| ||||
Excerpted from the book Done Deals, edited by Udayan Gupta, Harvard Business School Press
The maturity of the venture capital industry is illustrated by the manner in which generational change has taken place and the way the industry has broadened its scope geographically. Peter Brooke exemplifies both the generational change and the geographical expansion.
Brooke was the founder of TA Associates and responsible for making it one of the preeminent venture funds on the East Coast. He also was one of the first American venture capitalists to attempt to export venture capital en masse. But what Brooke considered to be pioneering and entrepreneurially groundbreaking, many at TA considered a diversion of hard-earned institutional capital. In 1985 Brooke broke off from TA to start Advent, exclusively for investing in global venture capital.
The "experiment" has more than proved its validity. Advent today manages more than $4 billion in total assets in twenty-four countries, and the Advent model has been widely imitated by a large number of U.S. funds that now recognize the value of being an "international" venture capital fund.
Brooke may be one of the few venture capitalists to have studied venture capital as a global entity and to have understood its strengths and limitations. His prescription for Asia, where U.S. investment banks and investors have been both the catalysts to change and a cause of the trouble, is a remarkable insight into Asian business and U.S. aspirations in the region.
When I got out of the Army in 1956, I joined the First National Bank of Boston as a trainee, and gradually worked into a position in the credit department where I was doing two things: making very advanced loans for a very famous dealmaker by the name of Serge Semenenko, a household name in financial circles at that time, and making loans to technology businesses that were bursting out of MIT and Harvard as a response to the the Sputnik challenge.
It seemed obvious to me that the business of the bank should be to finance the only valuable raw material we had in the region—namely brains. I felt that the bank shouldn't go around the country syndicating credits for General Motors and other national companies—it should concentrate on the core strength of the region in which it operated. The way to develop that business was to organize a lending program that would make small amounts of loan capital available to MIT and Harvard spin-offs and help build their businesses.
So very early on, I was lending small amounts of money to small companies, helping them attract equity capital, and helping them make management decisions. I was very much involved with some of these small start-ups—not simply as a lender, but also as an advisor. This was in 1958, 1959, and 1960. In effect, I was a venture capitalist using the bank's capital, and that was how I got my start. All of these companies were technology-based, and were responding to the technical challenges of their day.
At that time the federal government was contracting with small undercapitalized companies. They were front-end loading the contracts, providing the progress payments. For instance, a professor could leave with his prized doctoral student and begin an instrumentation company with a modest amount of his own capital—say $10,000—and manage a $250,000 contract for the federal government because the government would virtually prepay that contract. The first installment came before the work was even started. With very little capital, these companies were able to get into business. And there was essentially no risk because the contracting officer would accept almost any proposal as long as it pushed the science forward. So even though the lending appeared very risky, in effect it wasn't risky at all.
In working with these companies, I got very close to those who were providing equity capital at that time: American Research and Development and the wealthy families in New York such as the Rockefellers, the Phippses, and the Whitneys. I would lend money to a company, and if I thought it was particularly attractive and making good progress, and the loans were exceeding reasonable limits, I would take those companies to one of the family venture capital providers in New York to see if they'd like to invest. That's how I came in contact with Bessemer Securities, the holding company of the Phipps family, in 1961. During that same year I went down to reorganize and run their venture capital operation in New York. I continued to do the same type of investing as in Boston, but with equity capital, not loan capital.
There was a good deal of altruism in what the Phippses, the Rockefellers, and the Whitneys did initially. They wanted to prove that advancing technology and making money were not mutually exclusive. So they started to make investments in the '50s, without knowing whether they would work or not, or what the exit would be. It wasn't until the over-the-counter market became somewhat more active in the late '50s and the early '60s that the investments were able to be taken public. There wasn't an expectation that they would make a lot of money in this field. Their first stabs proved successful, so they simply put one foot after another and did more of that kind of investing. Only in the early '60s, when Digital Equipment went public,1 did the venture capital industry really take off. At that time, the New York families dominated the business—there was no real West Coast presence. Draper, Gaither & Anderson (a partnership formed on the West Coast around 1960), ARD, and the families—that was the ball game. The first real venture capital partnership in the current model wasn't formed until 1965, and that was Greylock here in Boston. That was followed rapidly by others on the West Coast, and TA Associates, which was formed in 1967.
