← Alt Goes Mainstream: The Latest on Alternative Investments, WealthTech, & Private Markets
Alt Goes Mainstream: The Latest on Alternative Investments, WealthTech, & Private Markets
Lincoln International's Brian Garfield - how is AI impacting private markets valuations?
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AI, AI. AI software, software software. Sassopolis of like, you know, the world is crashing. You gotta go a level deeper than that. There's gonna be winners, there's gonna be losers, and there's gonna be those in between. There's gonna be vertically integrated software companies, horizontally integrated software companies, and those that maybe play a little bit of both. That's the level that I think is really important as we're doing that evaluation and that's where I would guide an investor to also think through level deeper.
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Everybody's gonna eat with mainstream. All my family see see you on mainstream we're going mainstream.
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From Wall street to Melrose Avenue, we're going mainstream.
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Venture capitalists to athletes to creators to the person who has collected trading cards
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in a collision of culture and finance, we're going mainstream.
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This episode of Altgoes Mainstream is brought to you by Altimus, the full service fund administrator and transfer agent powering asset managers in private and public markets. As alts go mainstream, you need real expertise to handle complex fund structures, connect with key distribution partners, and handle sophisticated compliance reporting and transparency demands. That's Altimus High Tech High touch Solutions for over 450 clients and 2,500 funds with over 775 billion in assets under administration. Backed by an expert team of over 1200 employees, they place client service at the core of their business, helping you navigate complexity during your fund structuring or launch, and then supporting you through every stage of growth. Whether you're already in the market or thinking about entering private wealth. You can trust their team's deep expertise in retail alternatives to help you reach your goals. Learn more at ultimusfundsolutions.com or email infoultimusfundsolutions.com welcome back to the ALCOS Mainstream Podcast. Today's episode dives into the nuances of the numbers to discuss valuations, underwriting and the state of private markets. We sat down with Brian Garfield, Managing Director and global head of the portfolio valuations practice within Lincoln's Valuations and Opinions Group. Brian provides valuation and transaction opinion services to public and private alternative asset managers. He specializes in estimating the fair value for an array of financial instruments, including direct investments in senior unitranche and subordinated loans, as well as preferred equity, common equity options and warrants. His expertise also includes valuing secondary fund interest, co investments and GP stakes.
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Prior to joining Lincoln, Brian spent more
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than six years at Duffin Phelps llc, where he advised a wide range of alternative asset managers. Brian and I had a fascinating discussion about the current state of valuations and underwriting in private markets. Thanks Brian, for sharing your expertise, insights and passion about private markets and valuations
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in a collision of culture and finance.
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We're going mainstream
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Brian, welcome to the Elkos Mainstream Podcast.
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Thanks for having me. I'm really excited.
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Pleasure to have you. I think we have such an interesting conversation on tap at quite an important time. There's a lot going on about the convergence of public and private, better data analytics, valuation methodologies that are creating more transparency. We'll get to all of that. First, I want to start with your background. How did you end up in the valuation space?
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Michael was really by accident. Actually it was kind of funny. I interviewed with the expectation of working on purchase price allocations for financial reporting and when I started my first job the global financial crisis happened and a whole new illiquid market started to form through side pockets at hedge funds and there was a need for third party valuations. And so I was asked to start working on some of these accounts and I fell in love with it. I thought it was really interesting to get under the hood of private businesses, understand how they're set up to drive growth and leverage a lot of private capital, market knowledge and estimating the value of privately held companies.
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How much evaluation is art versus science?
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I think that you always start with a framework that is the science and the framework for the work we do is ASCA 20 fair value standards. So we always look to that when we're performing the analysis. But when you look at the underlying methodologies, there needs to be judgment and you need to use professional skepticism. And that's where what might be framed as art comes to play. But I kind of really view it more as just being skeptical, looking at adjacent markets, adjacent comps, trying to get under the hood and seeing oh, how is that similar to the deal or the portfolio, company or investment I'm valuing and that influences your decision.
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How much has the advent of technology as it relates to creating more transparency and more real time updates as it relates to valuations, has that made your job easier and also maybe blended a little bit more of the art and the science on a more real time basis?
