I’ve gotten a lot of good advice over the years . . . it’s
really unfortunate that I’ve forgotten most of it. Two nuggets, however, keep rattling around
inside my otherwise sparsely-populated skull.
First, in my younger and more athletic years I played
baseball. Back then, I was a pitcher,
although not one of those fireballers-in-training that got all the attention
from the hotties and Division I-A coaches.
Nope, I was a dependable – but less flashy – finesse pitcher with a
tragic flaw: whenever I started getting roughed up (which was often!), I always
tried to overpower the opposing team’s hitters with fastballs.
Unfortunately, when your three pitch speeds are slow,
slower, and slowest, trying to blow the ball past someone can become a dicey
proposition. Whenever this madness set
in, Coach C. would come out and say, “don’t
compound your mistakes . . . you’re in a hole; stop digging. Get back to your game plan.”
The second chunk of wisdom was imparted in the early part of
this decade by an LBO pro who was reflecting on the just-past ebullience in
Venture World: “Always remember that any
form of value-added, hands-on investing works best when time is cheap and capital is expensive. Unfortunately,” he continued, “in frothy
environments time becomes very dear and capital becomes very cheap.”
Implicit to this statement was an assertion that a pendulum
swings between ebullience and sobriety, between spirited overextension and
thoughtful focus, between openhanded wagering and miserly risk aversion. Here’s my question, though: whatever happened
to the swinging of the pendulum?
Despite a hiccup here or there (including the recent
mega-cap buyout world lock-down,) the velocity of money has been accelerating
across PE world. Sure, the deal pace has
slowed lately, but transactions are still getting done and double-digit billion
dollar funds continue to get raised. And
all those dollars will have to go somewhere.
At the same time, we hear tales of woe about slouching
return expectations and I’ve lost countless hours of sleep worrying about
compressing risk premia. It’s a
prisoner’s dilemma, of course. Returns are
going down because too much money is being put out, but a sizeable number of GPs
(and LPs for that matter) don’t want to stop putting money out because they
don’t want to sit on idle cash.
And why not sit on idle cash? Because that prevents people from going out
and raising their next fund which in turn postpones the augmentation of their
fee stream. Maybe I’m painting with too
broad a brush, since I know plenty of managers who are still capital gains motivated
and not just W-2 focused, but it just seems that a handful of folks are
enjoying robust enough fee streams that they can look at their carry as a nifty free option owned at their limited partners’ expense.
Since all economic analysis is done on the margin, it’s
these current income focused cats who are inverting the time and money equation. You can’t begrudge them, though, since their
incentives are clear: get the money out fast, get involved in too many things,
see what sticks, and raise the next fund.
As long their investors allow them to keep raising subsequent funds,
there’s no disincentive to stop.
I just hope that along the way – when times inevitably get
tough – we all have the wisdom to know that we’re in the hole and should stop
digging. Compounding your mistakes is
the worst thing you can do when trying to compound capital.