Michael Granoff came to the secondary world indirectly. He majored in molecular biology as an undergraduate at the University of Pennsylvania. Afterward, he was a staff member for the U.S. House of Representative’s Appropriations Subcommittee on Foreign Operations while going to Georgetown Law School at night.
Feeling he would be happier as a client than as a lawyer, Granoff began his career in private equity without any previous business experience. He served as vice president of TEI Industries, then as president of Golodetz Ventures. After nine years of learning the ropes, he started Pomona Capital in 1994 with an inaugural fund of $45 million. The firm’s latest fund, Pomona Capital V, closed with $582 million and is 60% invested. Granoff expects Pomona will be fund-raising again by the end of 2004.
All the while he kept his hand in politics, working on the Presidential Transition Team in 1992 and starting a forum at the University of Pennsylvania that featured annual speakers including President Clinton, George Soros and World Bank President James D. Wolfensohn. Granoff currently serves as an economic advisor to several Democratic presidential candidates (he declines to say which ones). His office on New York’s third avenue is decorated with photos of Clinton, Tony Blair, former treasury secretary Robert Rubin and others.
Does your government experience help with your work?
You can take positive and negative lessons from government. The positive ones are that you learn the value of teamwork. You learn how to deal with issues that have many facets and many sides to them, some of which you can’t control. You learn a lot about process, how to make things happen, and the microscope on what you do is pretty intense. You have to perform at a very high level when you have people watching what you do, what you write and what you say. To a degree, people listen to you more than they should. So that heightens your awareness. Those are all valuable experiences.
I was asked by President Clinton to serve on the board of the [Albanian-American Enterprise Fund] that helped Albania. I was later elected chairman of that board. When people here complain about how hard it is to do private equity I tell them what it’s like to do it in a country where there’s no real legal system, the phones don’t work and the power goes out three times a day.
Would you ever go back to working in government?
I don’t have any great desire to. I was one of the only people on the transition team that didn’t want a job. It was very interesting to be able to talk to the President and other people about things and do what I was doing. In a way, I had more credibility running a business and talking about economic issues. Also, working in that kind of political environment is not always a very pleasant thing. People get called before hearings and have to hire lawyers. There was a very corrosive atmosphere.
I used to joke a little bit with President Clinton that when I saw him that I was the only person he was going to see that day that didn’t want a job or want anything from the government. There’s really nothing the government could do to either harm or help our business except for general macroeconomic policy. He joked, Forget about today, I haven’t met anyone like that in five years.’ And that made it interesting.
The negative part of government is that there’s an attitude that nothing lives, nothing dies, no bottom line. Everybody thinks everything is just going to continue, and that’s not a great working environment. In this environment, it’s the opposite. It’s very clear that there is a bottom line. This company, Pomona Capital, is a relatively small company. We have 17 employees. We can decide what we want to do, how we want to act. What kinds of deals we want to do, what we don’t want to do. We have so much more control over what we do, and that’s so much more fulfilling in a lot of ways. You can really see the results of what you do. But I do think it’s important for people in the private sector to participate in public policy. I think it’s a real shame that we leave public policy to bureaucrats.
What should people know about Pomona Capital?
We are probably more risk conscious than others. We value a risk-based approach to investing, more so than other private equity firms and probably more so than other secondary firms. Also, we wanted to concentrate only the highest quality assets. We think about it in a kind of distressed context. We don’t want to buy distressed assets. Sometimes we’ll buy from sellers that are distressed, but we want to buy the best funds that we can. Given the very high disbursement of returns between funds we’ve found that the best thing to do is to buy the best quality assets.
Do you see Pomona becoming the size of Lexington?
We have tried to size our funds in a way that we’re matching capital to deals and not the other way around. We kept our fund sizes relatively small. Each of the funds has been oversubscribed by a lot. We wanted enough capital to be able to do what we wanted to do, but not so much that we were pressured to put capital to work. And pressured not just because we had the capital but pressured because of the incentives. We wanted to make the money we were going to make on the carry rather than management fees.
Does your approach differ from other secondary investors?
We have deliberately tried to position our business in the least efficient side of the market. Like in all markets, there’s a more efficient part and a less efficient part. The more efficient part is bringing in a busload of people and having an investment bank do an auction. We like to find deals that are less competitive or non-competitive. Over 70% of our deals we’ve done historically have been non-competitive. You have to spend a lot of time doing that. We proactively source most of our transactions in a very methodical way. What it means is that, one, you have to build relationships directly and, two, you have to cover a lot of ground.
If you’ve ever been on an aircraft carrier, before they start flight operations, they line up the crew and then walk down the flight deck and pick up any piece of metal that may be on the deck and may get sucked up into a jet engine. It seems like an incredibly inefficient way of doing it. You have all this amazing technology but then you have a bunch of guys with brooms walking on the deck. They can’t figure out a better way. So in a very methodical, organized way you have to cover a huge lot and that’s hard to do. That’s why you don’t see too many people doing it. Those transactions tend to be smaller. They tend to involve groups of funds instead of portfolios. We’re not the natural buyers of huge portfolios of funds. I think that strategy has given us a lot more control.
How important are personal relationships in secondaries?
People don’t do business with us because they have to. They do business with us because they want to. We’re not Citigroup or an institution where people have to do business with us. So, we’ve been very conscious about reputation, that people can trust us.
Being a general partner is like running for reelection. They run for reelection every time they raise their next fund. We assure that limited partner that they can trust us, that their information is going to remain confidential. We’re not going to run tombstones on the deal. We don’t talk about the price that we pay. That we would treat sellers in a fair way with regard to disclosure and that we were good partners. We see a lot of deal flow because limited partners know they can talk to us, that we’ll do what we say, that we’ve never had a transaction not close once we’ve agreed on a price. We’ve never been denied consent to transfer interest. We don’t re-trade. If we say we’re going to do something, we do it. Those kids of soft reputation issues have taken time to build and have made a very big difference.