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Technology is a great thing. Technology's been so helpful. It's really allowed our platform at Lincoln to augment what we're doing and focus on what really matters. What I mean by that is automating elements of what we do because they're repeatable and they just effectively fall in stream. They that is where you can really leverage technology. And if you overlay that with spending now more time in understanding the businesses, understanding the investments, understanding the exit strategy, understanding when an exit's gonna happen in these deals, that's a great use of time. So we used to spend a lot of time putting together a summary schedule, for example, for our clients. That's not the highest and best use of our team. The highest and best use of our team is to take that summary schedule, look at all the investments, bifurcate them by what are your growers and decliners? What's been the performance since last quarter? How does that compare to benchmarks that are out there? That's the value that we look to bring at Lincoln.
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When I listen to you talk about that, where my mind goes is there's obviously more and more investors coming into private markets. Some of those investors may be newer entrants into the space. They may not be as familiar with private markets. How do you think they can and should understand valuation through your eyes? And what should they be thinking about as they understand the types of underwriting or methodologies that you're using to help kind of create a real time picture of a business?
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Yeah, I think the first thing that everyone should be aware of is that when we're doing the valuation, we're taking the perspective of a market participant. We're putting ourselves in the shoes of the buyer and the seller at the same time and essentially coming up with that cohesion of harmony and what we think the price or range of prices would be for an underlying investment. And so what we're getting is a lot of information to help influence that decision. So we're getting, for example, the investment thesis and the memorandums that are being considered as part of that initial underwriting. We're getting the legal terms as part of that investment. We're getting the financial information as part of that investment. And all of that information is think of it going into a funnel. And as it goes into that funnel, it helps us understand where we are with that particular investment and its value. And every valuation that we do always starts with the purchase price. It's not like I come up with the value out of thin air. If you bought a business today for $100 million at time zero, we anchor our valuation to $100 million. Why is that? That's because a buyer and a seller agreed to that in an orderly market and orderly transaction. And so as you think about rolling that concept forward, it's what's the buyer and the seller are going to do based off the now the new information we have anchoring back to the $100 million purchase price and what's evolved since then?
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How do you unpack some of the nuances of that as it relates to the specific buyer? What I mean by that kind of to appeal. Another layer off that question is certain people might have certain insights into markets. They may have a view, they may be paying a certain price for a certain reason. Whether one or another party agree with that's a different question. How do you get to that layer of nuance as it relates to thinking about evaluation? I get that there's some very cut and dry element to it, is this is the price someone paid, someone was willing to transact at that price. So therefore that's the price. But another party, that is investor, might have chosen a different price. So how do you think about some of those nuances?
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It's really interesting you bring that up. So keep in mind that when we're doing the value, it's not about you frame the valuation at the starting point as an entry price, but when you do that first valuation, it's about being an exit price. So a lot of times what will happen is we're kind of in the deal and from a valuation point of view, we're getting it each quarter or now each month, or even more frequently now, each day. And we're understanding either the momentum that the business has or any headwinds that the business might have. And then what we're going to do is we're going to start to understand what the exit is looking like, who that exit market is and how the exit's going to happen. So, for example, we might even in many cases, as the exit nears, get an ioi. And that IOI is going to shed a lot of light on what an exit market is looking like, who the exit market contains and, and what the exit's going to be. And then there's going to be that period in between the entry and the exit where we're assessing what's going on with other deals that are going on in the market. And I think where we have this advantage at Lincoln specifically is that we sit on an investment banking platform. So we're understanding what's happening in all the industry verticals and segments that we see each and every day. And that's a real big differentiator.
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I think that's a really important point because what that gets to is there's obviously different cycles in businesses. In markets, there are times when valuations are higher, there are times when valuations are lower. I think to give one example, in Private equity. I think the delta between public market and private market valuations are actually, or EBITDA multiples are actually the highest they've been in recent time. So there's different times when it makes sense to allocate to certain parts of the market based on where multiples sit. Other times it may be harder to do. So how do you think about valuation through that lens?
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So we at Lincoln collect a lot of data. And for every portfolio company that we value, we're collecting the fundamental information. So revenue, ebitda, gross profit, et cetera, we're collecting the investment level information. Last year we performed 25,000 portfolio company valuations. So because we're so data intensive, we ended up creating what is called the Lincoln Private Market Index. And what we've observed is exactly your point. There are points in time where the private and public markets converge and there are points in time where they're different. When you're valuing a private company, what's important is to look at other relevant private market transactions and use that as a key benchmark and consideration in your analysis. If you think about a lot of the public market companies, they're very, very large, they're very, very diverse, and many times the private company, the private markets, depending on the size, certainly as you go bigger in the market, you'll see that diversification. But you go to a smaller deal, they might operate in a specific segment where there is no pure play comparable. And actually the most pure play comparable is the private company that Lincoln sold. And we'll know that multiple and we'll use that in thinking about the valuation process.
