which creates major liquidity problems to startups). Indeed, Draper Fisher Jurveston studies different environments in countries around the world, and provides its entrepreneurs with a real advantage.

Moore’s law, broadly stating that a new technology is invented every 18 months, is actually accelerating; in other words, every 14 months a new industry is created and provides everybody with an opportunity to do something really interesting. To be a successful entrepreneur, think big and think several years into the future – what will the next big things be? Colonizing March? Endless energy sources? A cure for death?

To create a successful company:

a. Solve a problem.

b. Create a revolution: overthrow the status-quo, ask yourself what seems as though it has been existing forever and will never change (Retail stores? Post offices? Cars?)

c. Zero business model: imagine financial statements with more zeros in them (Amazon put 0s in accounts receivable and inventory; hotmail had 0s for marketing costs, as it relied on viral spread).

Do something that 9 out of 10 people will tell you is impossible. If 9 out of 10 people think it is possible, then you are too late. Change the world.

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