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Institutional investor profile: Jacques Lilli, advisor to the chief executive, European Investment Fund

The European Investment Fund is part owned by the European Investment Bank, part by the European Commission and part by a group of 30 European financial institutions. With E2bn under management, the EIF's mission is to support the creation, growth and development of small, entrepreneurial companies in Europe, but by acting independently and commercially.

What type of investments do you tend to look for?
‘We have two sides. Our main focus is on venture capital investing, but we also offer guarantees to small and medium-sized companies.

‘On our venture capital side, we only invest in funds. Our two main focuses are, first, technology - preferably early-stage technology - and second, regional funds, especially in the less developed regions in Europe. We are mostly known for our VC investments.'

How do you tend to find out about investment opportunities?
‘Right now, we see every fund that is of interest to us in Europe. It comes from proprietary deal flow. We also tend to study areas - and this is where we differ from other fund of funds and institutional investors - we do prospective thinking in terms of areas or technologies that we would like to invest in and sometimes we prompt firms to be creative in that area. We take a fledgling initiative and we roll up our sleeves and we help to structure it.

‘So, for example, take biotech in 1999. At the time, we felt that biotech was being shunned by venture capitalists, so we made a couple of interventions there. We now have one of the largest portfolios in early-stage and mid-stage biotechnology funds. We did the same in Agrifoods and creative content in 2000. These were areas we identified that we wanted to be present and then we either conveyed the idea to someone or someone approached us and we transformed what was a regional fund into a pan-European idea, for example.

‘It's a two-way thing. We go fishing ourselves and a lot comes our way, just because of who we are.'

How do you decide which sectors you would like to be investing in?
‘It's a mixture of things. We conduct market studies and technology studies. We also use European Commission and private sector studies to identify target areas. We talk to experts in different technology areas, we generate ideas within the team and make up our own minds as to where we should be investing. What often happens is that we may be looking for an emerging technology opportunity for two years, and then three come along at the same time.'

How do you conduct your due diligence?
‘We are known for the thoroughness of our due diligence process. Often other investors wait until we have decided to invest before they will commit. We have a responsibility to these investors.

‘We are very methodical, but we never lose sight of the fact that every VC fund is its own world. We look primarily at qualitative issues. Not that the quantitative don't matter, but what can really make a difference is the chemistry within a team, the ability, the skills map within a team. During the due diligence we will sometimes reassess either what we believe is possible within a certain area or we will talk to the team and say, “look your angle is nice, but we believe you should look again at your strategy within this specific area” Or it could be that they need to bring on board a different type of skills to make full use of their strategy. The track record is important, but the qualitative issues are vital.

‘We're also very fast compared with the rest of the industry. Once we decide to look into a team in depth, we have a relatively fast process. It depends on every team, but the average time it takes us to do due diligence and decide is about two months.'

What do you look for in private equity fund managers?
‘Ideally, you would be looking for previous experience. But in the areas we look at, that is never a complete proposition. You may have bits and pieces of that experience, but not all in the same individual, you may have the right individual experiences, but no cohesive team track record. It's a range of different things.

‘We're looking for excellence and the team's ability to carry out its investment strategy. It's a forward-looking activity. To give an example, a team may have been very good at early-stage investing. They decide to raise their third fund and they want to go into later stage. We may not feel that they have the right background for that. We may feel that they were very good at early-stage investing, but they now need two investment backers for a later stage fund. Or it could be something else: a team that is good at software is not necessarily good at biotechnology or the health area.'

You also invest in many first-time funds, don't you?
‘Yes. Managing that is an operation in itself. We need to make sure that we can strike a balance and dedicate the right attention to the people who best fit our fund objectives.'

How does an investment in a first-time fund differ from investing in a more established team?
‘We are seen as the first-time fund specialists. There is a saying in Silicon Valley - I'm not sure that it's right - that says that you need to lose $2m to train a venture capitalist. More established teams have much better processes, their relationship with institutional investors is much smoother in general. However, when you have people who are richer and more established, there may come a point of routine. Yet when you see a young team that is getting into an area, there is a lot of idealism - in a good sense - in that there is a lot of drive and enthusiasm for an idea. However, you can already see what some of the issues they will have are. We roll up our sleeves and get into the workings of the team.With an established team, we may not want to do this. If it's a proven concept, it should be more of a decision about whether we want to invest in it or not or whether it fits with what we want to achieve or not.

‘In a less established team, I may decide whether I like it or not, but I can influence funds to change because I can see a potential problem in a few years' time. We've seen this process over and over. It's a dynamic process, where people grow apart. You need to be sure that these types of issue are encompassed in the way that the team is structured.'

‘But we don't just split the teams between “experienced” and “not experienced”. It's down to how high powered they are as individuals and as a team. You may have a very good corporate team going in to private equity, or a very good technology transfer team going into private equity. In the end what really matters is technology expertise and a certain nose for investing.'

