Private Equity: The Secondary Market

Ten minutes south of Zurich is a little town called Zug. In Zug, we had the opportunity to meet with a few folks at a publicly listed investment firm called The Partners Group, which is one of the major players in what is referred to as the private equity secondary markets. Below are a few things we learned about PE “fund of funds”.

A typical private equity fund is composed of “limited partners” (LPs) and “general partners” (GPs). The limited partners contribute the money to the fund and the general partners go out and find companies to buy and then manage these investments on and active (or passive) basis. Because the GPs are doing all the work to make the LP’s richer, GPs are compensated in multiple ways (e.g. a percentage of assets under management, carried interest, co-investment rights, etc.). The LPs are typically institutional investors, wealthy individuals or another PE fund (called a fund of funds).

A fund of funds is basically a PE fund that, instead of directly acquiring companies, invests in other PE funds that do. Most fund of funds invest in new PE funds. This is called the “primary market”. This process involves LPs analyzing GPs track records and their proposed investment strategies; valuation is rather subjective because there are no assets in the fund yet… it’s very similar to a venture capital investment where the investor is evaluating the management team and their ability to executive their proposed business plan. As the GPs begin to aquire companies, the net value of fund changes in a pattern that is referred to as the “J-Curve”. I won’t get into the details of how the J-Curve works, but I’d highly suggest Goggle for more info.

Now, let’s discuss what happens when an LP (that most likely owns holdings in several funds) decides to liquidate its own portfolio. If it’s a large LP with several investments, it will hire an investment banking firm to conduct an auction process that is very similar to any other sell-side deal (build a book, build a list, call the list). If it’s a smaller LP, it may opt to find a buyer on its own through an independent finder. The finder is simply a match maker and doesn’t conduct an auction process, so they are typically compensated 50-75 bps rather than 1-3%. This process of one LP buying the investments from another LP is what the secondary market is all about. The idea is to buy out other LP interests at an inflection point (hopefully the bottom) on the J-Curve. This provides an opportunity for the secondary investor to achieve a higher IRR because it doesn’t have to wait out the early years of the PE fund when there are no cash distributions to the investors.

Switzerland – More than Cheese and Chocolate

If I had one pre-conception of Zurich, it would have been from all the movies… you know, where the bad guy has his crony wire the ransom payment to his Swiss account in Zurich. It turns out, that there are a number of reasons why the banks in Switzerland have gotten such a noble reputation. Sure, Switzerland has several tax advantages, but the main thing that sets the Swiss accounts apart is their high level of confidentiality, primarily due to Swiss banking laws. The simple act of opening a checking account is nothing short of the stereotypical process seen in the movies where the client is taken into a sealed room in the back of the bank and given an electronic key to open the safe. The names of most clients aren’t even known to employees.

Zurich is the “private wealth” capital of the world. Nearly most of the bankers in Zurich focus on convincing high net worth individuals ($10m+) to hand of their money for a management fee. Fortunately, we had the opportunity to visit with a few Columbia alumni working at UBS and Credit Suisse to get some inside information about the whole process. Basically, in order to be successful in PWM, you need to be good with people, know your stuff, and have an entrepreneurial drive. There are two types of wealth managers: hunters and farmers. As you’d expect, hunters bring in new clients and new money for the firm to manage and farmers are typically stewards over existing accounts.

So what should you consider if you’re thinking about working in Zurich?

Upside: low tax rate (10%), mountains and lakes within 2 minutes from the office, great transportation, very clean city, amazing chocolate, high paying jobs, reasonable rent, clean air, good hours, centrally located (1-2 hrs to anywhere in Europe), and you don’t need to speak Swiss, German, French, or Italian (the 4 official languages) to live there as nearly 90% of the population also speaks English.

Downside: very expensive (e.g. equiv. of $300-400 for shoes, $15USD for a combo meal at McD’s, etc.), small town with not much to do, really uptight laws, regulations and fees, Swiss are very nationalistic and often dislike foreigners, and finally… you might just get stuck there because you never want to leave.

Frankfurt: the other Mainhattan

Frankfurt is much different than I had anticipated. What I expected to be a quintessential German town, turned out to be a very modern city, which strangely reminds me of Charlotte, North Carolina. Although it is a much smaller city than London or Paris, Frankfurt has the tallest buildings in Europe and because it sits directly on the Main River (pronounced Mine) it is often referred to as the other “Mainhattan. It also has an un-proportional amount of investment bankers, giving the town its other nickname “Bankfurt”.

There seems to be lots of advantages to working in Frankfurt. Because most of the companies operate in several foreign countries, most business is conducted in English. So if you don’t speak German, you can still get by okay. That said, you would be much better off working for an American-based firm, rather than one of the three large Frankfurt-based firms (Deutsche Bank, Commerzbank, and Dresdner).

Another advantage is that the city is very affordable to live in. Euros spent on rent go much further than they do in any of the other major financial city centers; you also have the convenience (and luxury) of being able to drive your Mercedes or Porsche to work around town without having to worry about finding a place to park. Compared to Paris or London, prices for everyday goods are nearly half the price in Frankfurt. The public transportation is excellent (you don’t even need to swipe your card to use the subway, trolley or bus), but since Frankfurt is a small, clean, and pedistrian city, you can pretty much walk anywhere you need to go.

Clearly one of the downsides to living in any small city is the dearth of nightclubs, restaurants, and cultural centers. Although Frankfurt seems to have many of these things, one thing it does lack is diversity.

For more information about the CBS Pre-MBA World Tour, visit www.cbsworldtour.com.

"With great power comes great responsibility" -- Spidy's Uncle

While here in Paris, we met with a few CBS alumni, including the President of the Alumni Club of France. Among the many intriguing items we discussed, one important theme seemed to leave us with yet another perspective on our careers: responsibility. Much like the famous line from Spiderman, "With great power comes great responsibility", we were reminded that, as new Columbia Business School students, we are now part of a larger community that has the ability (and inherent responsibility) to make a positive difference in the world.

One of the great aspects about Columbia is its diverse and global student body and alumni organization. Our community does not just include New York, it encompasses the entire world. During this trip I have been reading “Making Globalization Work”, by Professor Joseph Stiglitz. It has been a real eye opening experience to realize that perhaps “another world IS possible”. As leaders of our next generation, it will be up to us to solve the challenges of globalization. Globalization is happening whether we like it or not, but how it should happen is the question.