Private Equity Spotlight: A conversation with Thomas Weinmann of REIA Capital

In this episode of our Private Equity Spotlight series, Reed Smith partner Nik von Jacobs is joined by Thomas Weinmann, Managing Partner at REIA Capital, for an insightful conversation about his work and the intricacies of the fund of funds model.

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Intro: Hello, and welcome to Dealmaker Insights, a podcast brought to you by Reed Smith's corporate and finance lawyers from around the globe. In this podcast series, we explore the various legal and financial issues impacting your deals. Should you have any questions on any of the content, please contact our speakers.

Nik: Hello, everyone. I'm Nik Van Jacobs, private equity partner at the Munich office of Reed Smith. And today I'm welcoming to our Dealmaker Insights series, Thomas Weinmann from REIA Capital. Welcome, Thomas.

Thomas: Hi, Nik. Great to see you again or talk to you again on a podcast.

Nik: Once more, it's great to have you with us, Thomas. Tell me, who is REIA Capital?

Thomas: So we are basically a fund of fund advisors. We manage money from private individuals and small endowments, small pension funds, and ultimately we invest the money in private equity funds. And our speciality is basically we focus on small cap private equity funds, not on the big names, on the real small names, unknown names, but on the ones who have a better performance.

Nik: That's fantastic. And I know you're very active in Europe since a long time. And today, given that we're focusing on the U.S. I think it's worthwhile that you also have a reach out to the U.S. and I'm looking forward to hearing on that.

Thomas: Yes. Actually, we have been in Europe with our model for more than 10 years. I'm personally, I'm in the private equity space for more than 25 years. Now, we now move to the U.S. with a partner because we actually want to invest our own money plus the money of our investors in the U.S. to get more and better diversification into our portfolios.

Nik: Interesting. And I think you just teamed up with the U.S. likewise fund of fund. Tell me about what that is like, who it is, what's the background, and what your search was like.

Thomas: Yeah. Actually, their background is quite similar to ours. The people who are working there, they've been in private equity funds before, spent more than 10 years in PE funds, and then decided to basically start a fund-to-fund business. They initially did it through a multifamily approach, so a family office approach. So it was not that they started just as a classical fund-to-fund. And they, in a way, yeah, I think I would more call it we are a copy of them more, not knowing when we founded ourselves because they operate in the same manner, coming from PE, doing a very deep due diligence, only focus on small cap, and they only do it for their clients from the U.S. In the U.S. market. And we've done the same, but on the European side, so other side of the Atlantic. Now we join forces. They help us to get access to good U.S. funds. And yeah, let's wait and see what might even develop in the future.

Nik: That's interesting. And where do you see the comparisons and the overlaps in terms of, well, let's say the market, the investment approach, and the process of holding those portfolio companies?

Thomas: It's actually quite interesting. If you look at the small end of the spectrum, so in small cap in Europe and the US, you ultimately see that fund managers have the same approach, which sounds a little bit strange. They try to find smaller businesses. They often only buy, let's say, a small majority, and a large minority is still with the previous owners. They look into operational improvements. They do a lot of M&A or add-on acquisitions. And then they often sell the businesses to larger funds or strategic buyers. And that's something we see on both sides of the Atlantic. When you look into the return expectations, pretty similar. When you look into the real returns achieved in the past on these sort of models. Similar, where are really differences? The US market is slightly larger than the European market. I would say in the US, you have roughly 50% more fund managers. So we are more towards 18 to 19, perhaps even 100 or 2000. In Europe, we are more towards 1,200 fund managers in that size bracket. So you have to dig a little bit deeper because there's more to be digged through. And the other thing is, in Europe, often we see fund managers who are getting larger tend to become more management fee driven. In the U.S., you have that also sometimes, but the very good funds often also stay smaller on purpose. So it's much more difficult if they stay smaller to get access to them if they have a stable investor base. So you need more of an entry ticket into the funds, which is less the issue in Europe.