I never moved from Boston to New York. I commuted on a weekly basis between August of '61 and January of '63. I was always about to move my family but I never could bring myself to do it. I was too confirmed a New Englander. So I quit Bessemer in January of '63. It was sad in a way because I had reorganized the firm—made it a much more hard-hitting effort—and the successes were beginning to show. The companies that I had invested in were going public and things were on the upswing. It was a job that I really knew how to do. So when I gave the job up, it was for lifestyle and family reasons rather than for professional ones. Back in Boston, Ogden Phipps, the chairman of Bessemer, and Jack Kingsley, Bessemer's president, gave me a contract to follow investments in the Northeast, which was a wonderful calling card for me.
I took that contract and approached three investment banking firms in Boston—Paine Webber, Hayden Stone, and Tucker Anthony and RL Day—asking if they would have an interest in starting a venture capital management company, a company that would first start putting together venture capital deals to sell to their clients, and then eventually raise capital for a venture capital fund. They all were interested. I selected Tucker Anthony and RL Day because they wanted to do it but didn't know who to do it with, and wouldn't interfere with the way I wanted to do it. The other two firms had an idea of how it should be done, but they didn't know anything about the business. We formed a company called Tucker Anthony & Co., Inc., that was jointly owned by the partners of Tucker Anthony and RL Day and myself.
We started that firm and put together deals that were quite successful. I began with a modest amount of capital, and at the end of a couple of years, the Internal Revenue Service came to me and said, you know, you're accumulating too much capital in this corporation and you have to pass it out as a dividend. That would have been prohibitive.2 So we liquidated the company, took the residue after the partners paid their taxes, and then invested the remainder in Advent I, the first partnership managed by TA Associates. In 1967, Advent I was formed with capital from the partners of Tucker Anthony and RL Day and some of their wealthier clients. We organized a very small partnership, only $6 million. We made small investments, $50,000, $100,000, and $150,000 in size. And that was the beginning of TA Associates.
In 1972 we followed with Advent II, a $10 million partnership. Advent III began in 1978 with $15 million in capital. Advent IV followed in 1980 with $65 million in capital. And Advent V was formed in 1982, I believe, with $165 million. At that time it was one of the biggest funds. When we completed Advent IV, with $65 million in capital, we became self-supporting. You see, in the period from 1967 until 1980, when Advent IV began, I hardly had enough revenue to keep the team together. There was hardly enough revenue from a $6 million fund, a $10 million fund, and a $15 million fund to pay the six young partners we had. In terms of people, it was a large partnership; in terms of revenue, it was a small one. So I had to do all sorts of consulting to keep the team together. And I was the only one who could do that since I was the only one with the name and the experience. The others were fifteen years younger than I. At that time Kevin Landry was a twenty-eight-year-old kid.
Not only did I consult for firms like DuPont (which had an interest in venture capital), Xerox, and International Nickel Company, but at the same time I started to investigate whether I could replicate our model in Europe. This was in 1972, and it pushed the envelope pretty early in the game. But I was fascinated with economic development. I had always thought of venture capital as the ultimate economic development tool, both for this country and for other countries that were underserved with capital. I felt that special programs could be designed to help these countries capitalize on what their people did best. I thought this could be done on a regional basis within the United States as well as on an international basis.
In 1972, when the Ministry of Industry in France wanted to investigate the forces that created venture capital around Route 128, they hired Arthur D. Little Inc. to do a study of what made these burgeoning technology-based companies successful. Part of the study was to look at the role venture capital played. They asked if I would write an appendix to that report describing the venture capital experience and the role that it had played in capitalizing these new ventures. In the course of writing the report I met the Deputy Minister of the Ministry of Industry, Christian Marbach. I convinced him that venture capital had been vital to the success of these companies and it could do the same in France. Marbach was a very innovative person. He returned to Paris and with the backing of Credit Nationale, the long-term lending institution in France, convinced the government to give tax incentives to individuals and institutions that invested capital in a new venture capital fund.
Taking Venture Capital to Europe
The venture capital fund Sofinnova was successfully launched in 1973. I became a founding director of Sofinnova. TA Associates became an investor and we put a young man in Paris to be the advisor to the company. I traveled to Paris five times a year, and spent a week of each visit with the companies Sofinnova had invested in, helping them to develop their business. Sofinnova, along with a few corporate clients, gave me the opportunity to travel throughout Europe to see if people would be interested in venture capital. I must say it was tough sledding because of the socialist environment. Economic growth was stagnant. There was no initiative. However, I developed some very good contacts, and when the Thatcher revolution occurred, we were in position to move rapidly to replicate the TA Associates model in various places in Europe, starting in the United Kingdom in 1981. That was our first foreign affiliate. Sofinnova was not an affiliate. We had an interest in Sofinnova by virtue of our investment. And I of course was an advisor and a director. But the first affiliate, Advent Ltd., was formed in Great Britain in 1981.
