Generational Change in Private Capital Markets

This September, the Southern Capital Forum hosted its annual conference. Members of our Investment Strategy Team had the opportunity to both lead and participate in workshop discussions. I moderated a panel discussing “Generational Change in Private Capital Markets.” Below is a brief overview of the discussion along with key observations and takeaways.

According to a recent study conducted by the Kauffmann Foundation, in 2016, five of the top 10 states for entrepreneurship were located in the Southeastern United States. What’s more, the Southeast accounts for nearly one-quarter of the country’s population, one-fifth of its GDP, and 12% of its patent filings.

Given this, why did the region only fund 2.8% of venture fund commitments across the country last year?

Some have suggested that the culture of risk taking in the Southeast has been different from the “chase the unicorn” mentality that motivates behavior, focus, and commitment elsewhere, most notably in Silicon Valley. Silicon Valley raised 66% of capital in 2016 according to the National Venture Capital Association Yearbook. The second largest source came from New York and Boston. Others have pointed to the fact that, relative to other regions, the Southeast’s most successful entrepreneurs tend to be “one and done” instead of the serial entrepreneurs who build several companies in succession, often across several industries.

Despite these challenges, it is quite clear that the Southeast is alive and well with entrepreneurial activity. At Balentine, many of our clients are entrepreneurs and business owners in transition, and we have seen firsthand these vibrant local communities of entrepreneurs with robust ecosystems to support them.

For example, Atlanta boasts world-class institutions of higher education and successful accelerators and incubators, has a burgeoning reputation as a leader in the FinTech, cyber security, and healthcare technology industries, and sits in the unique nexus of transportation, distribution, supply chain logistics, and cargo networks. This offers entrepreneurs a unique window into the opportunities created by the “Amazon effect” shaping today’s economy. Kabbage, the Southeast’s most recent unicorn, is a good example.

Elsewhere, the Research Triangle in North Carolina has been very successful in orchestrating industry, university, and government collaborations to attract scientific research and new technology companies to Raleigh, Durham, and Chapel Hill.

How can general partners, limited partners, and family offices with funding to offer reverse this trend?

Identify new private capital strategies that may emanate from the winners and losers of the new economy

• The ESG (Environmental, Social and Governance) movement, which is entrenched in Europe, is becoming increasingly important to address within private capital. How that may impact returns is still being debated.
• There is a greater demand for private capital strategies that can move up and down the entire capital structure—investors are still thirsting for yield as an important component of total expected return.
• The transparency of private capital strategies is at the forefront of the millennial generation’s mind-set. Technology is making available data that were not readily accessible before. While Preqin is still a major player in private capital data, firms such as Pitchbook, Crunchbase, and Atlanta’s own eVestment have all expanded their database and reporting capabilities.

Examine sourcing, deal dynamics, and structure

• Within the industry, there is a greater focus on fee alignment rather than just fee levels.
• Possibly the biggest change is the nature in which deals are being sourced today. GPs can’t assume that deals will come directly to them. Having non-overlapping networks amongst partners remains critical in GP’s ability to source deals.
• Modern-day entrepreneurs look different. No longer are they the blue blazer, "Blue Ridge Grill for lunch" crew. Instead, think Mark Zuckerberg.
• Today’s entrepreneurs have a much deeper understanding of the funding stack and how competitive they can be in attracting capital. These entrepreneurs also use their own private networks to access capital.

Revealing governance and succession-planning issues

Here in the Southeast, family offices have long played an important role in supplying capital to entrepreneurs. As investment decision-making becomes more structured within family offices, there is an opportunity to engage the next generation with these private capital funding opportunities. Many family offices have established a formal investment committee to address issues about sourcing, dynamics, and structuring of deals. The central challenge for family offices, then, will be determining their strengths and weaknesses.

Given their importance as a source of funding to private capital ventures, family offices should ask themselves whether they work well with the raw material (i.e., supplying capital) or with processing (i.e., sourcing and vetting deals). They should focus their resources on their core strengths and consider outsourcing the areas in which they do not have a comparative advantage to advisors that specialize in those areas.

By seizing this opportunity, not only can family offices improve their investment returns and engage a younger generation, but they can also invest in their own backyard and help the Southeast grow its reputation as a haven for entrepreneurs.