Advantages of Private Equity Emerging Managers

Emerging managers in the private equity world face a laundry list of advantages and disadvantages to getting their businesses up and running.  The challenges – both the positive and negative – are perhaps more strongly felt in the private equity realm than in many other professions.  This post discusses eight advantages of emerging managers, with next week’s post addressing the disadvantages.

Before going further, it’s probably a good idea to define what an emerging private equity manager is.  An emerging private equity manager is generally a firm with less than $31 million in gross income over the prior three years or less than $1 billion under management, and/or a firm with at least 51 percent of its equity owned by a woman, minority, or disabled person.  In general usage, though, an emerging manager is an individual or firm attempting to establish itself, whether as a group of individuals creating a spin-off of an existing firm (individuals with lots of industry experience) or a group of individuals with little prior investment management experience.

With this background in mind, what should emerging managers be thinking about when it comes to getting off the ground?

Here’s a short list of eight advantages of the emerging private equity manager, adapted from comments made by John Koeppel:

1. The first is that emerging managers in the private equity space are able to make potentially high-yielding investments in under-served sectors, typically ignored by the more established investor.  What are the under-served sectors?  Interestingly, there are appears to be no consensus definition.  In looking at some industry specific studies, under-served sectors include the agriculture industry, the transportation equipment industry, non-metallic mineral products industry, construction, mining, manufacturing, and textiles.  The fact that some of these industries show up on the under-served list may be a little surprising, although there are certainly lengthy reasons as to why the data show what they show.  In any event, under-served industries represent an advantage of the emerging private equity manager.
2. The second advantage of emerging private equity managers is diversification.  Investors likely already have a strong (or weak) group of established managers.  Emerging mangers provide a much needed diversification from the less risk-loving nature of established managers (not to say that established managers don’t take a good amount of risk, just less).
3. Third is the connection emerging managers have with local entrepreneurial talent.  In general, emerging managers are connected with a niche area of entrepreneurial activity, and certain investors are looking for this expertise/connection.
4. The fourth advantage is the ability of emerging managers to adopt focused governance rights, such as the practice of Public Pension Capital, where operating budgets generally are more open and scrutinized.
5. Number five is the ability of the investor and the emerging manager to align term interest, and build stronger, more mutually beneficial relationships (loyalty).
6. The sixth advantage is the ability of emerging managers to be more nimble and adaptable, meaning emerging managers bring new ideas, fresh talent, and a desire to exploit market inefficiencies.
7. Seventh is that smaller managers have the potential to produce better returns.  Of course, the potentially higher returns come with higher risk.
8. Finally, the eighth advantage of emerging managers is the ability to align social goals with the potential investors, something becoming increasingly important in the competitive world of social investment.  Social goals may include economic development, environmental issues such as renewable energy, and Sharia law compliant investments.

All in all, emerging managers have some significant advantages in the private equity sphere over existing, established managers.  Granted, selling the advantages of investing in an emerging manager in no easy task, but then again, as illustrated in this post, it shouldn’t be impossibly difficult.