Adam Capital Management

Adams corking attention line of descent IV Joel Adams, consume out and popular secernner of Adams Capital Management (ACM), a $700 trillion primordial-stage jeopardise great(p) planetary house invest in the info applied science, ne devilrking infrastructure, and semiconductor industries, glanced up as his shake t completelyyer worldwide first mates trooped into his polish office on a brisk December morning in 2005 for their annual retrospective and planning meeting. The main(prenominal) altitudeic on the agenda was a in the alto modelher ace, ?would 2006 be the right m to launch their fourth stock?Since freshly- do 2000, ACM had been deploying its $420 jillion third m adepttary lineage, using its foodstuffs graduation exercise dodging, an approach shot that identified and sought to p schoolge advantage of discontinuities in spite of appearance the common chord manufacture segments it targeted. Having invested in a society exertioning much( prenominal) a change, the gen eonl partners then channelise the investing funds by a five- smirch unified oceanfaring corpse. In November 2005, ACM Ill change a portfolio comp any and made its branch distri besidesion to its limited partners (Lips).The funds portfolio in like manner had 18 other operating companies that were showing even growth, ND two new investments were in the due patience phase and preparing for net examination negotiations. The question as I date stamp it, said Adams to his partners, is whether we rent to draw to a greater extent than(prenominal) companies and generate accessal distri exactlyions to our Lips before we off set apart raising ACM Since Scams graduation exercise fund had unlikable in 1997, the investment purlieu had byg integrity from robust to hysterical to deflated and straightway, finally, to what appeargond to be a modest recoery. Likewise, Scams performance had been whipped roughly.Fund I was close top-quartile, Fund II could reach slap-up with a few breaks, ND Fund Ill, a 2000 vintage fund was too new to tell, Adams noned ( happen upon endanger 1 for performance data). The firm had espo social occasion its dodging in part to tick itself for potential Lips. But the partners to a fault believed that the uncontaminated opportunistic approach of many an(prenominal) accident firms?whither each general partner was a good deal given wide leeway in determining which, and how many, foodstuffplaces and biding models to invest in?could cause the firm to lose good deal of the portfolio as a whole.With issue a food grocerys commencement dodge, through which the entire firm hold upon the foodstuffs of interest before engendering individual companies, the partners tangle that firms would invest more on the al-Qaeda of the fashion of the moment than on melodic phrase fundamentals or trade analysis. In Fund Ill, ACM had taken more pregnant take inership positions than in the past?ty pically 35% or more?led all deal, and held a seat on every visiting card. In 85% of the funds investments, it was the offset printing institutional money in the company.Adams believed that this was the whole way to respond to the sharply chip capriciousness of the infer capital market name a collection of very good companies and testify nice f them to be. familiar spirit Ann Lemon wrote the master edition of this case, Adams Capital Management March 2002, HOBS occurrence No. 803-143 which is being replaced by this form prepared by Professor field Harmony and Senior Research Associate Ann Lemon. HOBS cases are substantial solely as the basis for class discussion.Cases are non intended to serve as endorsements, sources of autochthonic data, or illustrations of effective or ineffective management. Copyright 2006 President and Fellows of Harvard College. To order copies or request permit to reproduce materials, call -800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http//www. Hobs. Harvard. Due. No part of this publication may be reproduced, stored in a retrieval system, apply in a spreadsheet, or transmitted in any form or by any meaner?electronic, mechanical, photocopying, videotapeing, or otherwise?without the permission of Harvard Business School.This document is authorized for use only in FINDINGS Alternative summation Classes SSL/2013 by Jason Zen at University of bare-assed South Wales from March 2013 to folk 2013. 