Adams Street Partners A Pioneer Investors Approach To Constructing Private Equity Portfolios Case Solution

1. What are the most pertinent issues in due diligence in a buyout transaction? In your opinion, which is the single most important factor in a due diligence that is often overlooked, and can lead to eventual failure, explain?

The important issues that need to be considered in carrying out due diligences of a buyout transaction are as follows:

• In a takeover type of buyout, legal implications are an issue but they need to be considered in detail because massive legal costs can result in a failed buyout.

• Valuation of a private company buyout is a major issue as its shares are not publicly traded, unlike publicly listed companies.

• Lack of information about companies incorporated in emerging or developing nations makes due diligence problematic.

• Identifying all possible risks in a private company buyout is a stiff task as private companies’ information is not publicly available.

• Buyouts are normally completed with the purpose of reengineering and transforming the company hence prediction of future cash flows is also a major issue.

The most important aspect of due diligence is to take a holistic approach and perform a thorough analysis. The focus is just on the valuation and financials of the company. The most harmful consequence of not following holistic approach is that you tend to underestimate the risk of the investment.  Hence, the probability is high that the investment would negatively impact the firm value.

2. Discuss advantages and disadvantages of investing in private equity via a fund of funds vehicle or directly. How does Adams Street mitigate some of the disadvantages?

Private equity firms invest with a medium to long term perspective in mind. They are able to add greater value to the companies held in their portfolios as compared to publicly governed companies. Private equity firms invest a lot of resources in analyzing many investment opportunities to find out that one company that has got all the desired characteristics. The investment choices for private equity firms are abundant. They can invest in start-ups; buy unloved divisions of corporations, or they can invest under-appreciated public companies take them private and reengineer it to add value. Investing through fund of funds adds value by reducing risk due to increased due diligence and diversification.

The access to investing in private equity firms is restricted, and they cannot be accessed by many types of investors. Barriers of entry are also high, and investors are required to commit very large amounts. Private equity firms make a committed investment that is they stick to their investment for several years hence investors’ money is locked up for some years. 

Adam Street introduced a fund of funds vehicle in 1979. Through this vehicle, small investor could also access and invest in private equity firms. Adam Street designed employees’ compensation package in such a way that employees had vested an interest in the success of the company. Hence, the alignment of interest issue was also addressed.

3. Propose the eight criteria used by the Portfolio Construction Committee, chaired by Hanneke Smits, to assess the investment potential of various geographies (see Exhibit VI). Why do you think the U.S. Fund receives such a large weight (see Exhibit VII)?

Hanneke Smits and his team follow a top down approach for geographical market assessments. The proposed eight criteria are as follows:

• The first and foremost criteria are to determine the overall country risk.

• Key Economic indicators should be assessed. 

• Strength of Corporate governance should be checked.

• Legal framework and rule of law should be evaluated

• Market status: Determine the level of development of markets in the region especially financial markets