How large can a Private Equity fund in Vietnam be?
No one can tell how much money a PE fund in Vietnam can raise, but I can say raising USD 1 billion PE fund in Vietnam will be very very challenging. I’ll explain why.
Fund size has an impactful meaning in Private Equity (PE) model but not that much in Venture Capital (VC) model. I believe that (1) deal size and (2) fund management fee play a large part in explaining the why.
Let’s start with the deal size – given they focus in investing into companies at different stage, the difference in investment deal size between PE and VC is profound. Investment amount into a start-up company made by VCs in SE Asia typically range from USD tens thousands to USD 500k. Few large VC deals in the world raised up to a few millions – but that’s it. VC never goes too big from the beginning. Rather, they spoon feed the entrepreneurs by series of different investment rounds to encourage the entrepreneurs to achieve key promised milestones. On the other hand, PE deal size can be much larger, starts from few millions to even billions in the largest Leveraged Buy-Out deals. The reason is (1) PE gets into companies in later stages – when the companies have already been large and (2) PE normally wants some influences into the management. They believe in value adding actions toward their portfolio companies that cannot be realized if they hold too small ownership. Thus, a VC who holds USD 100 millions such as IDG Ventures in Vietnam can have a portfolio of around 60 companies (implied average deal size of USD 1.6 million per deal – which I believe has been upwardly biased by some large deals). Meanwhile a PE who holds the same amount of money may be managing a portfolio of around 15 companies, implied an average deal size of USD 5-10 millions/deal. Now think of it this way: because it breaches the VC model by increasing the average investment deal size, a VC can find it very hard in both raising an USD 200 millions in Vietnam market and managing a portfolio of 120 companies. This differs to PE. PE can instead of investing USD 10 millions to hold 25% of a company it can invest either USD 20 millions to hold 51% of the same company or using that same USD 20 millions to buy 25% of bigger companies. Thus, PE funds have the tendency to raise much larger money under management comparing to VC funds.
Fee structure between two type of models also has a key different characteristic. There are two main types of fee in fund management industry. The first is Management Fee – ranging somewhere from 1.5% – 3.0% of total asset under management in PE. The second is Incentive Fee or a form of profit sharing scheme – that is when a fund has a successful investment, 80% of the profit goes into investors’ pocket and 20% goes into fund manager. For VC, the Management Fee is typical very low, or even 0%. On the contrary, a successful PE can have bargaining power to charge its investors up to 3% of the total asset under management. If a successful PE fund raises a billion dollars fund, its fund managers have theoretically already pocketed USD 30 millions from the total asset under management (in practice it also depends on how much capital is called/drawn down to invest). Thus, PE fund managers have incentive to raise larger and larger funds because Management Fee is undoubtedly a noticeable income source.
The question will then: how large can a PE in Vietnam be?
Various thinking and calculation methods will lead to various different arguments and estimations. But one of the, I think, legitimate approaches is benchmarking PE fund size toward total country’s GDP. Let’s think of it this way: Vietnam’s 2012 GDP is USD 130 billions, US’s GDP is USD 15,000 billions, or around 115 times larger than Vietnam’s GDP. If Vietnam has USD 1 billion PE fund (PE in traditional sense, not PE which invests into real estate) then its impact to Vietnamese economy will theoretically equivalent to USD 115 billions PE fund that operates in the US market. USD 115 billions PE fund is 3 times larger than total amount of money raised by TPG, Texas Pacific Group – the world’s largest PE fund by far, in 2007-2012 period. Or equivalent to the sum of the size money raised during 2007-2012 by TPG, The Carlyle Group, and KKR together.
Clearly this gives a perspective but not an absolute measure. Various factors can affect the estimation: how dense is the competitive landscape of PE industry in Vietnam, how much money from PE industry an economy can absorb is clearly various, stage of the economy, investment climate, or even the benchmarking countries (we can use China’s, EU’s, Japan’s GDP as well as PE funds in those countries instead of using US’s figures).
However imaging how much impact that a USD 1 billion PE fund has into Vietnam’s economy can be interesting. Let’s say this fund would follow traditional growth investing model with significant minority interest of 25% ownership into investee company per deal. Then this USD 1 billion PE fund will have exposure into a total of USD 4 billions equity (25% ownership each, implied 100% equity of these companies are 4 times higher). Let’s assume these companies have a 1:1 debt:equity structure, then this fund would have influence into a total of USD 8 billions of asset. If revenue turn-over asset is 1.5x-2x, then this PE fund has exposure into USD 12-16 billions revenue stream. This number is equivalent to 9%-12% of the whole country’s current GDP.
The idea of this 1 billion PE fund has influence up to more than 10% of a country’s GDP is just freaking awesome. But that’s why USD 1 billion PE fund invests only into Vietnam would be a legendary hallmark if in the next few years anyone can do it.
10:33 PM – July 7th 2013, Ho Chi Minh City, Vietnam
P.S.: This is my first tablet post – typing through an iPad is quite a fun and time consuming experience :-).