806-077 ACM knew this outline was non without its risks. Fund Oils portfolio contained few rinsing companies, but, Adams said, When you bear a signifi backt testis of the company and it doesnt do closely, that hurts the fund. Going to market with a good wee archaeozoic fund, a struggling randomness fund and a yet unproven third fund big businessman not be easy. The Lips may want to know wherefore we dont go mainstay to taking small positions in more companies, he not ed. L have to be able to give them an answer. Venture Investing in 2005 The starting line half of the 21st century had authentically witnessed the Dickens best and lather of eons. The final years of the sass had seen an unprecedented runup in venture activity. Everything had increased?the amounts of capital brocaded, the management fees paid, the amounts invested, the expenses that companies could command, the exit valuations received, and the speed with which investments became liquid. As the century changed, so did the venture environment.The NASDAQ reached its flier in March 2000 and by 2001, the fellowship had come to a grinding halt. later on(prenominal) a decade marked by continuously rising amounts of capital menstruation into venture funds, 2001 raised half of sasss record of $71. 7, and 2002 and 2003 raised barely 10% ($7 billion and $8 billion, respectively). L (See troop 2 for fundraising data). By 2005, the numbers of deals, their price levels, and the size of the rounds had all fallen considerably from their peaks in 1999 and 2000. Since the precipitous drop, though, they had steadied (see border 3 for trends).The initial decline, termed a pick out wreck, reflected the fact that almost tether years of record-breaking venture activity had funded too many companies chasing too few customers in almost all engineering science customers had cut their capital expense budgets, and on top of that, were suffering from a backlog of in the beginning applied science investments that had not yet been to the full implemented. Spending on technology fell off sharply. As a result, portfolio companies importantly underperformed expectations, often forcing their investors to resort to inside rounds for act financing because all firms were trying to concern their own troubled portfolios.There afterwards, activity had resumed albeit at a lower level. A pass on complication for the venture capital ( polyvinyl chloride) fabrication was the longe r path to liquidity. The Initial unclouded Offering (PIP) market dried up in 2001, only to revive?at least to a degreein 2004 and 2005. The number of venture-backed mergers and acquisitions had stayed reasonably steady in the vicinity of 300 transactions from 000 through 2004 and even ciphered likely to continue for 2005 base on first-half data, the number of Ipso had plummeted from 264 in 2000 to 41 in 2001 and a mere 24 and 29 in 2002 and 2003.Although this number had tripled in 2004, to 93, sasss first half saw an uninspiring 20 Ipso, a number even so close to the join for all of 2002. 2 By mid-2005, though, glimmers of recovery pierced the gloom. premature ventricular contraction fund- raising for 2004, at $1 5 billion, equaled the sum of the previous two years total. Firms had triages the worst of their problem companies, by change them for the reason repertory, merging them with other weak companies, or shutting them down.Technological evolution provided market opportu nities for recent companies and some older ones, weaned off the easy-money of the bubble, had brought their harvest-homes to market and were profitable. Disclosed prices for mergers and acquisitions rose to the heightsest number since 1 Abstracted from data from mystical Equity Analyst and Asset Alternatives. 2 Thomson Financial/Venture Economics, Venture back M&A mess Holds Steady, www. Nava. Org, accessed December 8, 2005. 2 IQ 2002. 3 The door to the PIP market, blown off its hinges in 2004 by premature ventricular contraction-backedGoogles debut, reopened, with new companies price their offerings almost every week. The pace and valuations of deals had uprisen, and with it, investor confidence. Its not that polyvinyl chloride has ferment hard, said one veteran venture capitalist. Its Just gotten back to averageal. Adams Capital Management Joel Adams, founder of ACM, grew up in Phelps, New York, a small town between Rochester and Syracuse. My dad have a dairy farm, r ecalled Adams, and his and doing chores. Adams was 15 when his beget passed away, leaving his father with no extract but to delegate most of his wifes responsibilities to the three children.Looking back on those days, Adams said At the time the confluence of events was a booby hatch of a wake-up call for a teenager, but I in veritableed invaluable slightons about(predicate) money and time management. later on graduating from the University of buffalo in 1979, Adams conjugated nuclear hoagy manufacturer prevalent Dynamics, where he became a test engineer, the exit engineer liable for starting and testing a subs nuclear reactor and re feeding General Dynamics during the Navys sea trials of the new boats. In 1984 he travel to Pittsburgh to attend the rail line school at Carnegie Mellon University (UCM), lured by its fond program in entrepreneurship.During Adams second year at UCM, he worked part-time for Foisting Capital, a small polyvinyl chloride firm that invested on behalf of the Fosters, a loaded Pittsburgh family. Adams get together Foisting after graduation as a Junior partner, with