Quick notes on LPs #5- CRPTF and Insight Partners Opportunity Fund I Recommendation Report(part 2 of 3)

Today we are going to be looking at how the Private Equity Consultant’s structured their recommendation for CRPTF to invest into Insight Partners. The goal of this posting is to help both emerging and established GPs understand what Private Equity Consultants are looking for in evaluated funds.

To the left we have a summary of everything we are going over and how it relates. Note the Private Equity Consultant for this report was StepStone.

Investment Strategy

Merits (rephrased from StepStone):

1. “Creative capital structures” allow for downside protection. In this case, creative capital structure being a preferred share with 1.5x liquidation preference.
2. Insight has developed an expertise in this industry as proven by their track record.
3. A concentrated portfolio of 8–12 companies- generally seen as riskier from a portfolio standpoint- risk is adjusted by contractual returns.

Risks (rephrased from StepStone):

1. Target returns for the fund are lower than what the average private equity sponsor targets. Note: StepStone does not seem to have done any situational analysis regarding what conditions the fund can outperform under and what conditions can cause the fund to underperform.
2. Increased competition (see picture below)
3. Opportunity Fund will be targeting similar companies to the Flagship funds, but focused on funds that have less than 25% IRR or the seller wants too high of a price. Insight will not be investing into the same company through both the Opportunity Fund and the Flagship Fund

Source: StepStone Group

Thoughts (solely my own):

It is strange that StepStone has not done a scenario/sensitivity analysis of the fund to understand under what broader macro dynamics the fund would need to maintain target returns.

The diagram showing the competitive market is a nice touch and helps show us how involved different PE players are within different sectors.

Management Team

Merits (rephrased from StepStone):

1. The team is experienced in software and technology investing.
2. The ability to leverage an in-house consulting team gives Insight an edge in supporting companies post-closing.
3. A culture that cultivates the ability to source deals and win them lead by Jeff Horing.

Risks (rephrased from StepStone):

Source: StepStone

1. No dedicated team to oversee the Opportunity Fund. Large portfolio of over 200 companies in the Flagship Fund.
2. Two MDs, one VP and three principals had left in the last fund cycle.

Thoughts (solely my own):

On the merits, everything is reasonable, because Insight has a track record.

On the risks there is one thing worth pointing out: the investment report only states Jeff Horing by name when discussing the culture. This implies that Mr. Horing is very active within Insight’s daily operations. Depending on the LPA, it would make sense to have a form of key person insurance that is brought up. Additionally, as Mr. Horing is nearing retirement (as of the date the report was published he was 56 years old), what does succession planning look like at Insight, and have they started to plan for it yet?

Track Record

Merits (rephrased from StepStone):

1. Track record of superior returns both on a relative and absolute basis. Metrics include: net IRR, net TVM and DPI
2. Loss ratio of 10% vs the standard 12%. Loss ratio has decreased as fund generation has increased.

Risks (rephrased from StepStone):

1. this is a first time strategy that is StepStone is implementing.

Source: StepStone

Thoughts (solely my own):

First thing worth pointing out. The Private iQ database differs from Cambridge Associates’ (CA)database on Private Equity funds. CA reported DPI of 2.0 for PE funds with a vintage year of 2000. This would mean that there are possible arbitrage opportunities for fund managers, as it would seem that StepStone and CA have different fund data available.

Fundraising & Portfolio Fit

No merits and risks listed.

Funding shows how LP commitments are coming in.

Portfolio fit looks solely how fund will match CRPTF investment mandates.

ESG

No merits or risk listed.

Thoughts (solely my own):

There is a lot of discussion around ESG policy in the StepStone report. UN PRI and TCFD seem to be an interesting topic worth discussion at a later time. Insight uses Malk Partners to run their ESG DD and Insight further invests into ESG by ensuring that portfolio companies meet the goals outlined in the ESG DD 6 months after deal closing.

Key takeaways for both emerging and established VCs: bring up ESG-related matters in your LPAC (at least place it in the agenda), discuss ESG matters in annual report, and meet with portfolio companies six months after closing to ensure that they are acting on post-DD recommendations.

Recommendation

In StepStone’s view, a commitment to the Fund represents a compelling opportunity for LPs looking to partner with a leading software-specialist investor targeting attractive risk-adjusted returns. Insight is one of the leading private equity firms focused exclusively on software, software-enabled services and Internet business. Excluding the Firm’s most recent Fund, Fund XI, all of Insight’s funds since 2005 have generated first quartile returns for investors on a net TVM and net IRR basis. While the Opportunities Fund will not invest in Flagship portfolio companies, the Fund will leverage the knowledge, intellectual capital, and sourcing capabilities of the broader Insight platform, benefiting from industry expertise, relationships and access to proprietary information. StepStone believes the Fund’s strategy of targeting a variety of both structured equity and non‐control debt securities as an attractive approach to generating risk‐adjusted rates of return while emphasizing downside protection through creative capital structures.

Conclusion

There was a lot to unpack in this report. Summary of all the cool bits to take note of:

1. Understand your target returns and be able to clearly articulate how you will reach them. In the case of StepStone it is through preferred stock with a 1.5x liquidation preference.
2. If possible, try to have an internal consultant as part of your PE/VC team, as they can work with portfolio companies on a range of different problems.
3. Track record is very important. StepStone referred to Insight’s track record in different sections of the recommendation report.
4. There are opportunities for arbitrage between CA and StepStone. Now with CA no longer publicly publishing their benchmarks the room for arbitrage is going to grow.
5. ESG is taken seriously and has a whole section dedicated to it in StepStone’s recommendation report. If you are ESG focused: host an ESG-related event at your LPAC, discuss ESG related metrics in your annual investor update, and (if you want) sign up for UN’s TCFD/PRI.

You can find the full recommendation report here.