Private Equity Seeding/Investing in Emerging Managers

Dan Pogue:

Thanks, Elana.

Peter Birk:

It's good to be here.

EMS:

Absolutely. To kick off the conversation, tell us a little about the firm and how both of you got to where you are today.

DP:

So, Peter, myself and another colleague of ours who's not on the podcast today, Chris Keller, so our team at Catalyst is much broader than that, but the three of us are the core investment team at Catalyst day-to-day that oversee the implementation of the strategy. And I'll maybe start super quickly with our personal backgrounds. I think it's relevant for what we're building today at Catalyst as part of Moelis Asset Management. And then I'll touch a little bit higher level on the organizational construct. But the three of us have been longtime friends, colleagues going back over ten years now. We've known each other and worked together and in some fashion, going back to 2012, 2013, and really where the three of us all started together, were at a Midwest based boutique investment consultant that worked with a lot of institutional clients in an advisory capacity and the three of us were specifically among others part of the private equity research team there. And we were very fortunate in those roles to be exposed to really the gamut of private equity from small buyout to venture to large buyout to credit, you name it. But I think we were very fortunate as it relates to our roles today to have from an internal leadership perspective at that firm as well as to have a lot of trust with our third party advisory clients to really go off and prosecute a thesis that we had collectively as a team at that firm around emerging managers within private equity and that thesis was born out of a confluence of things. I think first and foremost, foundationally, we were always striving to get better about how we could unlock some sort of differentiated value or alpha within our clients' diversified private equity programs. And naturally that led us to smaller, less efficient market opportunities, oftentimes at the lower end of the middle market, whether that was in the growth equity capacity or a buyout capacity. And more from a team or a firm philosophy standpoint we had a thesis and it was probably more novel then than it is now, but at the time it was relatively novel, this thesis around trying to find teams that were yes, highly aligned and had good track records, et cetera but that had some degree of specialization. A lot of times it was some combination of sector specialization or transaction type specialization and or operational specialization and sort of the intersection of trying to find those less efficient market opportunities combined with a high degree of alignment and specialization naturally led us to this thesis going back ten years now around emerging managers. And so, if you look at the funds that we partnered with alongside our clients at that consulting firm, about a quarter of those funds actually were in the emerging manager space. So, we weren't doing seeding or anything like what we're doing now, but the general philosophy was born within our team at that firm about ten, 11 years ago now.

And so, fast-forward to today, what we're doing at Catalyst is in some ways really a continuation of what we've been focused on now for the last decade together as a team. And we're doing it within a very supportive firm at Moelis Asset Management. I think importantly, Moelis Asset, which now ballpark over the last ten years has grown very thoughtfully to about $8 billion of AUM with deep roots in the alternatives investment space. I think importantly, Moelis Asset has a rich history in the seeding space across alternatives in the venture space, the private direct lending space, et cetera. And we effectively take that shared philosophy from the top down and just apply it very specifically to private equity.

So, really, we want to be that early institutional strategic value add partner at Catalyst for all of the private equity GPs that we back. And just quickly on the sandbox that we play in, so that's clear because seeding, anchoring, it can take a lot of different forms. We're specifically focused on private equity managers with an emphasis on small buyout, lower middle market buyout and growth equity across both North America and Europe. And we're flexible on fund size, but I think if you look at where we like to play at the lower end of the market, it tends to lead us to fund sizes that are $500 million or less, $750 million or less, something like that. So that's the team in the organization.

EMS:

Great. A very interesting journey and overview, Dan. So, this segues nicely into the follow-up question I had for you, given your firm's focus on seeding, PE, love to hear your high-level overall outlook for the space right now.

PB:

Yeah, thanks Elana. So, we're perhaps a little biased here, but of course we see a lot of opportunity in backing emerging managers both from a seeding capacity and also just as a regular LP commitment. What we really like about emerging managers is their ability to having a team be aligned to the focus of the GP, bring some of the best talent to bear on those individual portfolio companies and the value-added capacity of those team members as well as the markets in which they focus. So, often these groups are focusing and smaller businesses that have the ability to add a lot of value from a managerial sophistication perspective, but also from bringing in the sector specialization and the networks that these teams have.