Are market forces becoming more important than personal connections in getting deals done?
The secondary business is a lot more about sweat and the people that you have than it is about the broad range of the market. It’s not that we’re a market hedge fund and have some algorithm that nobody can understand. Our business is about execution and is much more about the people. We’ve had almost no turnover on our investment team since we started the firm. That’s different from most of the people in the secondaries business and it makes a huge difference in our business.
Will disclosure push more public pensions into secondaries?
I don’t think so. UTIMCO is one of our investors, so we are a live subject. We’re a little different from others, since we’re only buying fund interests. Disclosing fund interests is different than disclosing company information, which I think is where the focus is in the opposition to disclosure. I think that there are issues that are important for the industry to make sure that company information stays private and some other issues that I’m not too worried about. I’m not afraid of having our returns published. The danger in publishing private equity returns is that if you compare them to other assets, you don’t get an accurate picture of what’s happening.
What’s changed in the secondary market over the past year?
In some ways there haven’t been all that many changes. Deal flow continues to increase, somewhat dramatically I would say. Deal flow is a function of only two variables: how much money has gone into private equity and how much of that turns over. If you look at how much money has gone into private equity over the past few years, it’s a lot. And the turnover rate has increased just because of the overall economic environment.
One thing that has changed is the dynamic between buyers and sellers. One thing that’s happened is that there has certainly been a shift of pricing power from sellers to buyers. A couple of years ago when we looked at portfolios, someone brought us a portfolio and would say, I want to sell the whole thing. Give me your price tomorrow.’ Now people come to us with portfolios and ask us what we would buy. So we have an opportunity to choose assets in a way that we hadn’t before.
The last few transactions we’ve done, a lot of them have been transactions where originally the other seller owned quite a large portfolio. We came back and said, We’ll buy these funds,’ in a way that was compelling to the seller, gave good value to the seller and good value for us. That actually has made the market less efficient, not more efficient. Most of the assets we buy may not be the assets one of our competitors wants. You’ve had more structured transactions. Sellers who want more than the best price want to make sure it gets done. They want it done in a certain amount of time. They want to preserve their relationships with general partners, and that’s led to more negotiated transactions.
As an observation of the competitive environment, I think everybody in the secondaries business has become more disciplined. You haven’t read of very many big portfolio sales at record-breaking prices. Even from people who had previously bought those types of assets for record-breaking prices. And there’s a reason. I don’t think those transactions have worked out all that well. I think the people who did them are now a lot more careful. So overall, even in competitive situations, we see much more clumping of prices than huge spreads. Most serious people in our business look at things plus or minus in a similar way. I’ve seen more discipline that way recently. I’ve seen people pay prices I wouldn’t pay, but I haven’t seen people do crazy things.
Have your buying interests changed?
There has emerged a third category of investment for secondary players like us. It is to divide portfolios of direct investment in companies with management. We have done a couple of those transactions, a few smaller ones. That’s certainly a pertinent area of interest. It’s an area we think has its own set of risks. There’s only a small subset of those transactions that are of interest to us, but there’s a lot of product in that area, so it’s certainly an area we’re looking at.
We didn’t buy a lot of venture capital product in the last couple of years because the risk/reward didn’t make sense to us. And now that’s beginning to get washed through. We’re beginning to see more venture product that we could buy than we saw a year ago. So we look at every company and every product that we think about. For a while we didn’t see a lot in the venture world that met our criteria. Now we’ll probably do a little more in that area.
There’s also a subset of specialty buyout funds in Europe that interest us. We expect to be doing more European deals. There’s a relatively small subset of funds that meet our criteria, but that subset of funds is of a very high quality. We have a parallel fund-of-funds where we’d like to be investors in their new funds.
What are the biggest challenges facing secondary investors?
The biggest challenge to us today is just asset quality. It’s not deal flow, and it’s not pricing, per se. It’s asset quality. The issues that face the secondary business are the issues that are going to face the private equity business. There are lots of opportunities. If we do it right, now will prove to be a very good time to invest. At the same time, I don’t know if there will be a lot of momentum and there’s not going to be something inside that makes B-level decisions into A-level decisions. The price of B-level performance will be quite severe; the punishment will be severe. The challenge for private equity investors is how to distinguish the wheat from the chaff, and the same challenge is going to apply to secondary investors.
If people don’t do that, there’s not going to be a tailwind that saves you. In the end, our returns are all made up of what happens to these companies. We can’t do it by realizing our discount. We hold these assets for multiple years and we need to buy assets that are going to grow.
Michael D. Granoff
Chief Executive Officer
Born: 1958, Portsmouth, N.H.
Education: Bachelor’s in molecular biology, the University of Pennsylvania, 1980, law degree, Georgetown Law School, 1986.
Employment: VP, TEI Industries, 1985-88; President, Golodetz Ventures, 1989-1993; founder/CEO, Pomona Capital, 1994-present.
Public Service: Associate Staff Member/Representative of the Chairman, U.S. House of Representatives Appropriations Subcommittee on Foreign Operations, 1981-84; Member of the Transition Team, Presidential Transition Team for the Department of the Treasury, 1992-93.
Board Seats: Chairman, American Bank of Albania.
Last Book Read: The Clash of Civilizations by Samuel P Huntington.
Favorite Movie: The Godfather, Part II
Did you know? In August, he and his family spent 16 days on safari.