Nik: Interesting. And in terms of the market, in terms of the assets you see, would you say there's a huge difference?

Thomas: No. In reality, not really. It sounds strange. I think what you might have in some areas, you might have more assets in Europe than the U.S., for example, for manufacturing businesses. But that's also a regional thing. business services, you see a lot in the US. You might more regularly see financial service business models in the portfolio of private equity funds, less the case in Europe. But really, if you go to the bottom, it's pretty similar. It's a similar model and similar return expectations. So the good question is, why do you still go there? I think overall, on a long-term period, it's similar. But if you look in certain, let's say, timeframes, certain vintages, it might be that there's the U.S. A little bit more positive on the optics and then other times when European fund managers showing better returns for a short period of time. And if you want to have a good diversification, you should not leave out the one or the other.

Nik: That's interesting. And does the market, sort of the size of the local home market, play a big difference? Does it make a difference? I mean, if you look at Europe with those various jurisdictions, various regulations, etc., are there more sort of operational costs attached to that or does that level out?

Thomas: No, I think on a smaller spectrum, businesses are often very local. So in Europe, you have, of course, the borders and the languages and legal systems which are different which creates some let's say a separation of fund managers and their approaches in the US I would say often the small cap funds focus on a local area as well so they do not go all over the US to buy assets because it's just too expensive from a logistic point of view so if you're based in Chicago you regularly focus on the area in Illinois, and you just don't often go to California just to buy assets. It's just easier to do it locally, and you have sufficient number of investment possibilities also. So in this respect, I would even say it's pretty similar, but in the U.S., you have a bigger market in respect of you have not these language barriers. So you have English and Spanish, I would say. In Europe, you have many more languages. And then I think on the legal barriers, they are lower in the U.S. than in Europe.

Nik: Interesting. And tell me, do you also sort of have specific sector focuses in terms of where you invest or are you very open and let it play out?

Thomas: We operate a fund-to-fund model. And as we don't have the crystal ball in front of us, and we're investing over the next 10, 11 years when we do a commitment, we ultimately need to diversify. So, I think it would not be a wise decision just to go into healthcare only or in tech or business services. But what we do is we try to pick fund managers, and that's irrespective if you're talking about the U.S. or Europe. We try to pick fund managers with a sector specialization. Because very often that sector specialization is a USP. We try to find people who do something much better than, let's say, journalists. And that's where we see basically an upside, better returns, but it also helps us to diversify within our portfolio. So we want to have business services, we want to have healthcare, we want to have tech. And what helps us, if the fund managers have a clear-cut view on their industries they want to invest in and have a USP, how they basically, for example, source businesses, how they help the businesses to grow faster. If you have such a situation, then we can actively build a portfolio, which helps us to get a diversified investment for our investors and ourselves.

Nik: Great. Looking at such funds, in how many funds does one of your funds then basically, or together with your partner, do you invest? And what sort of might be roughly ticket size, which you invest? And finally, what assets, in terms of the bracket, what is sort of the asset class or the range of sweet part, if you like, of those funds investing into individual assets?

Thomas: There we have a slight difference. In Europe, we target to invest in 10 private equity funds out of a single product. And it ranges, the investments ranges between seven and a half to even going up to 15 million euros. And that's based on the 100 million target size we have for our fund. In the US, the target size is slightly smaller. We only want to achieve $75 million dollars for our fund there we're gonna have 20 percent of our investments in co-investments because we get the co-investments alongside our partner and therefore it's it's reasonable to do that we want to do five two to ten co-investments so basically two to four percent of the fund of each fund from our end goes into co-investments and the remaining remainder so the 80 percent goes into seven, perhaps max 10 funds there. So the diversification is a little bit smaller, but in reality, we end up somewhere between 80 and 100, 110 companies, realistically.

Nik: That's a great diversification for your investors then.

Thomas: Yes, yes. And it's not too diversified, but also not too, let's say, too small and too few companies.