the firms new $14 zillion fund. Shortly thereafter, the firm and Adams became baffling with bosom/Foisting l, a Joint venture formed with Patricia Co. To manage the $40 gazillion fund that the state of Pennsylvania cute to invest in PVC. In 1994 after nine years with Foisting, Adams, SCOFF Andrea Joseph, old secretary Lynn Patterson, and causation partner nib Hulled armed Adams Capital Management, Inc. O grasp the Foisting portion of the $60 million PAP/Foisting II, raised in 1992. In 1997, ACM raised its first fund, the $55 million ACM l, with its markets-first investment strategy. Discontinuity-based investing Ever since he had Joined Foisting, Adams had been dissatisfied with what he considered a escape of focus and discipline in the firms investment strategy. Heres a nuclear engineer, walking into this manufacture, with a very small fund in P ittsburgh whose strategy was to be diversified by stage, by constancy, and by geography, Adams recalled. After about a year, I said, This isnt a strategy at all? you could do anything. He was especially nonplussed by the method acting of developing deal flow. Rather than tuition about markets and then targeting particular proposition proposition deals within them, he said, The approach at Foisting was to open the mail in the morning to see what business plans had arrived. Two of Adams experiences at Foisting present him with the power of targeted investing. The first was his entailment with distinct Corporation, a developer of software applications for applied science produce data management. l understood the issues of applied science data management from my says at General Dynamics, Adams said. L was a much smarter investor aspect at an industry that I knew. non only was he a stop investment manager and board member, he know, 3 Ibid. 3 but he was also a part negotiato r. Entrepreneurs are passionate and biased about their businesses, he said. If the first time I hear about a market is from the entrepreneur, Im at a puffy disadvantage. His second revelation was even more powerful. desire a computer in 1987, Adams happened to learn about a mail-order operation in Texas called PCs Limited that custom-reinforced in-person computers and gash retail prices.After speaking with the companys CEO, Adams invested $750,000 in the coming(prenominal) dell Computers first outside venture round. Had the firm held this position, it would have been worth $382 million as of the end of September 2005. Adams realized that dell had pissd such(prenominal) an explosion of apprize by exploiting a discontinuity ? a dramatic and sudden change in a grand and established market. In this instance, the discontinuity snarly distribution. The rise of direct distribution strike the large personal computer manufacturers, which had exceedingly entrenched outworks of re tail dealers.These networks, Adams noted, couldnt be unwound overnight. Dell could build a multi-billion dollar business from scratch because his large and sleepy competitors could not respond to this distribution discontinuity in time. As ACM expanded, Adams resolved that any new partners would be engineers, and thus bring their technical breeding to bear in thorough examinations of a few promising markets (see evidence 4 for partner biographies). Scams strategy evolved to focus on investments in markets that the partners already knew well and had already identified as attractive.A few initial prerequisites had developed over time. The first was that the companies in which ACM invested would sell to businesses, not consumers, and their observe propositions would be driven by authorise on investment (ROI). Thats ROI for the customers, not us, said Adams. Our first question is, If somebody is acquittance to procure this companys product, what does the Chief Financial Officers recommendation guess like? The second quantity was that the business was fragmentation applied technology, or one of the first companies to use a specific technology for a specific application.Given the partners engineering back earths, the firm focused on the discipline technology (IT) and telecommunication/ semiconductor industries, areas that were, in their view, experiencing significant discontinuities. The most important criterion was that, as in the case of Dell, Scams portfolio companies would exploit discontinuities in existent markets, shifts that would create opportunities for start-up companies to become market leaders. In the IT industry, the partners anticipated that the need to create virtual enterprises on a globose scale would force companies to look for highly adaptable systems.The telecommunications industry, set about with global expansion in bandwidth requirements for data, seemed to be face with an entire rethinking of the existing technology and infrastr ucture, time reaching the limits of current silicon technology appeared likely to revolutionize the semiconductor industry. mystical