The affiliate was a management company owned one-third by TA Associates, one-third by David Cooksey, who was one of my partners, and one-third by another individual, Mike Moran, who was a partner of David's. We decreased our ownership position over time to encourage other people to join the management team. From England, we moved rapidly to Belgium in 1982, to Germany in 1984, to France in 1985, to Scandinavia (Sweden and Norway) in 1985, to Austria in 1986 and 1987, and to Italy and Spain in 1988. This was a very ambitious schedule. At that time that I was working on developing Europe and also expanding to Asia. We formed our first and only fund in Japan in 1982, and one in Southeast Asia in 1983. Until 1985, all these affiliates were owned in part by TA Associates.
I found myself in the 1980s trying to manage TA Associates, a domestic venture capital company, and trying to organize an international venture capital network at the same time. I determined in 1981 that I really wanted to concentrate on the international aspect and made two of my partners senior partners.
It became obvious in '83 and '84 that I had more of an interest in globalizing TA Associates than did my partners. I remember at the end of one year after we had raised a lot of money and the income was high that my partners said, "Well, how much money are you going to take out of our pockets and spend on advancing the company in Europe and Asia?" And I said, "Well, probably $1 million." There was a deathly silence. I knew then and there that if I was going to build a global company, I had to do it outside the profit-and-loss statement of the partnership; it had to be done in a separate company that was self-financing. That's when I arranged for the capitalization of Advent International and negotiated with my partners the transferal of the international program from TA Associates into Advent International.
When Advent International started in 1985, it inherited all of the affiliated programs that had been the property of TA Associates. With these programs and capital raised from European clients, Advent International was in a position to keep pushing forward.
The investors in Advent were families in Europe for whom I had made a lot of money. One was a very wealthy French family by the name of Bemberg that would have provided all the money we needed because of our successful investment performances in the past. There were two other investors—Sofina in Belgium, and Orange Nassau in The Netherlands. They put up the capital to allow me to follow my dream of making a global company.
To this day, I'm very sad that we couldn't have kept the whole thing together as TA Associates. We had a powerful organization, not just in venture capital, but also in investing in the media and real estate sectors and in the international side. The year that we all went our separate ways, the real estate team, the media team, the venture capital team, and the international team raised $1 billion in total for our various enterprises. So even way back in 1985, we were a very powerful company. And if it could have stayed together, it would have been the most powerful company in the world. Not that Advent International hasn't risen to a high level, but it would have just gotten there faster.
I wanted to build an institution, and frankly, the money was irrelevant. I wanted to build an institution that used venture capital as a national and international development tool, working with different cultures and different people to improve the way they managed their affairs. That was the underlying thesis: to have people in various parts of the world manage their human and raw material assets more effectively with the provision of capital and management assistance. If a company's competitive advantage was in raw material, we could help them manage their resources more effectively by capitalizing their companies more adequately, by working with them to develop export activities, and by managing their affairs better. That was my desire. I wanted to see if it could be done abroad the way it was in the United States. I thought it would be useful from both a financial and a societal standpoint.
What I set out to do was not to start an investment organization all over again, but to be an advisor to our affiliates abroad in running their investment programs, and to help them and their portfolio companies in technology transfer between Europe and the United States and between the United States and Asia. It wasn't until 1987, that some of my old investors came to me and said, "You know, you've got this fantastic network of people around the world who are making private equity investments, venture capital investments. Why don't we set up a fund that will co-invest with them? One that will capture those deals that your affiliates are syndicating to others." So in 1987 we started the first fund managed by Advent International, the International Network Fund (INF). The INF downloaded one third of its capital to its affiliates and network members, and co-invested the remaining two thirds with them in situations where Advent could add value.
Advent was represented on each investment committee of each affiliate and had the right of veto on any deal that was put forward. But that did not give us the quality control that we needed. What we really needed was U.S.-style due diligence. We were not getting the return on the International Network Fund that I wanted. So in 1990, we established our first office in London to coordinate our affiliates and to build a direct investment organization. I sent Doug Brown over to run that office. He established and executed a strategy for us, opening offices in Milan and Frankfurt, and then in Paris this past year. Now we are a direct investment organization only. When we do a deal, we work on the analysis with our affiliate right from the beginning and we sign off with our own people. We don't depend on our affiliates for due diligence. Every deal we do we will show to an affiliate, and if it wants to join that deal, it is free to do so. Our affiliates are the recipients of deals from us rather than us being the recipient of deals from them. We concentrate on different types of investments—recapitalizations and acquisition financings. We do not make early-stage investments as do our affiliates. We are into both financial and managerial restructuring.
