When private equity giant Warburg Pincus decided to venture into the real estate credit space in Asia last year, it had the option of several entry points.

As a growth-oriented investor, it could have backed an early-stage credit startup, invested in an established entity alongside other partners. It could have started small by acquiring a portfolio of credit assets.

Wells: leading Warburg’s new Asia RE credit venture

Instead, the firm decided to build a company from scratch. In November, Gregory Wells, an industry veteran and the former head of Asia-Pacific at Greenwich, Connecticut-based private equity real estate firm Forum Partners, was hired as a so-called ‘entrepreneur-in-residence’ to develop a pan-regional real estate credit platform.

Start-up funding, right from the idea stage, has conventionally attracted accelerators, angel investors and venture capital firms; not so much the ‘buy, fix and sell’ world of private equity. However, for Warburg Pincus, one of private equity’s most prominent houses with approximately $58 billion in assets under management, this investment sourcing approach lies at the heart of a long-running entrepreneurship program through which the firm supports new ideas and experienced executives across sectors and geographies.

“You really have to be an entrepreneur as an ‘entrepreneur-in-residence.’ That is by design,” says Damon Beyer, managing director at Warburg Pincus’s investment support division, which focuses on organization, as well as talent and leadership development for portfolio companies. “They have as much skin in the game as we do and are working as hard as we are to find opportunities that work for both of us.”

The EIR program is one way Warburg Pincus invests in human capital. The idea, broadly speaking, is to develop potential leaders who can go on to operate a management company in one of Warburg’s chosen sectors or investment picks. So far, the firm has had approximately 35 EIRs across its six investing verticals: energy, healthcare, technology, financial services, industrial and, now, real estate. Around 60 percent of these have been in North America, 20 percent in Asia and 20 percent in Europe. Real estate has seen the fewest EIR opportunities, given the firm’s exposure to the sector is limited to Asia. Wells is indeed the first real estate EIR in the region, where Warburg has invested circa $4 billion in building real estate companies.

 “This is a way to bridge the divide between people like ourselves who are solely focused on the capital investing and asset management side and someone who is going to lead and grow the business”

Joseph Gagnon

“There is a big difference between someone who understands how to make an investment and someone who can run a business. This is a way to bridge the divide between people like ourselves who are solely focused on the capital investing and asset management side and someone who is going to lead and grow the business,” says Joseph Gagnon, Warburg’s managing director and head of Asia real estate.

People and ideas

At face value, the EIR program appears more like a venture capital bet by a private equity firm.  The executives running the initiative say it is more nuanced. A classic view of “valley venture” capital investing, Christopher Turner, managing director and the chief administrative officer at Warburg says, is more about making very big bets on several companies. A venture capital firm would pick a thematic sector it wants to invest in and then bet, for example, $10 million-$50 million on five companies.

“They don’t necessarily have in-house management resources that are used to vet these investments from an operating perspective. Usually these investments also come with a strong-minded founder or chief executive officer that isn’t really looking to be dislocated by a member of the VC firm,” says Turner. “Meanwhile, at the other end of the spectrum, buyout firms have well-developed advisory boards; sometimes they have operating partners that help them evaluate opportunities in a particular investment. But it is unlikely they are in line to go run it. An EIR is kind of a hybrid of these two things.”

But the element of uncertainty and risk involved in an EIR-led investment strategy is like what a VC investment might have. Turner acknowledges this means the firm needs to make sure it is pricing risk appropriately. “For example, a greenfield start-up broadband company in a frontier market would probably demand a higher return than a late-stage investment in US cable. What we try to be smart about is finding the right return for a specific investment, regardless of the EIR part of it. It is almost like capital allocation,” he says.

Take for instance Navitas Midstream Partners, an EIR-led investment. The Texas-headquartered oil and natural gas pipeline company is led by chief executive Bruce Northcutt, chief operating officer Bryan Neskora and chief commercial officer Jim Wade. Warburg Pincus led a $500 million line-of-equity commitment to the firm in May 2014, according to information on its website. Navitas made its first acquisition in September 2015 when it purchased assets from Denver-based DCP Midstream. And in October 2018, Warburg reportedly appointed investment bank Jefferies Financial to run an auction process for a $3 billion sale of Navitas. The status of the sale is not known.

What is now known as the EIR program at Warburg in fact started in substance decades earlier. In 2007, the firm invested in Laredo Petroleum, an exploration and production company focused on oil and gas resources in the mid-continent US. Laredo was the third company Warburg and CEO Randy Foutch had formed together dating as far back as 1997. Similarly, Mason Slaine, former executive chairman of Interactive Data, a financial market data provider, worked with the firm across a sequence of investments in an EIR-like capacity. One was iParadigms, an Oakland, California-based education software maker, in which Slaine had held a stake since 2006 and Warburg had been a majority equity holder since 2008. The firm was eventually sold for $752 million to the Singaporean sovereign wealth fund GIC and Insight Venture Partners in 2014. The sale price was more than six times Warburg’s initial investment in the firm, according to a Dow Jones report.

Turner says the firm eventually recognized the pattern and decided to call it an EIR program to formalize the pay, structure and title for these executives. “The ‘in-residence’ part of the EIR designation implies they are living with us,” he explains. “They are going to our group meetings, hearing what we are trying to do, making phone calls on our behalf, getting smart about our thesis on a sector. And it may end up with them taking on a management role in a company, or may become a rolling series of ideas, which they would want to invest in themselves.”

