I am never investing in a PE deal again out of my personal portfolio. Ever. Not VC, not angel investing, not growth.
Background: I'm a PE professional, and I went down the path of personal investment in PE because it was what I felt I understood. Plus my former shop was printing high IRRs which made public equities seem silly.
I mean, why settle for a historical average 8-12% return, when you can generate >30% IRRs plus influence the outcome thru activist investment in PE, right? Bad idea. So I co-founded a hospital chain, and put my own money in that as a partner in the opco, and also separately invested in a number of smaller illliquid PE positions. I regret that, and offer this as a cautionary tale.
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Negative Selection Bias: Unless you're Peter Theil or Warren Buffett, or at a major PE shop which is 24/7 immersed in an industry, no one is showing you great private deals. That means there's an inherent negative selection bias. PE funds screen several hundred deals a year, and do only a small handful. My old shop had a >98% rejection rate. But getting that kind of deal flow, and running that thorough a screening process means having a brand to attract dealflow, and running a team to sift through the volume. As an individual, you just can't do either. Simply put, if you're seeing a private deal - it's likely a bad deal.
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Illiquidity: PE funds and their LPs can stomach illiquidity. I thought I could but turns out I can't. It takes institutional time horizons to be in PE. If you're an individual investing out of your PA, how will you manage it if the investment doesn't exit for 5 years? Or 10? Want to buy a house to put your family in? Too bad, your money is stuck in a PE deal. Want to participate in the stock market rally? Too bad, the money's locked up.
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Never an exit / You might fund someone else's lifestyle: a variant on the above is the scenario in which the company does well, your investment thesis is validated, but the company can't/won't exit. Making the leap from private to public company is something that most companies will never do - and mostly likely you'll invest in a company with no exit. I invested in one tech company that became the leader in its niche, revenues are too small to IPO. Example 2 - 5 years in I'm still trying to sell the hospital platform I helped build. It's grown a lot, but finding a buyer is difficult. Most PE deals won't find an exit.
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PE is lumpy: The nice thing about public equity is it's easy to take a few thousands dollars and invest. It scales nicely. PE? Not at all. Minimums on PE deals even as a co-founder are hundreds of thousands. It's lumpy, and that concentrates the risk in your PA.
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You're a fuckable midget: In most deals - whether you're investing alongside a fund or going in as an equity participant in a business you start - you're a small player participating alongside giants. That means you can be crammed down, squeezed out, and in general just bullied and abused. Even if the company is a success, you can still find yourself on the losing end of the deal.
At this point I've invested in SAFE notes, a couple CBs, and the hospital I co-founded was structured as a partnership in which I am an LP. As a minority investor, I don't have much ability to dictate terms. That's reason #6 as to why not to invest in PE as an individual. In the case of the CBs and SAFEs I did convert to preferred stock which does have a coupon, but that coupon is accrued and isn't paid. I didn't have the ability as a tiny minority to negotiate particularly good redemption rights. I just had to take the agreement everyone else signed.
I could in one case put the equity back to the founder, and get paid the principle + coupon - legal fees. But coupon is just 8%, and so after legal fees it's quite dismal returns. Meanwhile there was another round at 2x my cost 3 years ago. But when will I ever see liquidity?
And the hospital I co-founded.... there's zero liquidity until we get acquired. We've been trying to sell the company for 2.5 years no. Not a ton of buyers running around for big chunky assets like that. I'd have done much better had I invested in public equity, and I'd have liquidity to boot.
Mind you, I'm not against PE as an institutional asset. If you as an LP have the long-term view, it's awesome. If you get with a fund that has a real edge - some unique secret sauce - you can make way better returns than public market.
But as an individual investor, I have gotten quite cynical. So I put together this post both to warn others about the risks of putting PE in your PA, but also to remind my idiot self of why I'm not going to make that mistake again, when the new-new-thing comes around.
To be clear, I am still a fan of doing PE as a proper fund management company, with a dedicated sourcing and DD team, patient capital, and enough resources to take your sweet time before plucking that 1 deal out of a 100 to invest in. But I'm really against doing PE as an individual.
In terms of how you can get screwed - the ways you can get pushed around as a minority individual investor are countless. You have no vote or BOD seat, so you're at the whims of both mgmt and bigger investors. They will almost certainly do things differently than you would have, and you can't do a thing about it. They may turn down acquisition offers, insult potential investors, decline partnerships, and put off / decline getting acquired.
Some examples include:
CEO repeatedly forgets his meetings with investors I set up for him. I've had him be belligerent to investors and argue them down.