down these areas, Scams partners sought to identify four uncomplicated causes of discontinuities (see Exhibit 5 for more on discontinuities) 1 . Standards. Despite the emergence of a technology technologies in an attempt to support their captive customer base.Even as customers wan the standard, the existing manufacturers perceived it as a threat to their oligopolies market positions, and were reluctant to study it. One such use was bowing Systems, which built communications devices that conformed to the ambience (asynchronous carry-over mode) standard for communications in wide-area networks. The big players at the time, AT&T/Lucent and Northern Telecoms, each had copyrighted protocols for those communications. These manufacturers cl untimely had the technical prowess and market muscle to 4 exploit ATM as well, but they were slow to do so for fear of cannibalizing their own interference shares.In April 1999, FORE was acquired by GEE Pl for $4. 5 billion. 2. Regulation. Unexpected regulatory changes could force market players to adapt quickly to a new market reality. An example of such a dislocation had occurred in the U. S. Cellular market where a host of new opportunities and networks had emerged after the governments creation of the PCS spectrum. From a technology point of view, the new spectrum provided a chance for GSM, the cheaper and more easily-deployed base station technology ordinary in the rest of the world, to gain ground on the unwieldy proprietary technology dominant in the United States.GSM equipment manufacturers and the young carriers who provided their services used their agility in the new regulatory environment to scrap the giants. 3. Technology. A technology-based discontinuity could take two forms. In one, it could appear as a whiz-bang parcel of land that took big competitors months or yea rs to duplicate, such as Apples Macintosh operating system. Alternatively, it could involve the convergence of technologies that had hitherto been separate, requiring innovation to spare these once-disparate systems to interact.An example here was the rise of bodied remote access, which forced companies to buy technology that would connect the public carrier headphone networks to the corporations internal local area networks. 4. Distribution. Dell Computer in the earlier example provided the ultimate example of a distribution-based discontinuity?the rise of mail-order completely surprised existing personal computer manufacturers, to the great enrichment of Dell and its shareholders. This top-down approach to identifying markets was crucial in serving ACM come upon consensus about and control over where its partners would invest.Adams firmly believed, Market due diligence is the only due diligence you can do independent of a transaction. If you present the partners with the indu stry and market dynamics leading of time, then we can all let loose about each others prospective investment. Scams approach to identifying discontinuities included its Discontinuity Roundtable, a group of advisors that met periodically with the ACM partners to identify and discuss market discontinuities that could lead to fruitful investment theses. The 20-person Roundtable comprised industry experts and observers who attended meetings depending on the topic at hand.Among their number had been Clayton Christensen of the Harvard Business School cognize for his research on how innovation moved(p) markets George Symmetry, inveterate entrepreneur and founder and holy person of over 200 companies Attic Razz, occasion CEO of MAD, the chip-maker that competed against Intel and Mike Maples, former crib of Microsoft. The process required partners to write discontinuity albumen papers that advanced the investment dissertation and to present them to a Roundtable of earmark experts d rawn from the pool.The group would discuss the merits of the thesis under consideration, usually greening to chase two or three of the octette to ten papers presented in a meeting. The meetings would also identify other avenues for prox exploration. Once an investment thesis was exhaustively vetted by the Discontinuities Roundtable, the ACM partners would systematically search for deals in that domain. Sometimes this took the form of identifying pockets of excellence in the appropriate technology and supporting entrepreneurs in forming a company.In other cases, it was a matter of identifying and sorting through several existing potential investments. This process eve the partners deep knowledge of these companies opportunities and therefore made ACM more attractive as an investment partner. 5 Structured Navigation In addition to a systematic approach for identifying markets, ACM also developed a system for managing its investments, called organise sailing. The system was born out of the notification that early-stage technology companies shared many of the alike(p) benchmarks and indispensable many of the same elements to succeed.Jerry Sullivan, who had Joined the firm from MAC, Tektronix and Phillips, explained Our investments typically have high development apostrophizes coupled with the direct sales Orca characteristic of companies at these stages. The majority of our investments? 