Again, we think there's a lot of dispersion in this space as well. And so, there's a higher return on effort for individuals that are willing to go in and do the hard work on due diligence these managers and ensuring that they do have those value-add capabilities within this space. So, we see a lot of interesting opportunities with seeding these managers as well as being the value-added partner to enhance their ability with a back-office fund infrastructure as well as introducing them to our networks and the groups and LPs that we know within the space.

EMS:

Great. And as a follow-up, I'd love to ask both of you to touch more specifically on some of the greatest opportunities you see in your space and why.

DP:

Yeah, so it's interesting. We tend to avoid macro high level calls. So, if you think about how we think about portfolio construction with our strategy and how we approach the market, we will typically be well diversified across sectors, again, across the different flavors of strategy. When you think about growth, equity and buyout, I think where we spend a lot of time on our team in terms of saying evaluation is we tend to over index on the team or the human capital side of things and then making sure that it's the right team actually chasing the right opportunity. And so, I think when we think about opportunity, it's less through a sector lens. For instance, we have to have health care versus consumer and more through the team lens and the background of the team and has there been an evolution in the marketplace that we can potentially tap into to unlock value for our strategy going forward?

And so if I think about the history of catalysts and how we've approached the seeding space, the majority, if you go back six or seven years, the majority of seeding opportunities I think tended to come whether it was something that our team was focused on, or frankly probably the market as a whole, more from what we would call direct spin outs. So, typically two or three senior level people that lifted out of a well-known, established private equity firm, they had some form of attribution for the track record. They clearly checked the team continuity in the experience box, and so they fit pretty cleanly into what LPs like to see when it comes to backing new and emerging managers. And so, they lift it out of the firm and moved straight to raising a fund and they were off to the races. I think what we've certainly seen our fair share of that, and that's still a very fruitful aspect of the market and sourcing and pipeline for us.

But when we think about opportunity, one area that we're spending a lot more time in, and this is reflected in terms of the new GP pipeline, if you talk to our team about it, is the independent sponsor space. So, instead of someone leaving a firm and moving straight to a fund for one reason or another, there can be several, they choose to be an independent sponsor and not necessarily move straight to raising a pre-committed pool of capital, but they raise money on a deal by deal basis and typically do two, three, four deals on a deal by deal kind of SPV style basis as an independent sponsor to effectively then oftentimes, not always, but oftentimes bridge themselves to raising a true institutional pre-committed fund. And we really like that independent sponsor space. It's not that it's necessarily better than the direct spin outs in terms of the quality of the opportunities, but it's allowed us from an opportunity set perspective, from a broadening the top of the pipeline perspective to continue to see enhanced value there.

And it also, it effectively allows us to track teams for longer, frankly, so we can get to know teams when they leave a firm and they may be an independent sponsor for two, three, four years before they actually go to raise a fund. And so, on our side, the gestation period, the get to know you period oftentimes is longer with those independent sponsor opportunities. And so from a relationship building perspective and ability for the GP, there's talk a lot about whether it's today or outside of a conversation like this, our ability to bring not just capital but value to the managers that we partner with, our ability to sort of have the independent sponsors get to know us ahead of raising a fund and frankly do references and pressure test the value add that we can bring above and beyond capital. There's a lot of value in that I think for both sides.

And it's interesting, we don't actually, with our strategy, we are fund investors. We don't actually finance individual deals unless they are going into a fund, but we really like the inefficiency and frankly the quality of sponsors despite the inefficiency of the market that we see in the independent sponsor space and community today. And so that's a space where we're not only spending more time in terms of sourcing potential fund ones, but for people listening to this, there's definitely been several groups that I'm sure many of the listeners will have heard about in terms of raising dedicated funds effectively to go off and provide equity financing for these independent sponsor deals. And we think that's a really interesting model and we'll likely continue to see more of those.