Nik: Great. And maybe turning to the investors, what are your typical investors, right? I mean, what do they do? Are they institutions, individuals?

Thomas: Mm-hmm. It's predominantly, it's private individuals, but it's not retail, which is very important. So they ultimately invest with us between 200,000 euros in the European product or a quarter of a million in US product, a quarter of a million dollars. On the low end, going up to, yeah, even 10 million. So it's very broad number and brackets. And if you look at the private individuals, it's a lot of people coming from the industry, i.e. Investment bankers, M&A lawyers, people who have worked in funds or are active in a private equity fund, managers from portfolio companies of private equity funds. So people who know the industry, who want to invest in a diversified manner into their asset class. That's our core clientele with whom we started our business. We now have a lot of managers from big companies, big corporates. We also have entrepreneurs who want to invest their private money either directly or through their family offices or through multifamily offices. And we also have the one or the other endowment, even church money is investing with us. So they are also coming in, but these institutional investors are actually more the smaller institutional investors. For us, they are the larger ones. So they invest between a million and 10 million. So a lot of people and smaller institutions.

Nik: That's interesting. And does it also say roughly how many investors such a fund up here might have? I mean, having in mind, obviously, that the investment amount is different.

Thomas: Yeah. Yeah, I think for the European fund, it's very likely that we're going to end up with 250 to 300 investors. For the U.S. Fund, it should be at least 200. So we're talking about a well-diversified investor base, which is also helpful for them and for us, because it means we're not too much dependent on a single investor. And that's also very helpful for our funds in which we want to invest because we are a stable investor. We're not coming like tourists coming in and out, but we have a lot of people who are backing us and therefore it's much more stable and more predictable.

Nik: That's great. Thomas, maybe one thing we started easily by mentioning you're doing, basically, obviously investing into small cap. What's the rationale? Explain the rational small cap versus, well, large cap to take the other end of the pole. So maybe you want to give some differentiation and some explanation of the different mechanics and economics.

Thomas: Yeah. Perhaps I need to add something I didn't say at the very beginning. Before I started our fund-to-fund approach, I was actually working in large cap. So I've been in that part of the business spectrum for more than 10 years. So I've done public to private. I've done high yield bond issues. I've done IPOs I wouldn't say I've seen it all but most of it and on purpose I decided to move out of large cap into small cap because I see higher higher returns in the small cap space and that has a couple of reasons it's not a single reason so it basically already starts when the businesses are quiet very often the purchase price multiples are much much lower for a couple of reasons. So the vendor wants to stay in with some shares. He wants to have a partner for the next five years before he or she sells all the shares in the business. And therefore, the purchase price is not everything. It's very important, but it's not the main driver. And that's irrespective if you're talking about the US or Europe. And then the other thing is the smaller businesses, of course, they have higher inheritance and risk. So if you have a higher risk, let's say an investor pays a low price, has a higher return expectation. And that also shows up in the price you normally pay. And when you buy these businesses, the good thing is you can develop them. So if you have a global company with, let's say, 10,000 people. Ultimately, you cannot improve that much any longer because it might be already very good. So what we have is a lot of optimization in these small companies where they benefit from. We have a lot of add-on acquisitions where they benefit from. And there we have something we call the base effect. So when you acquire a small business and you buy another one or two at the same size, you double or triple the size of the businesses. Whereas when you buy a very large business and you even when you acquire a higher number of companies, if you have the market leader and you only acquire very small ones, you might have a small additional growth from the add-ons. So that base effect helps a lot. And then when you sell the businesses, you have two big advantages. First of all, you're not dependent too much on the capital markets because often the businesses are still too small so a buyer can digest them. Or you're not dependent to IPO the businesses because if you sell a business for a quarter of a billion euros or dollars, it's too small to put it on the stock exchange. So, for example, in today's markets, it would be difficult to IPO a company. Therefore, an exit doesn't happen. And the last point on the exit side is other than when you acquire often businesses in, let's say, as the only sole potential buyer, when you sell the businesses, you use an auction. And through auctions, you can actually increase prices dramatically. And that basically also helps the house when you want to earn more money.