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So I want to unpack a few subjective aspects to this, which may be a little bit harder. And I appreciate that, but I think
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I like hard questions.
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It's interesting. Clearly you do, which is great, but it's interesting to think about a few things. So there are times when the market participants in either public or private markets get very excited about a specific trend or topic. Like take AI as an example. AI has to some extent changed how investors think about many SaaS companies and SaaS multiples in public markets. That can be argued one way or another, but I just use that as an example as to some of the art aspects of valuations and how and why investors are thinking about certain markets in certain ways at a point in time. I'd love to just unpack that a little bit because it's such a fascinating aspect of valuations, is you have to benchmark to something at a point in time. How do you think investors if you put yourself in the mind of an investor, how are they thinking about it and how do they then take that perspective and say, you know what, this is a good time to invest in this category, this space, based on where the multiples are. Because some other investors will look at value and have a definition of value and they'll say, I don't want to pay a certain price because I think that is too high a price relative to what the historical comps have been.
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Yeah, I mean, I think that not every investor is created equal. I think when you think about the private markets and the types of investments that are in the private markets, they tend to be buy and hold positions. And our job is to estimate the interim periods from entry to exit at Lincoln, from a valuation point of view, we're kind of making those estimates as we go. And so the more that we could influence our valuations each interim period with actual private market data, the more substantiated we feel the analysis is. And let's take software and AI because that's a great example that's going on right now. There's a general comment that AI, AI, AI. Software, software, software. Sassopolis of like, you know, the world is crashing. You got to go a level deeper than that. There's going to be winners, there's going to be losers, and there's going to be those in between. There's going to be vertically integrated software companies, horizontally integrated software companies, and those that maybe play a little bit of both. That's the level that I think is really important as we're doing that evaluation. And that's where I would guide an investor to also think through, is take it one level deeper. You can't just say, okay, the software multiples and enterprise values are all down by on average 25%. So I should take every software valuation that I see and slap 25% adjustment on it. You have to go a level deeper. What I think is hard about the market right now, Michael, is that if you look at the fundamental performance across the software space, and this is through our Lincoln's private market intelligence, you'll observe that 70% of software businesses thereabouts are still growing on an EBITDA basis.
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Are a lot of those businesses sponsor backed?
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Pretty much all the data on the
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equity and credit side.
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Yeah, pretty much all the data that I'll talk about today is going to be all sponsored backed, which I think is fascinating. What the question now is, what's going to happen with that 70%?
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How do you, from that point, how do you think about valuing these businesses, given some of the potential impacts to them as it relates to things like AI.
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So I think we need to again start to bifurcate the level of disruption that's going to happen with these businesses. So, for example, is there domain expertise? How long are the contracts? Have we seen any trends to date that might influence how much of a change should occur to the downside in valuation? Being more specific, if you see that the retention of customer has already been declining, the trend probably could be in that direction where it's going to decline even more. And what that also signals is maybe that business was never a winner and it had nothing to do with the AI discussion we're having, but it was just a bad business. And the other part of the thing is there's going to be a lot of winners. Think of it more as like a K shape than a line that's going down. And I think that our responsibility is to diligence, understand why the particular business might be shaped up in that K versus down and be skeptical and ask a lot of questions. As we're going through our diligence, we do a lot of diligence on each deal and use that to inform judgment on that point.
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You mentioned you do a lot of diligence on deals. You mentioned you have a ton of data points, 25,000 valuations that you did last year. What are some of the key insights that you've picked up from doing all those valuations across all these different companies and industries?
