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ABSTRACT
Using the same framework for evaluating an investment in a publicly-traded company versus a
privately held company can be a recipe for disaster. While there is some overlap in the
evaluation process, there are significant additional considerations for investing in a privately-
held company that require a broader set of skills. The article identifies 5 skill-sets that are critical
to successful private-equity investing that are not generally taught as part of the
finance/investment curriculum in universities. Curricular implications for universities and
corporate training programs are discussed.
EXECUTIVE SUMMARY
The skills involved in being a successful private equity investor are much broader than those
required to be a successful public equity investor. A general partner of a large Atlanta venture
capital (VC) firm, summed it up this way, “There is a saying in the industry that it costs $40
million to educate a venture capitalist”, referring to the high cost of learn-by-doing in this
industry. Clearly, in his mind there is a significant gap between those sufficiently schooled in
investing to begin a career in private equity and those who are good at it.
The author identifies 5 skills that are essential to successful private equity investing, but not
generally required in public equity investing. They include (1) valuing businesses in an illiquid
start-up context, (2) contractually structuring the investment, (3) maintaining an effective
personal network to (a) ensure adequate deal flow, and (b) assist portfolio companies in securing
critical resources, (4) negotiating skills associated with both purchasing and selling an
investment, and (5) skills in coordinating thorough due diligence.
Resources for developing these skills are suggested. In the academic context, the following
recommendations are offered to better assist students in entrepreneurship or investments
programs acquire these skills:
(1) Do not rely on the “general business requirements” to meet these skills.
(2) Some of these skills are process skills, meaning that they are developed by practice – not
merely through understanding the process.
(3) Due diligence is on virtually no one’s curriculum.
(4) A course in private equity investing can be demonstrated to accomplish the purposes of the
business capstone class, and might be offered in lieu of Strategic Management, for example.
INTRODUCTION
Private equity investments are the financial umbilical cords of small businesses. Using the same
framework for evaluating an investment in a publicly-traded company (PTC) versus a privately
held company (PHC), however, is a recipe for disaster. While there is some overlap in the
evaluation process, there are significant additional considerations for investing in a privately-
held company. The purpose of this article is to identify the distinctive skill sets required by
private equity investors that are not as important to investors in publicly traded stocks. By
identifying different requisite skills, we hope to improve curriculum development for both
company training programs as well as academic institutions.
A fair question might be whether the differences between the skill sets of a good public-equity
investor are really much different from those of a good private-equity investor. Alan Taetle,
managing partner of Noro-Moseley, a large Atlanta venture capital (VC) firm, summed it up this
way, “There is a saying in the industry that it costs $40 million to educate a venture capitalist”,
referring to the high cost of learn-by-doing in this industry! Clearly, in his mind there is a
significant gap between those sufficiently schooled in investing to begin a career in private
equity and those who are good at it. While this author doesn’t contend that this brief manuscript
will reduce the cost to six figures, it is hoped that it will be worth at least a few million dollars in
savings to those learning the craft, while pointing those charged with curriculum development in
the right direction.
A second question concerning the relevance of this manuscript might be whether private equity
investing is occurring on a scale large enough to justify the presentation of such a framework to
the small business community. Between 1990 and 2000, total venture capital (a subset of private
equity) under management grew from $32 billion to $210 billion (Timmons, p.476-7). Since the
dotcom bubble burst, venture firms have continued to invest $35 billion, $21 billion, and $17
billion respectively in 2001, 2002 and 2003 (Fong, 2005, p5). Although numbers are not in for
2005, capital commitments are up strongly from previous years. The point is that private equity
investing is both large and rapidly growing.
ESSENTIAL DIFFERENCES
Ten essential differences between public and private investing can be identified. From these 10
differences, a set of 5 skills will be deduced.
• Private equity investments are illiquid and cannot be easily reversed when the
industry or company prognosis deteriorates. Instead, the VC firm must work with
the company to bolster its performance. Hence, the importance of the relationship
between the investor and the entrepreneur is of critical importance. Publicly held
shares can be readily dumped when trouble arises. PHC investors must work with
management in a constructive way to remedy problems.
• The costs of due diligence and legal contracting make small investments
generally infeasible. Legal contracting and due diligence are both extensive and
expensive. Brokerage firms that trade public securities have standardized the legal
contracting associated with buying publicly traded stocks so that it is virtually
transparent to the investor, and the costs are distributed over thousands of clients.