Our affiliates in Europe were inclined to do business the way merchant banks still do business in that part of the world. When they get a deal, they subcontract out the accounting work and the management and marketing studies to outside vendors, gather the data, do some analysis, and then decide whether they're going to do the deal. That's not the way we do our business. Our people dig into all of the data on their own. We spend a tremendous amount of time training our people how to do in-depth due diligence, how to do the appropriate kind of checks with suppliers and customers. We use outside sources but we conduct a lot of market surveys ourselves. We do a tremendous amount of background checking on the management team. This is a method that was not known in Europe when we opened our first office. It's getting to be better known now. But still, on occasion the analysis of an affiliate is quite casual. I found myself, while on their investment committees, saying at the eleventh hour that I didn't want to do a deal. It created a lot of angst between myself and the affiliate analysts. So to get around that problem, if a deal comes through an affiliate, we now go to work on that deal together with our affiliate right from the beginning. We use a team approach. What has come out of this approach is much better analysis and much better performance.
Europe versus the United States?
Some venture capitalists in this country take pride in the belief that ours is the only culture in which venture capital can succeed. This is inaccurate. The institutional structures in Europe have impeded the development of entrepreneurship. But if those structures are changed in a way that will allow people to express themselves, they will. We don't have the corner on entrepreneurial drive or desire. I think that Europeans have suffered from a socialist culture over a period of time, but entrepreneurs have surfaced in virtually every country that we've operated in. Given enough encouragement, capital, and freedom, they will prosper.
Doing business across Europe is still difficult. Although you do have a common market, a prospective common currency, and common standards, you still do not have the type of homogeneous market we have in the United States. European consumers are still biased against products from other European countries in their home market. And there will always be some degree of protection for locally produced products. It is going to take a long time for Europe to be a common market the way we think of the United States as a common market. And so we still have to think of Europe as a series of smaller markets. The United States is the largest homogeneous market, the one that everyone always wants to invade if they have a particular piece of technology or product that they think they can sell. But getting goods from there to here is a challenge for any rapidly growing small company. It's always going to be a challenge.
Another challenge is an active market for the common stocks of emerging companies. There is a lot of talk about the new markets in Europe. There is movement in that direction but they have a long way to go. When we have exited a European company through an IPO it has usually been through a listing on the Nasdaq. The first company that we made a lot of money on in Europe was Scandinavian Broadcasting System, a group of television stations in Denmark, Sweden, and Norway. Our exit was through Nasdaq. We've exited a Polish cable company through Nasdaq. Nasdaq is still the route to liquidity for a lot of our European holdings. We recently had a successful offering on the Milan exchange, but that was an exception to the rule. If we have a company with all the attributes that would be attractive to U.S. securities buyers, Nasdaq is the place we'll go. It will take a long time for the European market to catch up.
Two-thirds of our exits have been to trade buyers, and I don't think that will change. We've always made strategic investments in areas that have been attractive to others, whether they be a buyer of a public security or an acquiring company. But buyouts have always been a staple exit for our companies. The largest investment we've made was in the privatization of an East German company that manufactured railway cars. We sold that out to Bombardier for fifteen times cost, for cash, earlier this year. And that's the way historically we've exited our investments.
We will gradually move toward the globalization of the public equity markets. You will find that individual and institutional buyers in the United States are interested in buying securities of foreign countries that are in new and exciting areas. However, there is a hiatus in that interest now as investors recover from the recent turbulence in emerging markets. A lot of people have been hurt by recent sell-offs and by their exposure to emerging markets. When people are hurt, they don't make the distinction between international emerging markets and international established markets, or between developed and developing markets. They cast them all in the same mold. They're all hit with the same criticism.
Emerging market stock funds have done more to hurt emerging countries, and more to hurt investors, than any other asset class I can think of. I preach this constantly. Emerging market managers at Morgan Stanley or Goldman Sachs don't understand the depths of the management problems in Malaysia, Thailand, or wherever they invest. We do because we deal with them on a daily basis. We sit on the boards of these companies. We know about the lack of talent when we invest. We know what we have to add in terms of managerial support to make these companies successful. An emerging market manager has no concept of the challenges. The people who have been attracted to those markets, I think, have been ill-served.