Nik: That's great. You have a lot to exit market there. That's fascinating. Thomas, we started with the U.S., went to asset class as such, small cap. And now also for the benefit of the U.S. Audience, I'd like to turn to Europe because obviously that's something people might be interested in if they know the U.S. market. So maybe let's focus a bit on Europe. And maybe you want to give a bit of an outside explanation of what the landscape looks like with the various regions, how they are perceived in terms of economic strength. Maybe also sector-wise and what your approach in Europe is?

Thomas: Yeah. Actually, our approach from the investment side is a little bit driven by our investors. We have a lot of, basically, almost only German investors, and that means that we under-allocate money into Germany because our investors are already invested there. I wouldn't say we would not allocate money because we don't like Germany. I think if I would come from the U.S. As an investor, I would have a higher allocation to the German market than what we do. On our end, it's only driven by our investor base. I think in general what you see, if you look, I wouldn't go into, let's say, economic cycles with the next answer. I would more look where do you see better performing funds. And what we see is above average returns we see in the in the UK basically see it in the nordics and we say see very good returns in the bandlocks so on average in these three regions we tend to invest a little bit more than in the others in france we see very stable businesses. So a smaller dispersion. For us as a fund-of-fund manager, it also means we don't see that much alpha. And therefore, we are actually more reluctant to invest too much in France because we are alpha hunters. In Italy and Spain, we see a couple of funds who generate huge alpha returns. And there you actually need to know them, you need to find them, you need to get access to them. You might even have a language barrier. And in Germany, I would say it's a good mix. You have a sufficient number of very good funds. So if you're coming from outside, that's actually also an area where you want to invest. That's one thing. So you have a little bit of a regional mixture. The other thing is, if you look into the various markets, you have different industries. So just to take Germany and Italy, you often also have funds who invest in manufacturing companies because the businesses are there. So you have a higher share in these two countries, whereas when you go to Banalux, to the UK, to the Nordics, you often have a higher share of business services, tech companies, and also, let's say, consumer-driven concepts. So you have a little bit of a different industry mix. And if you want to invest in basically in healthcare, it's all over Europe. So there's no speciality on a local level. So you still have a little bit also of an industry flavor.

Nik: Right. And does that mean that overall you sort of mix geographies within Europe into every fund? or does it sometimes sort of more concentrate on the northern part?

Thomas: No, given we only bundle funds from a year and a half vintage, so 18 months roughly, we want to see everything. So we want to have a country mix, we want to have an industry mix, and we bring basically every 18 months a new product and bundle 18 months. So our investors who invest regularly do it in each and every product And through that, they get basically a portfolio of roughly 30 funds in, let's say, in a full-blown investment cycle of four to five vintages. But we also want to have a product which is digestible for our small investors. So they might only invest once in our fund-to-fund, then skip two programs and go after the first investment just in the fourth fund-to-fund again. And by doing so, they also need to have a good diversification on their fewer number of fund-to-fund products. Therefore, it's always a mix on purpose. And what we try to do is to find the best funds in Europe. In these 18 months, but in a mixed way and in a blended way.

Nik: And talking about Europe, do you also look at Central Eastern Europe? Has that developed to a level where you say that's interesting? Or is it investors generally still shying away from the border?

Thomas: Yeah, actually, we look into Poland, into Hungary. We look into Czech and Slovak Republic, Slovenia. So these are mainly the countries we're looking into. The number of funds is very small. The returns have not always been very great. We have seen funds which showed great returns, but where we have question marks on future returns. So we're looking into it, but realistically we would say there might be one GP coming into our program every, I wouldn't say every time, but every second time because the number is just very small. And we are very selective. In reality, we only want to invest in 2% to 3% of the markets.

