Q&A: HarbourVest Partners' Brooks Zug

Q: How did HarbourVest first come to invest in Asian private equity?

A: We started the firm in 1982 and our initial focus was entirely in the US, but we realized there was some activity taking place outside the US in venture capital, particularly in Europe and Asia. We decided this was an area that someday would become a much bigger part of the business, so we started to make some small investments. In 1984, I flew to Tokyo with Peter Brooke, whom we had invested in previously after he formed TA Associates. He set up Advent International and his approach was to get together with successful businessmen in different countries around the world and combine his experience in venture capital investing with their local knowledge. In Japan, he teamed up with a gentleman by the name of Yaichi Ayukawa, an MIT graduate who was very well respected in Tokyo. Together they formed Advent Techno-Venture and that was our first investment in Asia Two years later, Peter came back with the idea of forming a fund in Hong Kong – the Hong Kong Investment Trust – and the local businessman he teamed up with there was Victor Fung. That was our second investment. Subsequent to that, we made investments with Lewis Rutherfurd, Louis Bowen, Anil Thadani, Bob Theleen, and a number of other people in the Asian market.

Q: What was the performance like?

A: The early investments in Asia – not just ours but everyone’s investments in Asia during those early days – I would say generally were not very successful. Why was that? As is true in any new markets, there wasn’t a lot of experience: there weren’t entrepreneurs who had done it before; there weren’t venture capitalists who had done it before; there weren’t track records to look at to make judgments about who you would invest in. Other things that are critical to success in venture capital that were present in the US but weren’t present over there included stable governments, stable currencies, IPO markets, exit mechanisms. Those early investments were discouraging, but they were a way for everybody in the industry to learn.

Q: Did anything surprise you about investing in Asia?

A: We assumed that we as the investors and the entrepreneurs were on the same page. Those early days were really venture-type investing where we and the partnerships we were invested through did not have control of the companies, unlike the later models when the buyout business arrived in the late 1990s. Control was in the hands of the entrepreneurs and so investors were not able to exercise as much control as they might have liked to. This is a little bit of a biased point of view, but I think many of the early entrepreneurs looked at the equity that came from the venture capital firms almost like debt, and didn’t really think of us as partners. That was a surprise and it was part of the reason why we as an industry didn’t do as well in those early days.

Q: HarbourVest didn’t start participating more heavily in Asia until its first international fund – of $200 million – was formed in 1990. What was the impetus for this?

A: We had carved out a small part of our US program to invest overseas, mostly to gain experience. Some of the investors in those early funds in the late 1980s wanted us to invest more money overseas. We said we would come back to them with a fund that invested exclusively overseas, both in Europe and in Asia. It was really driven by a few institutions that were very forward-looking and wanted to gain access to those markets. One group, an east coast public pension plan, mostly wanted Europe, and then we had a west coast pension plan that mostly wanted Asia. We tried to accommodate both by giving ourselves the flexibility to invest as little as 25% in one of those markets and as much as 75% in the other. In the end we put about 25% of that first fund in Asia and the rest in Europe – and the European investments outperformed the Asian investments.

Q: When did Asia achieve critical mass?

A: I would say it was in the mid-1990s, even before we saw performance come out. In the mid-1990s the internet was being developed and it led to a lot of early-stage successes in the US, and I think that made investors interested in technology in Asia. The venture capital business was still nascent, but did begin to see activity pick up. Then in the late 1990s the buyout model began to become more prevalent. The combination of those two things drove the market to become much bigger.

Q: What led HarbourVest to open a Hong Kong office in 1996?

A: We decided it was time to open an office because that market was clearly going to become more active and we wanted to have a local presence. We wanted to be closer to the investments we were going to make and hopefully have better information and better due diligence capabilities. In the fall of 1995 I took a trip to Asia and interviewed a number of individuals around the region who were already active in the private equity business for major institutional investors. I was interviewing individuals but also looking at the institutions because one option was to do a joint venture with somebody who was already there. Eventually, I decided that we would open our own office and instead of hiring someone from Asia who brought local experience but wasn’t familiar with HarbourVest, our culture and our way of doing business, we would be better off having someone who was part of the HarbourVest team in Boston go to Asia. We also thought it would increase the odds of us retaining that person. We had seen a lot of musical chairs in Asia and it made us fear that if we hired someone to open the office over there they would be with us two years and then go on to the next opportunity.

