Planning your Investment Programme:-

Hopefully having read this far you will have a good idea of what buyout and venture capital are, what drives their returns, and what to look for when selecting funds in which to invest. You have also had a chance to consider the historic returns of each asset class, arranged by geography, and to take a look at how these might be influenced not just by transitory outside factors such as bubbles and market conditions but also to discern the workings of more lasting trends. We would like to turn now to the nuts and bolts of how actually to put money to work in the private equity field. It is all very well having a working understanding of buyout and venture, but if you are suddenly presented with an allocation of, say, $100 M for private equity, how should you go about drawing up an action plan and implementing it?

Cash Flow Planning:-

Remember, this is the profile of one individual fund, whereas we will be looking to commit to quite a number (ideally at least six in each vintage year). In planning our programme, therefore, we will have to overlay the profiles of a large number of funds onto an overall cash flow model. Thus, at any one time within our planned programme, we will have some funds that are in investment mode, some that may not yet have drawn down any significant amount of capital at all, and some that will already be harvesting their investments and returning money to investors. You will of course need to assume some money multiples, since once a fund programme is mature the cash that is fl owing back to the investor will always be greater than the money which is fl owing out by way of draw downs. We would suggest that you start with some very conservative default multiples – say 1.7× for a buyout fund and 2.3× for a venture fund – and adjust these to match actual performance as you go along.

Remember too that just as the J-curve will be the same basic shape for each fund but may be either squashed or elongated according to the fund type and market conditions (and may move within different ranges according to the amount and timing of cash flows), so too the pattern which you see set out in the figure above will occur either more quickly or over a more extended interval depending on whether the investment focus of the fund is on early stage venture (longest/slowest), buyout or later stage venture (roughly as depicted) or secondary transactions (shortest/quickest). We are looking here specifically at private equity funds, but it is of course quite possible that, in deciding your overall investment policy, you might decide also to participate directly in individual private equity transactions, particularly in the secondary market where various LPs commonly operate alongside specialist secondary funds. The purpose of this sort of outline cash flow modeling is not to provide a forecast of income and expenditure for accounting purposes.

We are dealing here with cash flows which are essentially unpredictable both as to their timing and their amount, over a period which stretches a long way out into the future. Such an exercise cannot possibly produce anything other than a guesstimate, at best. The chances of your cash flows in any one year conforming exactly to what has been predicted at the outset are virtually nil. If you are an accountant, you might find it hard to understand why in these circumstances we would wish to embark upon the exercise at all. Yet to criticize it in this way, or label it as pointless, is fundamentally to misunderstand the reason for embarking upon it. It is not to have something available as a yardstick against which to judge just how closely actual cash flows in future years may conform to what we predicted at the outset (indeed, the very word “predicted” is inappropriate – it would be much more correct to say “projected”). It is so that we plan our exposure from the outset in a methodical manner; it is always open to us to fine-tune this as we go along, but it is essential to have an overall plan within which to operate (and not to allow ourselves to be unduly distracted from it as we go along by short-term issues).

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