Private equity 3.0 with Robert Smith
Robert Smith, as Chairman & CEO of Vista Equity Partners, is head of what many consider the number one private equity firm in the world.
How did he succeed in investing in tech in 2000 where so many failed? This was the opening question from the Wall Street Journal’s Simon Clark in Tuesday’s first SuperReturn 2016 keynote interview.
The answer was by setting up a different business model, answered Robert, using an anecdote to explain:
“I happen to like cars. I love one particular car but three times out of ten it won’t start. Four times out of ten a warning light will come on. I have another car, and it runs every time I get in it.”
The point he was trying to make? That he built a firm that was based on repeatable outcomes, rather than one with an outcome that is based on uncontrollable events.
“Private equity 1.0 is the best platform for the creation of alpha,” said Robert.
“However, it is still a bespoke business. It is still a series of partners, typically, who are making decisions based on some investment thesis – oil is going from 80 dollars a barrel to 100, the emergence of middle class, ageing America etc.”
“They assemble a set of companies, a few managers, and go with that thesis and put it in a portfolio of 10 to 15 companies. Some do ok, some flush, they make 1.9 to 2.2 times their money and then investors give them another billion dollars and they go and do it all again.”
“I look at that model and think there is a better way to do it. Our philosophy is we underwrite only to critical factors for success under our control.”
Private equity 3.0
Vista is built around three main principles, explained Robert:
- An investment team that looks for businesses that fit its model.
- A group, Vista Consulting Group, who are subject matter experts, bringing specific knowhow on how to transform specific elements of a software company.
- Management teams working with the companies to make the transformation.
“For example, I’m probably one of the only PE firms that has full time trainers on staff to teach our employees how to do their job better,” says Robert.
“We have six and nine month bootcamps where we teach our new employees what our customers do for a living, how our products help them, how to sell, how to negotiate, and how to work within our systems.”
“We have our own system for hiring employees. One of the biggest challenges that industrial companies have now is how do they digitise? How do they find the employees that can help them make that transition? Most of those candidates want to go to a start up or a disrupter. We have our own system for evaluating talent and then ultimately training that talent to be effective in the transformation of the businesses that we buy.”
The fourth industrial revolution
“Private equity really has to start to think about its role in the Fourth industrial revolution, what some call the second machine age,” explained Robert.
“Every single company has to embrace digital. If you’re making white goods and it doesn’t interact with some form of system network, then it’s likely not to be a world-leading product, and ultimately won’t do well.”
“What private equity has to do is develop specialties that they can bring to the companies that they either buy, or the large industrial companies that they partner with, to help transform those businesses.”
“I think of 3.0 as not just the industry specialists but having specific capabilities that you bring to the functional areas that create that alpha.”
Partnerships
To date Vista has done 21 carve-outs of large industrial companies. In some cases enabling the company to meet its full potential, as Robert explained:
“The difference now is a number of companies are realising that if they sell to private equity they also want some of that upside as well, and to leverage some of the opportunity that that brings.”
And he offered the audience an example:
“We owned a company called Websense, one of the leaders in cyber security. We sold that business to Raytheon. They asked us to reinvest because they wanted to leverage our system for managing a software company.”
“In the last six weeks I’ve met with six industrial CEOs who are asking me: “How do I transform my business into a digital business?”
Looking to the future
Vista currently owns 30 companies with a majority stake in each. Could Robert transition to a model of fund with 30 companies with a minority stake?
“Within VCG we have a series of best practices,” he said. “Not every company wants to sell itself. Where it’s appropriate, we’re availing ourselves to those businesses to do growth equity investments, where it’s structured and where we can bring our specific brand of best practices.”
How may PEs does Robert think are equipped to help companies through this digital transition?
“I hope very few,” he laughed.
“It’s hard. This is not something you stand up overnight. It has taken us 16 years to get to scale.”
“I don’t think investors understand the size and scale and scope of what this market actually is, it is enormous in size. There’s over 80,000 companies and the proliferation of those companies is expanding exponentially.”
“If you think about that whole dynamic of capacity planning and fitting opportunities with needs, software ultimately governs that engagement and that interaction.”
“Where do we go from here? It is a huge market opportunity for us.”