Q: And how significant is Asia to your overall business now?

A: Four out of our nine offices globally are now in Asia, and they are run by local people. We opened those offices for investment reasons and I think while Asia today still represents a relatively small proportion of HarbourVest’s total investing worldwide, it’s gaining every year, it’s gaining disproportionately. The flip side is capital raising. While in the early days we didn’t anticipate raising any capital in Asia, what we are finding is that more and more institutions in the region, particularly sovereign wealth funds, want exposure to private equity worldwide. So, from a sourcing of capital point of view, Asia has become very important to us today.

Q: Does that mean the region has proved itself as a private equity market?

A: Asia has proved itself but not all the impediments have been removed. We still may have currency issues, we still may have government stability issues. We have better access to exits than we did 30 years ago, so that’s good. We have more experience both in the hands of entrepreneurs and in the hands of general partners of funds than we had 30 years ago. So, there are a lot of positives that have occurred. But Asia is more likely to be more cyclical than the US, for example, and certain other parts of the world. Clearly, this is a market that is here to stay and as we all look at China’s growth and its potential, if we aren’t all invested in China then we are missing a market that is probably going to be one of the biggest markets in the world and maybe someday will eclipse the US private equity market. But even that market has gone through and will go through cycles.

Q: What about the longevity of the fund-of-funds model globally?

A: I think we will continue to have fund-of-funds. There will be fewer firms active in that area but there are always going to be investors that need the experience and the access that a well-established fund-of-funds can provide. In some markets – particularly the US venture market and certain Chinese venture funds – if you weren’t an investor before you may not be able to get into the next fund. Fund-of-funds that have been around a while and have that access. There are also many institutions that just don’t have the budgets to build teams internally that can perform as well as somebody who has been in this business a long time through a fund-of-funds. And say they do gain a certain amount of experience, if the compensation doesn’t follow, what often happens if they will go and start their own fund-of-funds or other activities somewhere. Many institutions’ hands are tied because they cannot offer the same compensation. At least you know you can get stability with a well-established fund-of-funds where there hasn’t been a lot of turnover and the track record is relevant because it was built by the same people who will be investing your money going forward.

Q: What is behind the consolidation we have seen recently in the fund-of-funds space?

A: I would characterize the consolidation we have seen in the last five years more as an exit opportunity for the founders of those firms. A lot of fund-of-funds were established in the mid to late 1990s and there were two or three founders who kept the lion’s share of the equity. They are coming to an age now where they want to get their equity out and retire. At the same time, there are institutions that have been managers of public equities and debt and other types of investment instruments who want to expand their exposure to include private equity, so it’s been an opportunity for both sides to gain what they are seeking. There are probably only a handful of firms that are still truly independent. The only way that can work in the long run is if they develop mechanisms for transferring ownership from the original founders to the next generation of executives who are the ones currently doing the work and driving the growth of the firm. Certainly, at HarbourVest we expect to continue to be an independent firm indefinitely.

 Q: Would you therefore consider listing?

A: Listing is one way to get equity out but then you introduce other forces – you need to satisfy shareholders and often that might be on a quarter-to-quarter basis – that make you less independent. Similarly, if you sell to another corporate entity that has public shareholders, it may put certain constraints on how you construct your business and how far ahead you can look. That is why we feel that remaining independent is the best option, if you can accomplish that. The way we have built HarbourVest over the years is to spread the equity very broadly within the firm: as a founder of the firm I didn’t own more of the firm than seven of my other founder partners. There hasn’t been any pressure from someone looking to liquidate a 40% interest, for example, because nobody owns that much. What we’ve done instead is gradually shift that equity ownership to the next generation and we have structured financial mechanisms within the firm itself to support this. It used to be that eight people owned nearly all of the firm. Today, those eight people own less than 10%. 

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• Topics
• Fund-of-funds
• LPs
• Asia
• HarbourVest Partners
• D. Brooks Zug