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We'll need to have another 45 minute session to talk about that because there's so much good things. I'll pick out a couple really interesting data points on the health of the private capital markets. The first thing we see is we continue to see fundamental growth being positive. We're seeing more growers of EBITDA than decliners and we're still seeing positive EBITDA growth. We're seeing positive revenue growth. Those are really good signs. The other thing we're seeing is fixed charge coverage ratio has been improving. So the serviceability of debt is improving. Why is that? Well, we've seen the rate cuts come into play. So so far being lower, that's favorable to the market. The other thing that I think is positive here is we are also seeing the level of adjustments which sometimes comes into question being relatively stable. It's not like we're starting to see the adjustment threshold we typically see is 25 to 30% going from unadjusted EBITDA to adjusted EBITDA. That has not really changed. Those to me are influences on the positive. But let's dissect one thing a little bit more that we did and specifically isolate the 2021 vintage. So a deal done in 21 on
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the equity or credit side, this is on the.
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Just on the equity side, but I'm going to blend credit concepts into this. So we looked at every single deal and we went back every vintage, 2019, 2020 21, so on and so forth. And what we observed is there's growth. There's actually thereabouts 10% CAGR growth from entry to today across those vintages, which
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is from the 21 vintage or going
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back to 2019 from each of those vintages. 20, pretty much every vintage year is showing growth. Every vintage year is different. But let's call it 10% to use a nice round number. Then we dissected, we looked at leverage and what was interesting was that we started to see that there's higher leverage in every vintage year too. So what one might have expected was to see deleveraging, but we're actually seeing that there's more leverage in those vintage years.
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Are these companies not servicing their debt then or paying it back? And there is there a reason for that?
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We still continue to see good serviceability. We see a relatively, like I said, the fixed charge coverage ratio is favorable. So it's not as though they're not able to have the cash flow to service. But this influences your equity, your moic. So let's just take that, let's roll that forward now. Now let's look at the 21 vintage specifically. So you saw that the leverage was increasing despite the growth. But what's happened is that there has been a point in time where 21 vintages were at a height of entry multiples. And so if those multiples detract from the entry now you have a compounding effect. You have a lower multiple to be sold at and you have a higher leverage than you did at Deal Close. So what did that lead to? That has been the logjam in the 21 vintage. That's why deals are not getting sold.
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So segue to my next question, which is who? When I hear that you think about 21 vintage. The Bain report that came out recently, Global Private Equity Report, talked about that there's more companies than ever that are now being held for five years or greater.
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Yeah, I think they said like 32,000 companies or something like that.
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And that's the highest in private equity. Companies are extending their exit timeline. So there's A log jam in exits. Based on what you just said, what does that mean and what will happen if there's more headwinds for MOEC generation? Based on what you just said around higher leverage and likely more compressed multiples to be sold at relative to when they're bought, we're seeing a rise in continuation vehicle activity. We should unpack that because there's nuances to that too. There's some deals that are probably fantastic and make sense to be in CVS are great assets and there's some that may not be as great. What does what you just said mean for the market as it relates to exits and will firms continue to hold those businesses to try to see if there'll be an increase in multiples or an increase in EBITDA margin and then they will be able to sell and increase MOIC over time? Maybe IRR decreases a little bit too. But what happens in your mind?
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So I think we should dissect a few different things. The analysis we're talking about is just the 21 vintage. So I think to not make an overarching statement about the whole market but maybe focus on advantage. And if we think about that, what that means is that you're going to need to continue to see accelerated growth in order to kind of offset if there even was multiple compression. But here's the positive. I would say when we looked at the deals that are closing now, we are seeing that they're closing at favorable levels. So it goes back to this like K shape concept where I think you're going to see good businesses be winners here and not have this MOIC issue. And it's the segment of the poor businesses. That's where there's going to be that kind of this inflection point. You also mentioned CVs and our expectation is to see that also pick up, which has been very, very hot as it is.
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Do you think there will be a positive selection of the assets that are good assets from the 21 vintage? Maybe they had some headwinds for a variety of reasons we just talked about, but those end up being CV assets because they're good businesses and they continue to grow. There may still be both revenue, EBITDA growth, multiple expansion and potentially a greater exit.
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I think they could just have an exit. I wouldn't put them into a certain category. It could be a cv. I'm not saying it can't be. I would say that it will have a really good path to exit. And the way I would view this is that we're dealing with this iceberg of deals. And now we're seeing that iceberg melt as opposed to a dam breaking and all the deals happening at one time. And when deals have been coming to market to us, the deal quality is very similar. They're higher quality deals. And like I said in the data, the fundamentals are strong. And so it's just about market timing and bringing deals to market with a high degree of certainty.
