WHEN do you discover that you are cut out to be an entrepreneur? To answer
this question, it might be useful to look at the example of my own career.
I was born in Cairo. As a child I spoke French at home; Arabic was my second
language; I did not speak English at all. Then, when I was 11 years old,
President Gamal Abdel Nasser’s reaction to the Suez crisis made the life of
a Jewish family like ours very difficult.
Because my mother carried a British passport, we were forced to leave. We were
allowed to take 10 Egyptian pounds and a suitcase each; we had to leave
everything else behind. I left clutching my stamp collection and remember
worrying that somebody might take it away from me. We moved to London.
Once we settled in, I went to a state school in northwest London. I started
with the disadvantage of not speaking the language. Even so, I performed
reasonably well in my first year, especially in those subjects where mastery
of English was not required. By my second year, I had grasped the language
sufficiently to move up to the top of the class.
I studied politics, philosophy and economics at Oxford. Again, I was an active
and ambitious student and in my third year opted for what might be called
public life by standing for – and winning – the presidency of the Oxford
Union.
The high point of my presidency was Robert Kennedy’s acceptance of an
invitation to speak. There were crowds when he arrived; he stood on the roof
of a car to speak to them in the street before going in to address the
students in the debating hall.
At Oxford, I did not really think about the road beyond. My father, Michael,
forced to start all over again in Britain, did quite well in business at
first, but my parents’ financial future was not assured. Providing some
measure of security was an obligation of which I was very aware.
By the time I left Oxford in 1967, my father was 54 years old. At the age of
30 he had moved from working for a bank to setting up his own trading
business in Egypt, importing and exporting goods. Perhaps it was from him
that I picked up the idea of working for myself.
I was a product of the 1960s: idealistic and wanting to make a difference. But
I would have to make money somehow. My father suggested that I would be
better prepared for employment if I completed my education by going to
Harvard Business School.
It was at Harvard that I made my first real contact with the world of business
and money. In those days ambitious business-school graduates looked forward
to careers in big business, not enterprise. But, as luck would have it, I
arrived, in 1967, just in time to witness the beginning of two waves that,
over the next three decades, changed the shape of business around the world.
The first was the wave of entrepreneurship in new, high-tech industries such
as information technology and life sciences. The second was the wave of
venture capital that financed the high-tech entrepreneurs.
As expected, Harvard made me eminently employable, and I got an offer from
McKinsey, the management consultancy firm. But my nature is not to advise
but to do, and to lead. I left McKinsey after about two years to reconnect
with my Harvard colleagues and to launch the company, Multinational
Management Group (MMG), that was eventually to become Apax Partners.
We launched MMG to provide advisory services to entrepreneurial companies. We
knew we wanted to create a firm that was advising and, later, investing in
growth businesses, but young companies, by definition, are not able to pay
big advisory fees.
So we focused on advising larger entrepreneurial companies on international
expansion, raising capital through private placements, and advising on
mergers and acquisitions (buying and selling companies or divisions of
companies), especially where the transaction involved parties on both sides
of the Atlantic.
It was, however, seemingly the worst time to start a venture like MMG, and
successes were hard to achieve. The entrepreneurial wave that had started to
form in America had not yet reached Europe, where there was no
venture-capital or private-equity industry at all; rates of income tax were
high (in Britain, the addition of a surcharge on investment income meant
that the highest marginal rate of personal taxation was 98%); and there was
little entrepreneurial activity.
We tried to think out of the box. In the first year of our professional
partnership, 1972, we considered what would have been one of the first
private-equity buyouts in Europe, of the French crane manufacturer Potain.
For the deal to make financial sense, the equity investment had to be
leveraged with a significant amount of debt (just as one mixes equity and
debt when one raises a mortgage to buy a house). But in those days it proved
impossible to raise the debt that was needed for that kind of transaction.
We had the idea, but not the means. We were a decade too early.
To complicate matters further for me, in 1973 there were 3m unemployed in
Britain, a global oil crisis and a British coalmin-ers’ strike that led to a
nationwide three-day working week. In 1974 there was the secondary banking
crisis, in which several smaller London banks went to the wall. And from
1974 to 1978 there was a deep recession.
Sure enough, we struggled, and in 1975 two of the founding partners pulled
out. I had a conversation with my father about what to do. He advised me to
stick with it. I knew that developing an international firm advising and,
more especially, investing in young, growth companies was the right thing to
go for and, with my father’s encouragement, I persevered. I had not turned
my back on a career at McKinsey only to quit at the first obstacle.
I thought it was crucial formally to maintain the partnership even if two out
of the original four were leaving.
With (chairman) Maurice Schlogel’s moral support, Maurice Tchénio and I stuck
with it, albeit in more of an arm’s length relationship than before. Neither
of us was in for an easy journey. For the next nine years, every time I
finished one corporate-finance transaction I had to start another, just to
earn the fees to cover my overheads. But by sticking with it, Maurice and I
eventually derived the advantages that came from being among the first
movers in the fast-growing and highly profitable new field of private equity.