There is no one-size-fits-all definition for an EIR, however. The predominant flavor is having a serial entrepreneur like Slaine partner with Warburg to hunt for opportunities in a sector outside the firm’s current portfolio and then take on a leadership role – the energy team at Warburg typically uses this approach. Then, there are executives who help the firm source deals, but want a relatively passive role as a chairman or board member, instead of a chief executive. An EIR could also be someone who goes on to take on an advisory role in the firm’s existing series of portfolios, if any new investment opportunity cannot be found. Many investment firms globally have executives in the latter capacity as part of their advisory boards to advise on business matters, but the difference is that an EIR is in the trenches working with the deal teams every day.

Wells, for all practical purposes, is considered a Warburg employee and follows the firm’s compliance rules. The understanding is he would invest his own capital in the platform eventually and become a shareholder. Warburg, meanwhile, covers the initial expenses incurred in getting the platform off the ground, and then takes on a controlling stake.

“You really have to be an entrepreneur as an ‘entrepreneur-in-residence.’ That is by design”

Damon Beyer

“Warburg Pincus has tended to be a little more creative and at the forefront of forward thinking. There is a certain level of cost being incurred while creating a business using this approach, but the risk on that cost is that you end up with a large, scalable business that Warburg Pincus funds can invest in,” says Wells. “The firm also gets my expertise and experience in the market as part of the cost.”

Expense management

There are costs involved in incubating a company, but the firm believes these are marginal expenses and arguably much more cost-effective than other ways of sourcing deals like hiring a management consultant or a research provider to do a market study.

“Our usual investment size is typically in the hundreds of millions of dollars range, and EIRs are a reasonable expense given that investment size, and similar to the cost of other ways of exploring potential investments like hiring a management consulting firm,” says Gagnon.

The accounting of these costs varies case by case. PERE understands from people familiar with the process that if the EIR is appointed to build a company in a pre-identified sector, the initial costs will be considered part of the overall expense base of the forthcoming investment, which includes legal fees, financing fees and so on. In the minority of cases where the EIR’s mandate is exploration of a sector where Warburg may or may not invest, the expenses get charged to its balance sheet.

Out of the 35 EIRs, a third are understood to have ended up running companies. Another third became involved on the board of companies they helped introduce. The final third were those with whom Warburg could not find an investment opportunity matching its risk-return criteria.

When does Warburg know if an EIR bet is successful?

“I would say when it becomes self-funding. When it is cashflow-positive and can finance its own growth – that is mature growth to me,” says Turner. “Some other people might say it is when [the firm] starts attracting interest from other investors because it is in a different trajectory of risk.”

Out of the 35 EIRs, a third are understood to have ended up running companies. Another third became involved on the board of companies they helped introduce. The final third were those with whom Warburg could not find an investment opportunity matching its risk-return criteria.

Some years back, Warburg’s team toyed with the idea of entering the mining and minerals space. To explore the sector, the firm appointed Peter Kukielski as an executive-in-residence in January 2014. The former chief executive of ArcelorMittal Mining, Kukielski’s brief was to identify and evaluate investment opportunities in the mining industry with a view to setting up a new mining company. According to the UK Registrar of Companies, Anemka Resources was incorporated in July 2015. Peter went on to make some staff appointments, including hiring Philip Bao, who is now an investment professional at Abu Dhabi-based state investment fund Mubadala.

According to people familiar with the matter, Warburg bore the initial expenses related to an EIR, including paying office rent and so on. The firm’s underwriting group also identified a specific amount of capital that would be allocated to potential deals made by Anemka from one of the firm’s global private equity funds. Ultimately, the company failed to acquire any assets that matched Warburg’s risk-return criteria. The line of equity facility did not end up being drawn for acquisitions. Anemka Resources UK was dissolved in September 2017.

Turner still believes it was worth the effort. “[It] wasn’t a successful investment, but it was a successful exploration,” he says. “As opposed to having six banks come in and tell us about mining and what is for sale, we had someone who was aligned with us economically, whose rent we were paying.”

Brief to investors

PERE understands most of Warburg’s six active funds across sectors has invested in an EIR at some point, which effectively means Warburg’s institutional investor base has a direct stake in the outcome of an EIR hire and, ultimately, the program.

Warburg might choose to highlight an EIR-led investment along with other key transactions during an annual general meeting, or a quarterly investor advisory committee meeting. This is mostly done to keep investors informed about how the firm works with operating talent and sources investment.

When asked how the investors perceive this initiative, Turner says: “Our investors pay us to return profits to them. We are in the risk business. As you might expect, they favorably view anything we present to them that is reducing risk of the investment and assuring the profits.”

“They are much more interested in the actual investments than how many EIRs we have versus senior advisors,” he adds. “Those are interesting, general metrics to them, but what they really want to know is: if we are investing in personal wealth management, why are we doing so? They want to know why we like the space, management and return opportunities.”

In terms of capital commitments, essentially once Warburg and the EIR have identified an investible asset, the firm fills out a line of equity and calls capital from the investors – a standard approach in private equity fund investing. Although it differs case by case, it can take anywhere between three to five years between the time an EIR is first appointed and a capital call is made for an identifiable investment.

It is understood that investors are informed of expenses per normal procedures and signed off by the firm’s external auditors. But like every new deal, a detailed report is not provided until after the initial investment is closed.

The success or failure of an EIR-led investment, like other standard investments, ultimately centers on performance. But at a time when institutional investors are trimming their manager relationships and consolidating investments in the hands of a few firms, Warburg’s entrepreneurial approach to new sector forays, like in Wells’s case, can help its cause.