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What do you think the increased amount of capital coming into private markets and I appreciate that there may be nuances as it relates to whether it's private equity or private credit. What does that mean for what we're just discussing about? There's now businesses that maybe could exit from some of the older vintages. There's new businesses coming to market that people may want to invest in. How do you think the growth in private markets and overall AUM will impact how firms are underwriting and how they think about valuations?
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So I'm going to try to unpack this really simply. But I'm actually quite excited about the direction that the markets can go for a couple different reasons and it relates to things that are happening as we speak. So you have let's talk about the private credit direct lending market. I want to kind of just break down what we've seen with yields and then we could talk about this capital. So with yields we go to the height of the market. We saw, let's call that several years back where spreads were something with a six handle in front of it, high fives. And so for was at a peak level. So return profile is favorable, 13 14% with leverage. Fast forward to today and we see three rate cuts. We see all which impacts sulfur to the downside. We see now also a ton of dry powder enter into the direct lending market. That results in everyone chasing high quality deals. That causes spreads to compress. So now your Yield went from 13 14% to like 8.9%. And we see that through which we could talk about a little bit later, the S and P Lincoln Senior Debt Index, which is producing that level of return thereabouts. So then you say, okay, well I'm an investor, I'm seeing that I've got 13% paper return. I'm putting my money there which is exactly what we saw. Everyone went upstream. Now that it's come down a little bit, the capital cycles to private equity with your 17, 18, 19% return. So I actually think it's not about capital leaving the private capital markets. It's about shifting to get the return profile and what's then exciting. I think that this market's opening up an opportunity for spread widening where in the direct lending market. There's a lot of things that are going on between the SaaS, environment, energy crisis, a lot of things. And I think there's an opening window that we're going to start to see migration away from four and a half 475 to things that start with a five handle. When that happens, what happens? Direct lending returns increase and you start to see that starts to all evolve. And so it continues to be and has been a very favorable asset class.
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What do you think will happen to underwriting standards?
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Underwriting standards are really, really high. If you think about a process that we read about and that we talk about with our clients, these deals are getting scrubbed by the smartest people out there to whether they're going to make that investment. And what I think's happening with the underwriting standards, particularly right now, is you've got clarity on okay, so you're doing a deal right now. You're going to see in the underwriting memo discussion on AI risk, discussion on the impact of energy, discussion on any other geopolitical and macroeconomic impacts that are influencing the deal today. And if you look back in memorandums that were done over the last two, three years, AI has been mentioned. It's not like a new phenomenon. It's been there. And so I think that's the other misnomer. I think that what you will find though is that as that continued to be introduced, obviously it comes in scale. As AI starts to elevate, that's when you're going to start to observe the discipline.
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How were underwriting standards over the past few years?
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I would still say that the underwriting standards were extremely high. But you get smarter as you're influenced by things that are happening now. So you're going to underwrite in the environment that you're sitting in and then going to look to the downside expectations and the upside tailwinds that you expect the business to have in all cases and in all environments. I think that as you think about the vintage deals in 20, you know, the vintage deal today, you're going to have a lot of discussion on things that are happening right now. Some of those things may not have been at an earlier vintage because it was unpredictable. An unpredictable thing that's influencing a particular portfolio company and other of those things like AI that was known for quite some time. I think that the sophistication has increased which has led to further discussion in what's going on. If you're talking about a specific software deal, a software investor is going to have known a lot pretty much through all those vintage years.
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Where do you think firms have fine tuned their underwriting now, given how much of a spotlight is on the concept of underwriting and the growth of private markets, it's in the spotlight more. There are more evergreen funds, so more investors are starting to participate in private markets. Where do you think investors have really started to hone in and fine tune their underwriting that going forward will be a net positive for investors or allocators who they end up working with?
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It's funny, I think the asset managers, generally speaking, are constantly evolving the same way that you would or I would as you learn more or technology start to take over more. So I feel that the direction of travel is just going to be influenced by the general environment that's out there.
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Who do you think the advent of AI, the application of technology benefits more as it relates to asset managers? Is it large firms with scale budgets? Is it specialists who understand their market really well? Who are the winners and losers from that perspective?