The term “private equity” has come to be applied in imprecise ways, sometimes
to include venture capital and at other times to be almost synonymous with
buyouts. As I use it, it takes in the whole spectrum of investment in
unquoted shares: venture capital in new and early-stage companies; expansion
capital in more established firms; buyins of undermanaged firms requiring an
injection of new management; and buyouts of profitable companies of every
size.
There have always been privately financed companies. Private equity existed in
14th and 15th century Italy, where merchant bankers would fund enterprise
and trade. In the 16th and 17th centuries, when European traders were
travelling to the New World and the Far East, voyages were funded by private
investors, each of whom took a share of the risk and a share of the profits
in proportion to his or her investment.
By custom, the captain of the ship took 20% of the value of the cargo. That
rule still applies: private-equity firms generally take a carried interest
of 20% of the capital gain made by the funds under their management. Then in
the 19th century there were the private banks – Barings, Rothschilds and
others – which were funding private businesses.
The difference today is that the private-equity industry is not run by ship
captains or bankers but by firms for whom private-equity investment is a
profession. Our skill lies in our long-term professional approach to taking
business risk.
We raise funds, almost entirely from pension funds and institutional
investors; we identify companies in which to invest those funds; we take
large-enough shareholdings to have real influence over the companies’
affairs; we have a clear strategy in view for growth and for exit; we
strengthen the boards and executive teams of the companies in which we
invest and we make resources available for strategic initiatives.
Unlike the public-company model (that is, the model of companies listed on a
public stock exchange), in which shareholders are a long way removed from
operational and even strategic issues, the private-equity model is one of
close involvement by empowered, expert investors.
I wanted to raise large funds from institutions – funds that we could invest
at our discretion in a number of ventures over a long period of time, in the
process earning management fees and a share of the increase in the funds’
values (the 20% interest, which investors in the fund “carry” for the fund’s
managers). That was what was already happening in America. It was the
business model to aim for.
In stark contrast to America, however, conditions in Europe did not favour
entrepreneurship. Entrepreneurship requires an enabling environment,
including low rates of tax on capital gains, supportive stock markets and
policy initiatives to support enterprise and small businesses, such as only
governments can provide. There was no such environment in Britain or any
other European country.
Conditions improved when Margaret Thatcher became prime minister in 1979. Her
administration brought down the highest rate of personal taxation to 40%,
which led to a significant change of sentiment in Britain, away from a
“nine-to-five” mentality and towards an appreciation of the value of hard
work.
However, for all the pro-entrepreneur sentiments of Thatcher’s successive
chancellors of the exchequer, they did little actually to promote
entrepreneurial investment. Certainly, the Thatcher era left Britain with a
far better business culture than before, and with lower levels of income
tax, but we were still saddled with high rates of capital gains tax and an
unclear position about the role and status of entrepreneurs.
It was Tony Blair’s Labour gov- © Ronald Cohen 2007
Extracted from The Second Bounce of the Ball: Turning Risk into Oppotunity by
Ronald Cohen, to be published by Weidenfeld & Nicholson on November 8 at
£20. Available from The Sunday Times Booksfirst for £18 (free p&p)
on 0870 165 8585
THE SECRET LIES IN ANTICIPATING THE ‘SECOND BOUNCE’
IT was our first chairman, Maurice Schlogel, who used to encourage us to
anticipate “the second bounce of the ball”, as he called it.
Where and when will it bounce next? If you really understand your market, you
will get to the correct answer. You will be able to take advantage of the
next bounce of the ball, the one that is hard to judge.
In the private-equity industry the first bounce of the ball in America and,
later, in Europe, was venture capital, backing start-up or early-stage
companies.
The second bounce of the ball was buyouts, where private-equity firms bought
established, generally private companies that were not achieving their full
potential.
The next bounce of the ball was funds that could be invested in a number of
countries, not just one.
If you saw these bounces ahead of time, you could be ahead of your
competitors. If you opened offices internationally in 1988 or 1990, as we
did at Apax, instead of waiting until the multi-country bounce took place in
2000, you would have gained an advantage and raised and invested larger
funds than strictly national competitors.
The current bounce of the ball is the global one: funds that are not limited
to particular territories but can be invested anywhere – in America, Europe,
Japan, India, China or the rest of Asia.
We have seen a sequence of bounces in all industries. A bounce often follows a
change in the trend or a turn in the cycle.
In the computer industry, for example, at the time when the switch from
mainframe to personal computers was about to occur, some thought that the
second bounce of the ball would be that businesses as well as consumers
would buy PCs from retail outlets.