The legal contracting associated with private equity investing must be negotiated
on a deal-by-deal basis. It is not uncommon to spend $20,000 or more on the legal
documentation associated with the closing of a venture capital round. Due
diligence can also run $20,000 or more depending on the nature of the investment.
The lion’s share of this expense goes to IP audits, legal audits, financial audits,
and customer audits (to confirm the existence, terms of, and satisfaction with the
company’s customer contracts). This means that the private equity investor will
have to factor in considerable acquisition expense into the calculation of
investment returns.
The diagram below summarizes the five skill sets that are unique to private equity investors. The
“valuation” skill could certainly be argued to be a part of the public investor’s skill set. It is
included below to emphasize that valuation of companies that may have few sales, no profits,
and compete in new industries – common considerations for the venture capitalist – pose
significant challenges to conventional valuation methods. Concepts like Beta, a measure of
market risk that can affect value, become irrelevant. More precisely, projecting sales, EBITDA,
profits and cash flow – common valuation metrics – become even murkier than in established
businesses and industries. So doing valuation in this environment involves a different way of
approaching these tools.
Table 1 and Exhibit 1 below summarize the skills needed to be a successful private equity
investor that are not generally needed by the successful investor in publicly traded stocks nor
taught in investment majors. The “application questions” are : (1) To what extent does the
curriculum your business school recognize the unique set of skills required by aspiring private
equity managers? Does your investments curriculum need to be updated? (2) To what extent
does your private equity investment firm seek to develop these skills in its junior (or senior)
members? (3) As a private equity manager, which of these skills do you need to cultivate to
improve your overall capabilities?
Note that I have listed publications that I have found to be quite helpful in developing these
skills in the far-right column of the table. Other resources are certainly
available as well.
TABLE 1
EXHIBIT 1
Personal
Contract Skills networking skills
From the foregoing, it can be concluded that the “market-savvy” investor in public equities has a
lot to learn before he or she becomes a competent private equity investor. The task of private
equity investing requires a broader skill-set. As private equity becomes an increasingly large
proportion of the investment universe, academic institutions will have impetus to broaden the
offerings of their finance and entrepreneurship departments to include courses and modules
aimed at developing these incremental skill sets. Only one of the 5 critical private-equity
investing skills is commonly taught in university investment curricula – valuation. While the
depth of coverage of these 5 topics will differ according to a university’s particular emphases,
institutions who want to prepare their graduates for tomorrow’s investment climate should
consider working these skill-sets into their curricula.
The first recommendation is that business schools not rely on the “general business
requirements” to meet these skills. Rather, pedagogy for developing these skills should be
worked into the content of investment or entrepreneurship courses to ensure that the skills are
integrated into the investment context.
Secondly, some of these skills are process skills, which means they are developed by practice –
not merely through understanding the process. Network building and negotiating in particular
will require an experiential learning context where the skills can be developed and practiced.
Due diligence is not on anyone’s curriculum anywhere. Accounting departments may claim the
audit piece of due diligence, but what students of private equity need is a framework for
understanding what to look for and how to analyze it. The aforementioned book “Venture
Capital Investing” is devoted to this topic, as it approaches the art of investment selection as
basically one big due diligence effort. It makes an effective course module and provides a
framework for conducting due diligence.
Finally, a course in private equity investing can be demonstrated to accomplish the purposes of
the business capstone class in lieu of Strategic Management, for example. At the heart of the
course is determining whether a company is well-positioned in the industry for the future, and
whether it has the resources or competencies it will need to compete successfully. All of the
functional areas come under scrutiny as the company is analyzed. Students then can show their
confidence in the company by stating what they would be willing to pay for it and why.
It is hoped that this manuscript has been useful to those charged with developing curricula for the
entrepreneurship and investment tracks of academic institutions, and that it can serve to guide the
training efforts of private equity money managers.
REFERENCES
Fisher, Roger and William Ury (1991) Getting to Yes; Penguin Books, New York
Fong, Kevin in Ernst & Young (2004) Annual Venture Capital Insights Report, New York. p.5
Gladstone, D. and Laura Gladstone (2004) Venture Capital Investing; Prentice Hall Pearson
Education, New Jersey
Rosen, George (2005) Visiting class lecturer June 7 2005 from Corporate Investment
International, Orlando
Taetle, Alan (2005) Interviewed May 6, 2005, a general partner with Noro- Moseley, a venture
capital firm; Atlanta
Timmons Jeffry A. and Stephen Spinelli (2004) New Venture Creation, Irwin Publishing, New
York p.476-477; 501-518
Wilmerding, Alex (2005) Term Sheets and Valuations; Aspatore Publishing, Boston