And so again, back to opportunity, how do we evolve our pipeline, our business, but stay true to our strategy in terms of seeding funds? We think that there's definitely interest in our side in terms of potentially building on some of those independent sponsor equity financing models and seeing if that's something we can potentially tap into as a business as well. So that's a space that we really like.

EMS:

On the other hand, I'd love for both of you to address some of the greatest challenges you face in your space and why.

PB:

Yes, the greatest opportunity or the greatest challenge, excuse me, for any asset manager is going to be differentiating their capital. And so, we believe we have a thoughtful solution and many of the managers that we see believe they have a thoughtful solution to approach the marketplace, but ultimately, we need to convince both firms and LPs of the value proposition of our capital.

So, our motto is to be early, bring scale and add value, and the add value piece is a key component of what we're trying to do for the GPs in which we partner with. And again, that opportunity to add value comes through the introduction to our networks, the ability to add value to the infrastructure of the fund and advice and counsel and even vendors to use.

In addition to that, one thing that we believe we can differentiate on is that return on effort component where we are able to find a lot of those emerging managers through the hard work of getting to know 500 to 600 different managers within our pipeline and within our CRM, enabling us to really understand what the best managers are out there, the ones that have the ability to differentiate their capital and deploy capital in appropriate manner.

EMS:

To shift gears a bit, ESG and DEI are top of mind for the industry, and I wanted to ask both of you how the firm is approaching these topics.

DP:

Yeah, so I'll maybe start on that one. So, we have a holistic approach I'm sure everybody does to investment underwriting. So, DEI, ESG are certainly elements that we consider as part of that holistic approach whenever we're looking at a potential GP to partner with. We don't have some firms out there. We don't have necessarily an explicit ESG or DEI directed strategy or mandate, but it's definitely part of what we consider and focus on. We track certain aspects of that when we think about the pipeline and stats around that, et cetera. I think the important thing, and anybody who's active in the emerging manager space can attest to this. I think naturally we tend to find ourselves in situations where we're having earnest conversations and we've certainly in the past have backed at Moelis Asset groups that are really high-quality emerging managers and they are diverse teams in some form or fashion.

I think naturally we are very well positioned given that we're effectively trying to be the earliest foundational institutional capital for these firms. And naturally there are a lot of really high-quality diverse teams out there that operate in traffic in this emerging manager space. We're in a very good seat to continue to partner with those groups going forward. And so, it's something that we definitely, we account for it in terms of how we view the world. We've had a lot of success in terms of partnering with diverse teams that can add a lot of value for our portfolio, and I think it makes for a very healthy, thriving, emerging manager ecosystem.

EMS:

We've covered a lot of ground today, and I wanted to ask both of you about the various seeding models available.

PB:

Yeah, so first it's important to specify the various seeding models that exist out there. So, there's seeding, there's anchoring, and there's also GP stakes. We define ourselves as seeding and anchoring, which we provide a large LP commitment and generate a revenue share of some of the GP economics with those managers.

We view GP staking as a wholly different model, which is often minority investments in a well-established GP and allowing them to realize some of the value of the, again, established GP. Our model is really a shot in the arm in the early years of the GP to help them establish their franchise, but in those out years when they're no longer an emerging manager, our revenue share model has capped out and they're the full owners of their GP economics and allows them to continue to grow as a GP going forward. We believe that our model allows us to find some of the best managers who are not looking to realize any of their equity early years of in their life cycle, which can limit their ability to grow going forward given the perception of that model in the LP market, but also there's having to sell equity stakes in their business at its lowest value.

And so, we like our model, and we believe that positions us for a selection opportunity where the managers look to partner with us in order to get a shot in the arm for their GPs as they're growing their franchise in the early years. We believe that that allows us to leverage or gain some of the enhanced returns that come from emerging managers, but also further enhance those with the added GP economics through our revenue share model.

EMS:

Dan and Peter, I wanted to thank you both so much for sharing your perspective with our listeners.

DP:

Yeah, thanks for having us, Elana. We enjoyed it.

EMS:

And thank you for listening to the EisnerAmper podcast series. Visit EisnerAmper.com for more information on this and a host of other topics and join us for our next EisnerAmper podcast when we get down to business.

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