Over the past eight years Tern has transitioned from acquiring over 100% of a company (e.g., Cryptosoft) to a model that has the risk characteristics of a Private Equity Fund and the aggressive returns model of a Venture Capital Fund. Our model is a hybrid of how VC and PE funds operate overlaid by the fact that we are a public company.
How does the Tern model compare to VC and PE models?
As with the Tern model, both VC and PE models vigorously protect the performance data of their specific investments and report in the aggregate, key metrics to their limited partners. But unlike Tern, they do so without the required transparency that comes from being a quoted company. For example, PE and VC investment funds generally charge their LPs 2% to 2.5% of the committed capital of the fund annually for management fees, plus allocate deal closing fees per deal as part of their capital calls to the limited partners in the fund, generally without specific individual data.
The costs of Tern plc are published for all to see as part of our required filings. This is in addition to the underlying investment value of our portfolio companies, again, for all to see, including our competitors. That means competitors with whom we compete with to source deals and who do not have the same disclosure requirements can view our metrics. These competitors have large funds and are therefore well positioned to participate in fundraises of our portfolio companies. Without an ability to match their funds our negotiating position is materially impacted.
Conventional wisdom quotes that the earlier the stage targeted, the higher the risks and potential rewards. Unlike buyout funds, it is considered acceptable for the average venture capital fund to have numerous investment failures. Therefore, Tern has limited its portfolio to companies we believe we can make successful with our expertise, operating skills, and network of supporters.
VC firms often invest in syndicates alongside each other to spread risk and share opportunities and expertise. Hence, we at Tern spend a considerable amount of time marketing our portfolio and its performance to other firms that are of like mind, here in the UK and in the US. Firms that we trust and look to work with, to help fund the growth of our portfolio, given our limited headroom and access to follow on capital.
Our structure and how we work
As a group, we are small in structure with only five individuals, running the operations. In addition to supporting our companies via our board positions and marketing/partnering efforts, we also continuously create the market and investment models required to measure risk and predict future performance, that is done by the associates of the firms we partner with.
The skills needed are highly specialised and require a certain chemistry from the group. Chemistry that can be thought of as a set of competencies, not all of which are necessarily possessed by single individuals, but the key skills that Tern must possess include:
- Deal sourcing –. WE HAVE DONE THIS, “unearthing opportunities overlooked by others” (The Tern tag line).
- Research and due diligence – PE and VC firms often pay external consultants to do some or all this work, which Tern does not.
- Deal execution/financial engineering – This is a bit of jargon that refers to the dealmakers’ ability to masterfully structure an investment to his or her best advantage. A good financial engineer will be able to rework a company’s balance sheet and creatively apply capital-market products, preferred shares with exit advantages or convertible loans, such that the equity provider is positioned to gain as much as possible from the deal. These skills are most important when a portfolio company is being acquired or is itself acquiring a company (as was the case with Cryptosoft acquiring Device Authority Inc.); is being sold through an M&A transaction or in an initial public offering, (as was the case with Wyld Networks). We believe Tern has demonstrated these skills in all our portfolio companies in their syndicated transactions.
- Operating skills – Once we have made an investment in a company, we are tasked with adding value to the company. Many firms include operating partners – executives who have experience running a company in a particular sector or discipline, as does Tern. These operating partners may simply be there to support the incumbent management of the portfolio company, or they may help restructure the company, starting with the strengthening of the incumbent management team. A team with purely investment banking-style financial engineering skills may not have the wherewithal to effectively change the operations of a portfolio company. Likewise, someone who, for example, was a senior executive at a software company for many years, may not have the financial engineering skills needed to structure the best investment result. Hence at Tern, we have a blend of skills that we use to help our portfolio companies achieve results to ultimately benefit our shareholders.
- Salesmanship – We must gain the confidence of many parties. We must convince the management of potential portfolio companies that we will make a valuable investment partner. We must convince potential buyers on the public markets or in the M&A market that their portfolio companies are worthy of lofty valuations.
Typically, with PE and VC firms the founding partners are in charge and take the lion’s share of the selling activities and the economics. Unlike most PE and VC firms, Tern does not have other partners, who are salaried and are almost always entitled to a piece of the lucrative 20 percent profit share of the limited partnership called carried interest. The team typically includes vice presidents, associates and analysts; whilst Tern manages this all within the small team.
The addition of these back-office professionals is part of the institutionalisation of the private equity industry as it moves away from its hungry boutique roots. Tern has avoided this and remains very lean.
Access to funds and transparency
Tern, unlike VC and PE firms does not require investors capital to be tied up for years without any ability to access it. Tern’s investors can participate in a funding, elect not to without consequence and make trades in their shareholding to make interim returns and investment balancing on every weekday.
The long-term and illiquid nature of PE and VC funds makes it difficult to measure their performance while they are active. And because these partnerships are usually strictly private, it is difficult if not impossible for outsiders to access meaningful information on individual funds. Again, unlike Tern, which is traded every day and has public reporting provided from a regulatory perspective as well as via our Capital Market Days, Portfolio Updates, and other updates via the RNS system.
Private equity limited partnerships are sometimes called blind-pool investment vehicles because the limited partners cannot “see” in advance what deals are going to be done. Tern shareholders, our LPs, see all our material transactions via the regulatory rules and process.
All may not agree with what we do or how we do what we do, or the timescales and capital involved in building great companies, but via our hybrid model investors get to vote with their feet and with their wallet, anytime during the journey.
Our hybrid model
This is what we believe constitutes our unique investing, hybrid model:
- Our shareholders can participate in creating leadership companies in the IoT space
- Shareholders don’t have to contractually make long term funding commitments to gain access to otherwise generally unavailable opportunities
- Funds are efficiently and cost effectively managed by a group with the necessary expertise.
Our commitment continues…
I hope this article provides you with a better insight and clarity to our vision, operating model, and strategy. We are committed to creating valuable companies within Tern’s portfolio which requires diligence, experience, and expertise that the Tern team has. This is a full-time, exciting job for me and the small Tern team that we work hard at every day of the week.