Nik: And to give a bit of a feeling, how many, when you do sort of, you set up a fund, you look at your investments, how many funds do you screen in order to come down to those 10 to 15 funds, as you mentioned?

Thomas: Yeah. So over a year and a half, we can screen in the market technically, no, let's call it theoretically, we can screen 400 to 500 funds. That's, in theory, the market size. Realistically, half of them are not good. And we apply a rating to funds. So basically already half of the funds which we have in our whole database are rated at a level where we say, let's talk to them every two years. And there might be a surprise and there might be better than expected. The other half we actually look at. So we screen them on a constant basis. We go to all the big private equity fairs. We talk to them directly, call out to them, talk to the placement agent. So in reality, over a year and a half, we have at least 100, if not even 150 internal papers on funds where we have an initial screening. And then ultimately, we visit 15 to 20 fund managers in a final stage of due diligence to ultimately invest in 10. So it's a lot of funneling, let's call it this way.

Nik: Yeah, interesting. And I believe that at the end of the day, when it comes to due diligence, that's probably as natural, sort of the key of your investment activity, obviously. But I understand, despite your size, if you compare yourself with other investors into private equity funds, my feeling is you're very well esteemed given the quality of your developments also. And some lighthearted diligence in front of management teams.

Thomas: Yeah, actually, that's very true. So what we basically have, we initially only do quantitative analysis. So we look, for example, at value creation of the fund managers on a deal-by-deal level. So if you have a lot of numbers, numbers tell you a lot of things. You can ask the right questions. But where we also need to connect the numbers is with the team. Are the right people still there? Are the right people at the fund management team on a GP level highly incentivized? And is a team basically a team which wants to stay and move forward? And that's not always the case. So even if you have a huge GP commitment, it might even be that there's a disincentive coming out of that huge GP commitment and people get too cautious. They don't want to sell at the right time and they might hold on to assets too long. And to do this sort of analysis, you also need to have a lot of judgment and you need to apply... Basically your knowledge from history. And the good thing is we as a team, we have been working, and not just me, but also colleagues have worked in private equity in the funds. They have seen the development of fund managers over time. They've seen when there was a generation change in a fund management team. And they've also seen that some people might be motivated, let's say at one time, and that might change over time. And I think there we're coming in a part of our due diligence, which is not numbers-driven. It's really qualitative due diligence. And I think there it's very helpful. And that's one of our USP that we have worked ourselves in product equity funds.

Nik: That's helpful. That's helpful. Thomas, I could go on for a long time. I mean, just to come to the end. And finally, sort of linking your insights, your experience with the actual market in the U.S. And if opposed to or similar, Europe. In five sentences, what are your thoughts and is your perspective basically on the current market and the nearby developments in the U.S. And in Europe as regards the small cap space and private equity active in that space?

Thomas: We are currently going through a very volatile market and that is the best time for PE funds to earn money. It has always been because high volatility means that people who are forced to sell, sell at a low price. The other thing which is important, one of the main reasons why we invest in small cap is that we don't want to have a high dependency on capital markets. We're not dependent on an exit through an IPO, for example, or to get a high bond financing done. And in times like today, high volatility, higher uncertainty, it also means you can much easier buy assets. And sell assets because you're not too dependent and then the last thing is what people should not not leave out in there basically in the investment assumptions and return expectations the world has changed over the last couple of years so until beginning to mid 2022 we were in a low risk and also low interest environment that's not the case in the longer but that also means that return expectations have to go up. So nowadays, a couple of years after this change, we, in our assumptions, want to see 5% higher IRs from the fund managers because we have high interest rates and we have high risks. That's something you also should remember.

Nik: That's fantastic. I think that's a great outlook, higher IRs, right? Thomas, we had a great tour de raison Through your activities in the U.S., the basics and philosophy of your investment, and also looking closely at Europe. Thank you so much for those insights. Thanks a lot for listening to DealMaker Insights. And I would invite everybody to join our next series. Many thanks.

Thomas: Thank you.

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