90%?are software-based, so resource planning and allocations are well understood by all of our general partners. We feel that our structured navigation strategy applies to all companies within the model. Aspects of the structured navigation included 1 . Round out the management team.Like most other PVC firms, ACM was deeply involved in component part its entrepreneurs complete their management teams. Almost 85% of the management team without capital, Martin Neat, a former executive vice president with IBM and now ACM general partner, said. People are going to Join a co mpany that has some capital behind it, so we basically believe that if youve got a great luck thats well-funded, youre going to attract a masses of talent. ACM devoted significant resources to the creation of its service Group, which helped its portfolio companies in this area. . Obtain a incorporated partner or endorsement. The notion that an early stage company, hoping to exploit a sea change in a large existing market, could forge a confederation (an endorsement, a distribution deal, or an paleness investment) with one of the very players from whom it hoped to steal market share mimed entirely contradictory. But the ACM partners believed that this should almost forever and a day be possible. From Scams perspective, forging these relationships early would often create other exit opportunities. . Gain early exposure to industry and investment banking analysts. Industry analysts such as Garner, Gaga, and Forrester often created the first wave of market interest in a new techn ology. This groups validation could speed the acceptance or application of a new technology. fleck industry analysts could help create a market for the technology, analysts at investment banking firms could create an exit for the company, and ACM tried to make sure they met the portfolio companies early. First of all, the good analysts rattling do understand the businesses of these little companies, N. George Sugars, a general partner in the Silicon valley office, said. But the second thing is, bankers are in the fee business, and they need to put marriages together. Introducing the two parties early is a tactic that will set you up for deals later on. 4. Expand the product line. A first-generation applied technology company would be confronted by sigh initial costs of development and sales.In such a case, Bill Freeze, a general partner in Scams Boston office, observed, The marginal cost of the development for subsequent products or the beside sale is much lower. Once a new te chnology product had been developed and a base of customers secured, the costs of leverage that technology into another, similar product and exchange it into a base of existing accounts was comparatively small. But sometimes the entrepreneur hasnt ruling that out yet, he noted. Our approach ensures that the companies are adequately focused on this hold dear creation opportunity. 5. Implement best practices. Scams partners mat up up that their entrepreneurs should focus on developing products and selling them to customers, not on structuring stock choice packages or compensation 6 plans. After working with dozens of companies with similar structures, the partners felt that they should be able to provide boilerplate versions of plans that worked. ACM used these five steps (in no particular order) to manage its investments, complete.The process, the partners felt, not only made their investments more triple-crown, but also provided the partners in four offices across the U. S. Wi th a mollie understood internal barometer of a companys do (see Exhibit 6 for offices). If ten months into a deal you cant attract talented people, corporations dont care, and you cant get the bankers interested?youre learning something, observed Sullivan. And perchance you ought to get out. Defending the Strategy Was it really necessary to formulate such a rigorous strategy for investing in early- stage businesses?Adams admitted that, to a certain extent, the strategy was motivated by the practical necessities faced by a small firm based in Pittsburgh raising a $55 million fund in 1997. We had to get ourselves above the muck, and the way you do that is with a well-defined, market-centric strategy that you execute in a disciplined manner, he said. It had also given a small partnership, disordered among offices in Pittsburgh, Philadelphia (later Boston), and Austin, Texas (Silicon Valley was added in 1999) a common language and approach that facilitated communication.Adams balked at the conventional wisdom about PVC and venture capitalists?namely, that PVC was a personality-driven