The business of investing in growth and privately owned firms has experienced decline for the first time in years. The Swiss industry announced that it is responding by taking steps to improve its appeal.
After years of healthy, sometimes spectacular, growth in the size and value of their investment funds, Swiss and private equity and venture capital investors saw declines in 2001, according to figures published by the EVCA last month.
The amount invested by private equity and venture capital teams sank from SFr975 million in 237 investments in 2000 to only SFr368 million in 184 investments in 2001.
In fundraising, the decline was much more modest, which can be attributed to new fund of funds. The amount of capital raised by Swiss teams last year was SFr944 million, compared to SFr994 million in 2000 - a decline SFr50 million.
The fund of fund category is seeing an increase in Europe rather than funds that invest directly in privately owned firms, because the category is considered less risky and less risky is "in" these days.
The current state of the Swiss private equity industry and what it is going to do about it was discussed last week at a meeting of more than 300 members of the Swiss financial community. The event was entitled "Is Venture Capital Dead?" and it was hosted by the Swiss Venture Capital and Corporate Finance Association (SECA).
Dearth of co-investors for Swiss privately owned firms
The most dramatic change in the Swiss market is the lack of co-investors. Second and third round funding of privately owned firms relies on opportunistic co-investors who join existing or early shareholders in funding the various phases of growth of innovative firms.
But these types of investors have disappeared from the market for the time being. "Without the contributions from other investment teams, funds are having to pay out more cash to existing projects. That means there is less money for new deals and less money for co-investing in outside projects," says Dr Massimo Lattmann, a partner at Venture Partners AG.
Selling shares via traditional means, such as trade sales or public offerings on the stock market, is difficult and valuations are much lower than expected, meaning the returns the class is delivering are lower.
But it is not the end of the alternative asset class. "If you believe private equity and venture capital investment are dead, then you believe economic growth is dead," says Marinus W Keijzer, chairman of the board of Private Equity Holding AG.
It is a case of "creative destruction", suggested Keijzer, showing that he knows his Schumpeter.
Alternative asset class remains attractive
European statistics suggests the industry has stabilised in size after these declines. The number of private equity teams in Europe reached 831 in 1998. By 2001, there were 1,320 and that number seems to be sticking.
The alternative asset class remains an important aspect of a broadly diversified portfolio. "There remains a confidence in the alternative asset class in Europe," says Edoardo Bugnone, the current European Venture Capital Association (EVCA) chairman and who is also a partner with Swiss private equity firm, Argos Soditic.
Bugnone says that private equity will deliver returns in the future around seven per cent higher than the best public equity indices.
European private equity was less hard hit by the economic downturn than the US. The amount of money raised in Europe in 2001 fell by 21 per cent. The US industry raised by private equity professionals fell by 55 per cent in the same period.
Bugnone said that tenacity and experience would pay off in 2002. Investors should expect short-term returns to reflect portfolio company valuations, which are still decreasing. Bugnone reminds the industry that this is long-term business that continues to outperform public equities in the long run.
Secondary funds and cleaning up
Keijzer talked about the secondary market for private equity. He is president of the board of one of the hardest hit private equity funds in Switzerland, Private Equity Holding, a fund that was taken out of the hands of Bank Vontobel and transferred to Swiss Life Private Equity management last summer.
Since then fund managers have been divesting a seriously devalued portfolio. PEH lost SFr265 million for 2001.The standard way of doing this with alternative assets is to sell to so-called secondary funds. These are funds that buy individual shares, entire portfolios, or entire fund of funds when investors want liquidity before their committed time is up.
Keijzer said it was fairly easy to sell stakes last year to the secondary market, but now the situation is "atrocious". This year some of the secondary investors wanted him to pay them to take the stocks.
Bugnone pointed out that the secondary market is being flooded at the moment as many corporate venture capital investors, such as Intel Capital and Lucent, sell off and write down dotcom and telecommunications investments.
According to AltAssets Research, the secondary market is growing rapidly and will achieve six-fold increases by 2005 in reaction to demand and opportunity. Active firms with secondary funds include Pomona Capital, Goldman Sachs, and Coller Capital.
Transparency has its rewards
SECA is taking steps to improve its communications skills. SECA president Dr Massimo Lattmann invited journalists to sit down with dozens of members of the association over dinner, giving both groups a rare opportunity to talk about the business of investing in growth.
It is a big change for an industry that has taken great pains to capitalise on inefficiencies and lack of transparency in the private market. Lattmann, who leads the increasingly proactive SECA executive committee, says that SECA is changing "from a club to an institution".
In an industry that is being shaken to its roots, and where the opportunists and amateurs are backing out, SECA membership actually increased in the last few months, growing from 110 to 143 members.
There are some good reasons for the new openness. At the moment, SECA is lobbying the Swiss government for better taxation policies for private equity investments. In addition, employee stock option plans require some expensive legal advice and accounting gymnastics. The way it is set up is unfavourable for those who risk capital in young firms. SECA would like to see that changed as well.
Business reasons for improved public relations include the need to educate potential investors about the risks and rewards of investing in the alternative asset class.
Private equity wants to attract more pension fund money. To do so, it will have to communicate better. Lattmann said that a well-known study performed in the UK discovered that while pension funds were legally entitled to invest between five and ten per cent of their portfolios in private equity, few of them were doing so.
The reason that pension funds were not participating in the alternative asset class was due to ignorance rather than fear of risk. He says that the situation in Switzerland is similar to what it was then in the UK. He says that Switzerland has a long way to go before pension fund investment in private equity reaches five per cent of the value of the total available for investment.
by Valerie Thompson
Facts about alternative assets in Europe and Switzerland
Number private equity teams (EU): 1,320
Number of professionals: 4,300
Amount invested in 2000: €35 billion
Portfolios under management: €94 billion
Members of SECA: 143
Source: EVCA and SECA