Apax made an early-stage investment in a company called Computacenter that
thought differently. The insight that Computacenter had was that, if
businesses were going to buy a large number of computers, they were not
going to do it by queuing in line at a retail store. They were going to need
– and they would expect – a sophisticated supplier.
Computacenter, which correctly anticipated the second bounce from mainframes
to PCs in the business world, went to big companies that had a significant
demand for computer power and tailored software – such as insurance
companies – and said: “You are spending so much on your mainframes. We can
shift you to PCs and you will be able to do all these things much more
cheaply than you can today.”
Computacenter invested in a sophisticated, IBM-style sales force to address
business clients. It became a trusted supplier in a new field because it
anticipated the second bounce correctly and invested to take advantage of it.
Later on, as the market developed, Computacenter realised that there was a
further opportunity in the marketplace: to buy back all the computers it had
installed in its clients’ offices – because the clients were struggling to
manage their PC networks – and to run them on the clients’ behalf. Instead
of companies buying their own computers and having their own IT people,
Computacenter offered: “We’ll take all this burden off your back.”
This is an example of anticipating the bounces of the ball in the market
trend. If Computacenter had not taken advantage of these opportunities,
somebody else would have.
Computacenter floated on the London Stock Exchange in 1998, achieving a value
of just over $2 billion (£960m). It was a successful investment for us; we
made more than $500m.
EGOTISTICAL TECHNOLOGISTS WHO ARE BOUND TO FAIL
IN the early 1980s, I sat on the board of Sir Clive Sinclair’s company,
Sinclair Research. He was identifying market opportunities on the basis of
his remarkable, imaginative grasp of the possible impacts of convergent
technologies.
Identifying market opportunities was crucial for the high-tech entrepreneurs
of the 1980s and 1990s. While Sinclair had a brilliant understanding of
technology and technological convergence, and enjoyed success with his
electronic calculators, computers and portable televisions, management was
not his strength.
When you look at high-tech ventures, the people who had the vision were often
technologists who could not manage. Those who went on to be successful were
the ones who realised this, brought in good management and allowed the
management to get on with it. The ones who failed tried to do everything
themselves.
Clive Sinclair tried to do everything himself. In addition, he insisted on the
infallibility of his own personal reading of the market. He wanted to
revolutionise the car industry with his diminutive C5. He thought he could
do it because he believed he was the man who could revolutionise everything.
He designed the C5 in secret, with little input from outside, and the car
was a failure as a result.
Ego let Sinclair down in his relations with his investors. You cannot pour all
your energy, against everybody’s advice, into a car rather than a computer.
You must stick to the plan investors backed, or else get their approval for
change. In the event, we succeeded in keeping the C5 car out of Sinclair
Research.
But I and two other nonexecutive directors eventually resigned from the board
because we felt that, despite his undoubted talent, it would be impossible
for Sinclair to succeed.
ernment, which came to power in 1997, that gave the sector its biggest boost.
Blair spoke up in favour of institutional investment in private equity.
In 1998, chancellor of the exchequer Gordon Brown reduced capital gains tax on
business assets from 40% to 10%, which gave an immediate positive signal to
enterprise. He appointed the respected City figure Paul Myners to look at
institutional investment in private equity, resulting in a positive
transformation of British institutions’ understanding of the sector.
Brown did this as part of a clear strategy to make the British economy more
entrepreneurial, competitive and capable of steady growth and full
employment.
Today, private-equity funds account for about $1,500 billion (£720 billion) of
investment capacity (if we include debt, leveraged to equity at about 2:1),
compared with more than $40,000 billion of stock-market value across the
world. So private equity represents less than 4% of the value of quoted
shares.
By every significant measure – growth, employment, investment, productivity
and profitabil-ity – private equity has outper-formed the publicly quoted
market by a substantial margin. If that margin is reduced in future, it will
be because private equity has provided a new yardstick by which to measure
performance.
In private equity, the interests of the company, its management, the
private-equity fund managers and the private-equity fund investors are all
in alignment. In the public-company model, the interests of management and
shareholders are all too often in conflict.
Anyone old enough to remember the economic climate in the 1970s will know that
there has been a massive improvement in the world of enterprise and business
since then, and that the benefits have been widely, if not universally,
shared. Private equity can be proud to have been a significant contributor
to that improvement.
Brilliant piece in explaining the beginning of this form of enterprise. I feel Mr Cohen and others have a duty of marketing and making people more aware of the benefits of Private Equity Firms. Otherwise they will be dragged down by people that clearly don't understand the dynamics that the Private Equity firms bring to the United Kingdom INC space and enterprise.
Colin , London, United Kingdom
If only this were true. Finding risk equity capital in the UK has always been difficult and the advent of private equity buyouts has made it more difficult still.
Most VCs such as there are don't understand much about markets or technology and are not remotely as opportunistic as their US counterparts.
The question Cohen should ask himself is what has he actually created?
Scamp, Aberdeenshire,