business, and that successful venture capitalists were all genius dealers whose peck turned everything they touched into gold. L effective dont buy the rock star model that many venture firms promote, Adams said. Instead, he wanted to build a venture firm in the same way that most businesses were built ? with a structure in which any of its employees were, in principle, replaceable. We wanted to develop a system where you could throw anybody out of here and the thing will still piss along, he said. We wanted to build a system for executing this business. Were engineers, we think that way. Were not rock stars. We have a system for finding areas that are of interest, getting deals, and making them valuable. Thats what we do. The Funds Since 1997, the partners felt that strict regard to strategy, combined with the systematic portfolio management that navigation provided, had ser ved the firm well. They had grown from a $55 million fund to managing $700 million and from one office in Pittsburgh to four in areas in which 68% of all PVC activity in the U.S. Occurred. Each fund had been invested according to plan, although the results had not been entirely anticipated. ACM I had invested in 15 companies for a total cost basis of $55 million. culture technology accounted for 49% of the portfolio electrification for 30%, aesculapian devices for 11% and networking infrastructure for 10%. As of September 2005, the fund was richly invested and had exited all but one company, distributing stock treasured at $122. 7 million for a net IR to its Lips of 46% exclude below the upper quartile).The general partners hoped to achieve at least $140 million in total proceeds by the end of Fund Xis contractual life. With its small size, ACM I had aimed for percentage ownership in the low teens. The firm had held a board seat in 67% of its original 15 companies, and its pos itions could get diluted if it as 7 unable to participate fully in subsequent rounds. However, as Adams said, This was the home-run era of early stage PVC investing?significant returns were almost the norm. We had our share, with three acquisitions and three Ipso. That was a good fund. Based on the early success of Fund I and the frenzy around PVC, ACM had closed the $1 50 million ACM II at the end of 1999, followed quickly by the $420 million ACM Ill at the end of 2000 (see Exhibit 7 for fund statistics). In the over-heated environment of 1999 and early 2000, though, the partners found that the game had changed. At first it seemed that home-runs were still possible, said Adams position money to work was paramount. Unfortunately, this meant that we had less time to investigate new markets and we therefore had less diversification in the portfolio.If the big companies were looking for drop-add-multiplex-switches, that was what we backed as all of them were being bought because eve ry big company needed its own drop-add-multiplicities. We ended up with a lot of similar companies. Our goal was to own around 20%, and we usually had enough money to keep our position, which was not always the best thing in retrospect. Fund II had stayed the strategic course. Of the 14 companies in the portfolio, three had been acquired, five written off, and sestet were still active and showing strong revenue growth.The firm had moved away from investing in medical devices though. training technology made up 45% of the portfolio, semiconductors 38%, and telecommunications 17%. Although Fund Siss care for currently stood at a 40% discount to cost, Adams hoped that, with a few breaks, it could return the Lips capital. Fund Oils approach of taking big position had been adopted in answer to the changes that the partners noted in the market ??in particular, a reduction in volatility. As Adams explained, The days of the consistent home-runs are gone.Reduced volatility meaner that w e need to build portfolios that are more balanced and consistent in their performance. Were not looking for xx returns, although we certainly wouldnt disapprove them. I Just dont think thats the norm anymore. Instead, were looking to build a unassailable portfolio that yields xx to xx returns based on operating success?positive hard currency flow and net income. We look to own enough of each company that every deal is an impact deal, both for us and for the company. And here, because outcome volatility has fallen so substantially, we need to have diversity among our companies.You might say that beta has fallen so we must increase alpha. We had to assemble an kindle collection of really good companies that turn to significant discontinuities in the market and own enough of them to matter. Weve done that. Weve also added value to them through the ACM Services Group, which provides corporate partnering, enlisting and financial management guidance. By September 30, 2005, Fund Ill h ad called 74% of its attached capital. Information technology accounted for 59% of