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I don't think there's anybody that I talk to, regardless of size, that is not thinking about how to use AI in their business as an asset manager, Everybody is looking about it. It's not about the size. Where I think could be different is maybe how they're going to use it and what it might influence and how they might be able to scale with it. But there's nobody that I've spoken to that's AI. What are you talking about? Everyone is really honing in on it. What I think is important that might sometimes get missed is that these sponsors and lenders, a lot of time they are most all times they're specialized in the segments that they operate in. And so when you're talking about a group that is a smaller private equity firm that has an industry focus, they know that industry like inside and out and they know the operating models of these companies inside and out. They're in these deals with the management teams. And so what we find is that when we're talking to them about the activity that's going on and the reshaping, these industry specialists are augmenting the businesses based off the environments that are surrounding them. It's not that, oh, AI is here. Oh, this is a small company, it's zero, it's AI is here. Okay, how are you augmenting this business doesn't need to be augmented at all. How do we make sure we're Not a loser. Basically, how can we make sure we are actually not only breaking even, but we're a winner?
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You see a ton of data in this space, you work with a ton of firms. What are you most concerned about as it relates to the current state of private markets, underwriting and where valuations are today?
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As we sit here today, the thing that I would say is keeping me up at night is how energy prices are going to influence the entire ecosystem. Nothing to do about the private capital markets, but just which the private markets are in going to influence that whole ecosystem. And the trickle down effect, what do
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you mean by that and what are the knock on effects? So what should investors in private markets be looking for? I think public markets will probably see it first. But what are those signals that investors should be looking for just to be aware and maybe reposition their portfolios? They can't necessarily do anything about what they've allocated to in private markets if it's a drawdown fund in particular. But maybe they can recalibrate how they're thinking about allocations going forward or where they focused, et cetera.
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The one thing I would challenge, I don't know if it's the public markets are going to see it first. I think everyone's going to see the oil prices moving as they are. It's what is the impact going to be on my business as a function of that and how does that trickle down effect work? I mean, let's just kind of like go through a very small iteration of what could theoretically happen if oil prices continue to be at the levels that they are. And we're already seeing this, that's going to impact businesses that feed off of that, which is most businesses, and then it's going to impact the consumer supply
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chains and delays in supply chains.
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Exactly. So just so there's a ton of disruption. So it's not so much, oh, this is a private market thing. This is really just, this is a macroeconomic thing. And as a function of it being a macroeconomic thing, it's going to influence the private markets. As we think about how that impacts valuation, we have to be asking the right questions to our clients. Okay, we're seeing this. What does that mean to your future cash flows? Is this going to have an impact at all? Is there any hedging that you have in place because you were a high exposure portfolio company in the first place to energy prices? Or are you an indirect exposed deal? And if you're an indirect exposed deal, let's talk about what the influence is and to Some degree it might be too early to tell, but to other degrees we got to be. In all cases, I should say we need to be asking the question what
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are some of the biggest knock on effects in your mind that might affect valuations?
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Well, this is going to be somewhat obvious, but I think it's going to, depending on the business is going to impact top line and then it's going to impact your costs, depending on the business. So it could actually have a doubling effect in slowing revenue growth and then causing certain costs to increase to a degree that's going to therefore have an impact on profitability. But again, that's not a private market phenomenon.
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If that happens, are you hearing a lot of talk from sponsors that they may need to extend out their exit timeline or horizon to make it through this period? If there's a period of slower growth, reduced revenues, maybe increase costs, things might take a little bit more time, particularly at valuations that they underwrote.
- [33:56]
A
I think that it's too early to 100% answer that question. But I think it's equally as important to be taking into the considerations that the public market is having around these factors into the valuation. So what do I mean by that? You might be impacting near term cash flows but not long term cash flows. Yet impact of near term cash flow in a negative way would impact the business, the valuation slightly lower. You might be seeing some of your public comps being influenced by a decline in enterprise value and we would expect that to come through in the valuation.
- [34:30]
D
What should the translation of all this be for allocators, particularly the wealth channel that's thinking about private markets today?
- [34:39]
A
Quite frankly, I think from an allocation point of view, because this is a macroeconomic concept, I don't really segregate private to public. In this particular case, I view it as these are influences that are going to happen to certain businesses. And I appreciate that it's an allocation question, but it's a challenging question because to me it's more about am I in on the markets right now overall or am I not? And that's really more of the question.