The Morgan Stanleys and the Goldman Sachses have devastated some of these countries. They gave them the wrong idea about what was real. They were told, "Mr. Tiger from Thailand, you are something special, something that defies the law of gravity. So here's all this money." And the Thais said, "Okay, we'll go ahead and build plants, hotels, and so on." Then all of a sudden, it's not such a good story anymore. The money leaves and the Thais are left with an underutilized capacity that will take them years to work off.
The future of Asia will remain uncertain until the Japanese riddle is solved because Japan has historically been the economic engine and the supplier of capital to Southeast Asia. The Japanese will eventually be back to simply protect what they have already built. So eventually, when they complete the restructuring of their financial institutions, they will be back as a major supplier of capital to the region. Until that happens, I can't see that there's going to be any major recovery. Certainly U.S. institutions are not going to move in until they see some evidence of recovery. The only U.S. capital we can count on is from strategic investors, corporate investors, and multinationals that are looking to buy assets at a depressed price. Their investment will occur over a period of time. So eventually there will be a recovery, but it will be a long, long workout.
Up until now, the capital provided has been expansion capital. The capital we are employing or will employ now will be reorganization capital. It has to be, since there is contraction, not expansion. We will be investing capital to reorganize companies that have a good future but are hopelessly overleveraged or overcommitted.
Take the example of a feed mill company in Thailand, a fully integrated agri-industry and agriculture business. The group's core activities play a key role in every stage of production from seed supply to feed production to processing. More recently, the group diversified into international trade, the automotive industry, retailing, pharmaceuticals, real estate, and telecommunications. Now these peripheral activities have to be chopped off and sold. We're not going to invest in those activities. We're going to invest in the core business. And the price of investing in the core business is getting rid of anything that is non-core and focusing on what has been the company's strength over the years. Virtually every group was inundated with capital and said, "Well, gee. Why don't we try this? Why don't we try that?" And they expanded into areas where they had no knowledge. So the entrepreneur, if he accepts our capital, has to agree to de-leverage by selling non-core assets. We tell the owner that he's got to sell the stuff that's not relevant and concentrate on what is relevant.
In another case, we're putting up a fair amount of capital to enable a well-managed Hong Kong trading company to buy a very good distribution company in Southeast Asia. And the job there is to once again get rid of the stuff that doesn't make sense, cut out the related layers of overhead, and concentrate on introducing a different distribution structure.
A very formidable management team thoroughly trained in Western management techniques is executing this strategy. Without a strong management team I would not invest in any company in Asia. Complicating the situation in Asia is the fact that most companies are family owned. Many times the Chinese family is unwilling to give management control to professionals, relying on family members to run businesses that are becoming increasingly complex. In many instances the family members are not equipped to handle such a job.
The family unit can be seen as a limiting factor in the growth of a Chinese business. And not just Chinese businesses in Asia. There are examples here in the United States. My favorite example is Wang Laboratories. I was a director of Wang from the beginning and participated in its growth and its demise—a demise caused by the fact that the founding father wanted the business managed by his family. He did not attract or give authority to those who were more competent. That underlying risk exists in every company in which you invest in Asia. You have to be very careful. Getting back to the Hong Kong trading company, we are pleased with the investment because the company is professionally run and because we have structured the investment intelligently. We have crafted our investment vehicle such that it gives us a threshold return plus an upside potential that's significant—not unlimited, but significant. And we have assets to back up our position. In playing that game in Asia, we can't just put the money in the way we would in the United States. We have to invest it in a way that will give us protection and ensure our exit at a price that gives us the return our investors deserve. We are in a position to do that effectively now. This is why it's a great time for us, because there is no other capital available. The banks are out of the business. They have fired all of their people in the region, and won't be around for awhile. They're licking their wounds. And so if someone has equity money they can fill the gap—and if they're smart enough, they can start getting the terms they need to offset the risk they're running.
So I look at Asia—and I'm including Japan here—as one massive workout over a two- to four-year period. What we see as recovery is illusory. The underlying institutional problems have not been addressed. The necessary restructuring has not occurred.
· · · ·
(1) DEC was a big winner for ARD and one of the most successful venture investments of its time. [ back ]
(2) Because the firm was reinvesting its profits, passing the profits out as dividends would have cut off its source of capital. [ back ]
[ Buy the book ]
Related stories on HBSWK:
Done Deals