CEO paid himself a nice salary, and just coasted for years. No exit on that one, and he's living a nice life, so what does he care if I want an exit. He's got salary, lords it over 100 employees, and life goes on.
I made a seed investment in a company that became a unicorn. I had been structured into a special class of advisor shares because I was providing consulting + capital. Well the VCs who came in later had the BOD buy back all those shares at the last round's valuation BEFORE they would invest. So I got a bump in my valuation, but didn't fully participate in the company's success.
I could go on. I don't remember a public stock f'ing me over like this.
We own two hospitals, both in a tier 2.5 city in China's greater bay area. We use a Kaiser Permanente-like model, where we sell healthcare plans to corporates, who then have their employees be our subscriber/patients. We have >50,000 patients, serve >1,000 corporates, and have >1,000 beds. Want to buy it? We can negotiate a good price ;)
We made a couple of tactical errors which took this seeming winner into a problem child. 1) we own the physical assets, which has sucked up our capital, 2) we bought a second asset before fixing up and stabilizing the first hospital, and which further sucked up our capital. The moral is don't over-reach. And be super conservative on how you spend your cash.
Seriously, do you know of any buyers?
Very interesting, thanks for sharing your experience.
1) You mentioned you own the physical assets as a detriment to the investment (big capital checks) - how would you have done it differently the next time around? I'm not familiar with the hospital sector but would you have a 3rd party own the facility, you operate it via lease, and then on top you have contracts w/ patients/corporates?
2) When you said the first hospital was unstable for a period of time, what do you mean by that?
3) Any hospital sector-general advice you could share? Always interesting to hear from someone with direct operating and investing experience.
1) owning the physical assets is a detriment because it has used up all the capital we raised. We raised the equivalent of $100mn, but we used nearly all of it to buy the physical assets under the mistaken belief (and indication) that the local banks would lend to us against the assets. When they did not lend, it meant we had insufficient funds to expand the business, or even to finish repairing the larger hospital. Hence the larger of the two hospitals, with 1000 beds, has been empty for 4 years as it is not in a habitable state.
A better way would have been to use an asset-light model. Other operators have leased their facilities from the city government. Theoretically we could also have tried to work with a real estate player who could come in and buy the property at the same time that we undertook the operations of the building.
In any case, using up all our capital to buy the buildings has made it impossible for us to continue to fund growth.
2) I was referring to the uninhabitable state of the larger hospital, which we need tens of millions of dollars more to repair before it can be used
3) this was our first hospital investment, and probably the last. I don't think it's a great business, at least not in China. I don't think I have much advice beyond recommeding that one invest asset-light.
Oh don't be sorry. We fail, learn, adjust, and win. I'm not trying to complain but rather to self-teach thru sharing where I've failed, and getting the perspective of others.
I'm contemplating investing in some deals directly with a couple of funds that I've gotten to know and do advisory for. Such a strategy would still suffer from some of the above problems - illiquidity, to an extent being vulnerable to gamesmanship (ie. being a fuckable midget). But at least if you're investing in a decent fund they should be seeing the best deals and screening them well.
The question then becomes - are you investing on the same side of the table as the PE fund, or are you their tool? That is, are they charging you carry and mgmt fees, or will they do you a favor and let you invest without fees? Are they gaming their IRRs (many funds play funny games)? How are their DPIs (real money paid back to LPs)? Are they a small and high performing fund, or an asset aggregator? That's important because you want to be with small high performers who can grow your capital, rather than a megafund who just hits mediocre returns and gets fat on your mgmt fees. How disciplined is the GP (manager)? Does the firm's past strategy still apply in the current / future market?
I was previously at a fund that did triple-digit IRRs with high DPIs/realizations. We were just killing it as a small fund. The CEO got greedy, grew the fund to >$15bn, and now the funds don't even return the principle back. Caveat emptor. There's a lot of smart LPs that got burned with that one.
Oh absolutely. If you can get in with no fee, no carry, and it's a decent fund, it's one of the biggest incentives for working in a PE fund. Co-investment in specific deals is even better because you can cherry-pick. In most of the funds I've worked at, they didn't allow either fund investment or cherry picking. When you're recruiting, be sure to ask about this. I've found most MDs at PE funds to be greedy and not share. But there are enlightened funds out there for sure.
Fun story, one of my mentors was an MD at a PE fund, and his salary was fine, but he made >$100mn by directly investing in one of their star deals, and he went all-in with all of his chips. It went from less than $0.50 per share to >$100 per share. That's definitely how winning is done. (punchline, he invested in a 70 person startup that is now one of China's largest financial services companies with over 800,000 employees.)