- [35:11]
D
I think that's a great segue to a broader conceptual trend that's occurring which is the convergence of public and private, the ability to look at data and then there's obviously products now that combine public and private, that we're seeing asset managers both on the public side and the private side come together to manufacture together. And then you add in this, I think re architecting of how people think about public and private. So I think Now, a lot of allocators think about it on a spectrum. There's equity that is public, there's equity that is private, there's credit that's public, credit that's private. And you just then decide where you want to fit on that spectrum as it relates to risk, liquidity, illiquidity, et cetera. How do you think investors are now thinking about those concepts? And how are valuations and maybe some of the work you've done, the S and P Private Debt Index, the Lincoln Private Debt Index that you've created. How is some of that transforming how investors might think about this convergence of public and private?
- [36:18]
A
As I mentioned earlier, we're really big on data. So we've been collecting data since 2011. And for every portfolio company we value, we're collecting this data. And what we feel and continue to feel is important and why we went to the market with an index which the first one was an enterprise value index, the second one was a senior debt index, is because we want to bring transparency to this marketplace. And what is the S and P Lincoln Senior Debt Index doing? It's reporting on total returns, it's reporting on price, and it's bringing transparency to the marketplace so that you can start to benchmark. Okay, well, this asset manager has a return profile of X. And how does that compare to an aggregated set? What's also interesting about this index and why we think it's differentiated is because it's bringing, and then it will bring two things to the market. What it's bringing today is a deeper level of transparency than price because we have, and we know what, on an aggregated basis, the LTV profile is of the deal. We know the industry that the deal sits in. We know the vintage of the deal. We know information about the deal that allows you to dissect that index to a much more granular level, which allows you to really see what the heat map looks like, I would say, in terms of the return. Then as you kind of think about the other thing that the market is clamoring for and what this index will produce is more frequency. So actually, what's really interesting is 30% of what we value today at Lincoln is done more frequently than quarterly, which is allowing us to then transpose that into monthly reporting cadence, which will happen in the not too distant future with the index.
- [38:04]
D
Do you think that this more frequent reporting cadence. There's two elements to this. One is what it means for Evergreen Funds. We'll talk about that. But first I want to talk about a slightly more philosophical element, which is this more frequent reporting cadence. Do you think that this is changing how both operators and executives and investors are thinking about how they run their business in private markets or is it not changing how they think about their milestones? Are they hitting them and they still think like private markets operators or investors, as opposed to public markets operators or investors where they're constantly doing quarterly reports and they're mark to market every day effectively. So there's a different referendum on that business. Is this changing their mindsets or the way that they operate or behave at all?
- [38:56]
A
As you see it, this will be an opinion more than a fact, which I think is fine. But what I would say is that the asset managers are still going to look for the highest quality deal with the highest return to satisfy their investor base. Then there's going to be the functioning of that firm in terms of the type of information that they're going to be able to report on and accelerating that level of reporting. So call that the operations and finance function. That's what's evolving a bit. But the type of deal that you're going to go into is going to still be that high quality deal. But then in terms of the ability to. And where things are changing is where we're kind of going. Where things are flipping on its head is that people aren't thinking about quarterly anymore. They're not thinking about, oh, this is a quarterly process. You're finding yourselves going to the most frequently used cadence in terms of the subscription redemption structure within that asset manager and accelerating all processes to be in with that in line with that timeline.
- [39:59]
D
It's a great segue to the other part of the equation, which is Evergreen funds and the rise in Evergreen funds. How is that changing how valuations are being done? What needs to be done differently, maybe better in some senses, or certainly more frequent. So there's probably a whole chain reaction of things that need to be done differently as a result of that.
- [40:24]
A
Yeah. So the actual how do you value a business is exactly the same, the standard value exactly the same. None of that is changing. What is changing though, is how frequently you have to execute that valuation model, how frequently you have to receive information from the client to execute that model to the frequency that's required for that valuation. That's what's really changing. And so we have to set up with our clients an integrated, technologically enhanced format in order to receive information in an effective way, report to them in an effective way. And so we have a client portal called Lincoln Lens. Think just two years ago if you had 300 portfolio companies that we were valing for you, we have several clients that are in this category. They would receive 300 PDFs each of which that have 15 pages. Think about how many pages that is
- [41:20]
D
and you would print them, have to manually extract it. And it was probably not standardized either. Right. How do you think about the increasing standardization in the market and do both companies and funds move towards some uniform set of standards?
