Editor’s Letter

Given some tremendous successes with recent IPOs and the contrasting tsunami of underlying concern about the state of government finances in many parts of the world, we split this issue into the two big questions for venture capital and private equity (PE) funds: where to invest and what are some techniques for improving your game. The technique topics include special financing devices, crisp language for non-compete and non-disclosure documents, a better understanding of how best to communicate among investors and to portfolio companies, and how to project future price-to-earnings growth into valuations. The places we visit include the potential for emerging minority markets in the U.S., results from early-stage investors in clean technology industries, and the curious hypothetical idea of venture capital in the Canary Islands.

Our lead article takes a look at 176 PE deals, over the period of 2006-2009, and digs inside to understand why, quantitatively and qualitatively, the deals performed well or poorly. John Vester addresses the key question that all of us wonder about: Are PE investors really just “financial engineers” or are they “value creators?” Which do you think is correct? You may be surprised by these findings.

Our first technique piece proposes a way for investors to structure a financing entity that allows for access to low-cost sources of acquisition capital: a debt–equity hybrid that enables both public and private companies to securitize the “whole business” through a collateralized corporate obligation. Benefits for lenders result from shifting the administration of bankruptcy proceedings to creditor-friendly jurisdictions. Where are these parts of the world? This may be a shock, but the U.K. actually has a rather streamlined process. Jonathan Davis, Donald Samelson, Robert Schwebach, and Ralph Switzer take us through the legal, tax, accounting, and financial implications of this transaction from the position as an entity in the U.S.

Although most nondisclosure agreements and non-competes do not make much difference, every once in awhile they become vital documents in the value of a portfolio company. Linda Stevens starts with the basic ideas of what works and what doesn’t, and then reveals some commonly used covenant language that on further review can be legally problematic. There is no reason to not be careful with these agreements. We never know how much we may come to rely on them in the future.

How often do you speak with co-investors in a deal? How often do you speak with portfolio companies, and on what topics? Turns out, it matters. Philipp Neimann investigated 93 VC firms in Germany and tracked these conversations. Is there a correlation between interactions and eventual success? Do we really spend all our time on the troubled companies with the great ones just going on autopilot? How much does it matter what we talk about? And do interactions with co-investors appear to have any relationship to success of the venture?

Jason Voss has put into numbers something that may trouble many of us, the reliability of a price-to-earnings growth (PEG) ratio. This statistic compares the P/E ratio of a business to its expected future growth rate over a period some years ahead, often five. The idea is that most P/Es only incorporate some small look-ahead for growth, usually a single year. The theory posits that when looking ahead further, you can do a better job of valuation for a fast-growing company. A high PEG ratio means big growth ahead, and leads to a higher price. The authors run the numbers for us and reveal when it does and doesn’t work. How well do you think Facebook and Extended Stay America were valued? If they appear to be overvalued, how can we tease out the errors made? Take a look at this piece and you may be surprised.

Are there emerging venture capital investment markets right here in the U.S.? Cyril Demaria poses that provocative question in his piece on investing on minority business enterprises. While he notes the good evidence that government-sponsored MESBICs (minority enterprise small business investment corporations) actually have counter-productive outcomes, there may yet evolve promising opportunities in this sector.

Our final two pieces are exploratory studies looking at the financing of clean technology industries and starting a hypothetical VC industry in the Canary Islands. Carol Boyer brings data on the number of clean technology firms, their industry sector, and where publicly held, their performance. How many received private equity infusions? Did it make a difference? Her exploratory study provides some early insights.

What if we could start a VC industry in the Canary Islands? Other than a beautiful place to live, what would we need to develop the industry? Aušra Gvazdaityte uses American and European data to wonder out loud: What would it take to start a VC industry? Should the government provide money to the VC fund? Or start its own fund? Or not? This quick puzzle reveals interesting fundamentals about our industry.

Editorial Note

After more than 13 years, this is my final issue as editor. It has been my great pleasure to interact with our authors and subscribers all over the world, and it has been an agonizing decision to resign my post. But the press of new research in strategy decision-making beckons, and each of us can only keep so many plates spinning at once. You will be in great hands with our new editor, F. John Mathis of the Thunderbird Graduate School of Business. I thank both our authors and subscribers for their active involvement with the Journal over these many years.

James E. Schrager

Chicago, Illinois

August 2011

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