How can you be sure that a team that is very good at, say, technology transfer will make good investors?
‘You can't be sure. But what we do know is that depth of technology expertise in Europe will be an increasing factor for success in this area. That goes hand in hand with avoiding teams that fall in love with a particular technology. You may have people within a team who fall in love, but provided they have a counterweight in people who are extremely cynical about technology, then you might have the right team. We try to do skill mapping to see that you have a balanced team where information is free-flowing and where opinions can be divergent. That must be encompassed in the way that the team is structured.

‘So you need to be sure that the team can be flexible enough to adapt to new conditions and new environments. Especially in new teams. It depends on whether you have two or three people with very different configuration. It depends on the ages. You may have a very experienced individual and the two young wolves who will have to grow. You may have three very experienced people, but then you might wondering who would replace them in, say, five years' time. When we invest in the first fund, we are already thinking about funds two and three.'

How do you put together an investment portfolio?
‘You need to have a certain critical mass to have a good spread of investments. Good diversification is important. We have investments in around 150 funds at the moment. Our objectives have ensured that we have invested in the 15 member states, plus Central and Eastern European countries. In terms of technology, we also have diversification. So we have biotechnology, but we also have IT and TMT and some emerging technologies, or even creative content.

‘Another key thing for us is to invest vintage after vintage. You need to have vintage diversification. We are flexible, though. For example, this year, we saw that there was an opportunity in the market because people were not investing as much. We saw it as a good time for teams to have cash and actually buy. We have invested more than our cruise control.'

‘We also have diversification between pan-European funds against more country-specific funds. Our strategy is an iterative process. We constantly ask ourselves, where are the opportunities?'

What advice would you give to an investor new to private equity?
‘They need to make up their minds that it is a very long-term process and outlook. You see people pulling out because they see that vintage returns this year are bad, or they pile in because they see that internet valuations are high at the moment. It really is a long-term investment. If you don't have the ability or drive to see this as a five, ten, 15-year investment, then you may as well not get into it. A hedge fund will do it for you. It has much more liquidity.

‘The second thing is that, unless they're intending to create a large-scale operation, they should rely on people who really know the market - at least at the beginning. It's a very inefficient market. You need people to gatekeep for you. So they shouldn't go into a few investments on their own but maybe see a gatekeeper or a fund of funds at least almost as a training tool.

‘They shouldn't place too much emphasis on track records. That is primarily driven by justification purposes and not by intrinsic quality of the data or the fact that that is backward-looking data. Private equity is all about forward-looking processes. There is a little bit of adventure in this. Our funds that are established today as some of the best known names were newcomers to the industry back in 1997 or 1998. You need to invest some in new teams and new areas, if you want an opportunity to reap the gains.'

What's your perspective on what happened over the last two years?
‘What happened in the VC/private equity industry also happened in the public markets. It is difficult to say whether people were wrong to pile in or not. What is wrong is to pile into VC thinking that it's the same as piling into Nasdaq, where you can take your money out when you want to. It is puzzling to me, this misunderstanding about the nature of the industry.

‘It's puzzling and saddening to see how much money went into the sector in so little time. It was a very difficult environment to be in. Everybody seemed to making money and there was such a rush. Money meant so little. People weren't taking their time making investments and anyway, many of them were new to the industry and didn't have time to think and work out whether a business plan made sense. In a few hours, the opportunities were gone.'

What is the major issue for the private equity industry?
‘The issue of transparency is not going to go away. When you look at the way that public markets are misinformed, you don't want to put private equity at that kind of disadvantage. On the other hand, there is a lot that can be done to make information more timely, more clear, better benchmarked.

‘However, private equity will always remain the area of investment craftsmanship. We're not ready for ratings and benchmarks. People need to be making up their own minds, especially in early-stage technology investing. For a large buy-out fund you might be able to do this. In the technology area, you need to be able to have your own view or at least trust someone to have that view for you rather than following what other people do. It is not a listed market. Therefore it is not fully efficient. Transparency could not hurt this industry. Unfortunately it is against its very grain. It's a very clubby industry.

‘The other issue is that the viewpoint of investors is: I want to go into alternative investment. The real threat is hedge funds. They are more liquid. They have similar issues of transparency, but at least they are more liquid. One of the challenges for the market may be to provide some form of liquidity for certain investments. You could think of fund of funds, for example, with increased liquidity. The problem is that these investments sell at such a discount. The underlying asset is not listed and may take a long time to become listed.

‘The secondaries market may help liquidity. But the issue is that what you could achieve with secondaries, you could achieve with a listing. You have VCTs that are listed and management companies that are listed. The issue is the discount. In the end it seems as though the discount in this non-transparent world is maybe too great. The explosion of the secondaries market that we're seeing right now is a symptom of something that's not right rather than a solution to the issue. If someone comes and says they will buy the investment for 50 per cent, they are confronted with the same issue. Why 50 and not 60 or 30?'

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