- [41:38]
A
I think that you will see some of that. I do think there'll be some uniformity in terms of maybe what is being reported out. And that goes back to having an S and P Lincoln Senior Debt Index to benchmark against as an example of that. So using that as the benchmark against returns and performance. But in terms of some of the nuances that certain asset managers look at relative to others, I still think they'll be. Everyone has their way of looking at their deals and I think that will still exist on the internal level, but maybe on the external level I can see some more conformity in the reporting.
- [42:15]
D
What do you think still needs to improve from a technology perspective to enable better, whether it's collection of data, aggregation of that data, creating uniform standards of that data and then analysis that data?
- [42:31]
A
I think we're in the early innings of that process for sure. I think what makes it interesting is that every asset manager that we work with is extremely sophisticated and also has a certain way they want to see things. Technology is not so great about having 225 different types of. I want to see it this way, I want to see it that way. And if the technology evolves in a way that there is a bit more flexibility in the reporting, I think that will be. That to me is where there is an area of opportunity for the technology.
- [43:10]
D
Where does AI provide the most leverage in this process?
- [43:14]
A
I think that you can call from the data set is really, really exciting and different. The ability to say, hey, I want to know how many deals have a moic between 1.5 and 2.5. I want to know how many of my direct lending deals have a LTV of 50 to 75 and what the proposed range of values is like that to me, that callability is really, really important. And then it will accelerate the transparency that we can bring to our clients, which we do as it is, but quicker. And I think that's what's key.
- [43:51]
D
Do gps need to marshal more resources or focus on different things? And will there be gps who end up being bigger winners, whether it relates to fundraising and or honestly their ability to underwrite. Because if they have better ability to analyze their existing deals and do a better job with valuations, how they think about things, how they've done things. In the past, I've written something called persistence in process. I think firms that like people under LP's underwrite process, but it's the persistence in process that is what LPs kind of have to think about to be able to determine whether a manager actually sticks to that process and does that every time that they actually underwrite investing in a manager. What do gps need to think about? Because valuations like this is thought of as a post investment activity, but the reality is that post investment activity actually feeds into the pre investment activity of fundraising. The question is, how do gps need to think about marshaling the right resources to do better valuations, better understand how they've done valuations to inform future investments and therefore also attract LPs to their platform relative to others if they have better valuation processes versus a manager who doesn't.
- [45:08]
A
So what's interesting in terms of quote, unquote, better valuations, I don't know if it's a technology thing as much as it is just making sure you're doing some back testing. And so that's something that we do at Lincoln. So you look at your, the exits, what the price was, and then how was your range of values compared to that price? Was it in range, out of range? And we have a really high success rate on our back testing. That I think is a really helpful, informative statistic for the manager to then help evaluate. Well, what happened here? Why didn't I know that? And by the way, just because you're out of range on a back test doesn't mean that you did anything wrong very well. Possible that you have a strategic buyer that was not in the cards and you were right in the set of the comps from a implied multiple perspective. But you got the strategic buyer. I think in terms of shepherding resources for the technology side of things. Most firms we talk to have an AI committee, an AI person, a workforce that's very focused on that. I do think you'll start to see if you have more energy and more capital and more resources really centering in on that, they might start to separate themselves in terms of how quickly they can execute on inquiries that are coming from investors, how quickly they can execute in terms of turning things around and that will lend itself to greater transparency. That's why we at Lincoln are investing so much in technology, because we want to be able to bring those solutions to our clients because we know our clients are going to need that. And we've decided that that's just a really important strategy for our firm and for the portfolio evaluation practice, which I lead.
- [46:43]
D
I think that's such a great way to wrap this up. You mentioned a few words in there. Transparency, better valuation processes, and managers need to think about all these things. There's kind of an implicit discussion about art and science, which we talked about earlier. I think it wraps everything together so well in terms of how to think about this. It's a nuanced process. It's not easy to understand. You have to think about things in both this moment in time, but also think about what's happened in the past, what might happen in the future. Such a fascinating conversation. Thanks so much, Brian.
- [47:15]
A
Thanks for having me. I had a great time.
- [47:17]
D
Pleasure. Thanks for listening to this episode of Alt Goes Mainstream. I hope you enjoyed it. You can read more about Alts at my substack, Alt Goes Mainstream substack. Com. Thanks a lot and have a great day.
- [47:31]
B
We're going Mainstream.