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Abrupt changes atop two Vista funds spur LP reflection on key-person protections

On balance, the LPs expressed frustration with aspects of the turnover but that was mitigated for some by Vista’s record of consistent strong returns.

Leadership shuffles earlier this year at Vista Equity’s mid-market Endeavor and Foundation programs, coming as they did soon after recent fundraising, spurred concern among some LPs who have been forced to come to grips with a situation they had largely given up control over.

Key personnel provisions generally allow LPs to consider ending a fund’s ability to make new investments after changes like those at Endeavor and Foundation, but those protections on the two funds were not triggered by the departures.

Vista announced in March that Alan Cline, co-head of the small-cap Endeavor funds, and Rob Rogers, co-head of the mid-market-focused Foundation funds, were stepping out of leadership roles to be advisers. Cline has been with Vista for around 18 years through two different stints, while Rogers has been with the firm since 2002.

Both Endeavor and Foundation recently closed funds: Vista closed Endeavor II on $850 million in 2019 (a Vista statement last year said the fund raised more than $1 billion in capital commitments), while Foundation closed its fourth pool on around $4.5 billion in November.

Team stability is so vital to LPs that funds come with built-in protections against significant leadership changes. Generally, such provisions are triggered once a threshold is crossed of key executives stepping out of their roles, at which point LPs usually have the choice of pausing a fund’s ability to make new investments. LPs use this as leverage to approve any new leadership slate the firm is proposing, before reactivating the fund. In rare cases, LPs could decide to simply end a fund, redeeming any uncalled commitments and winding down the portfolio.

Key-person provisions on Foundation and Endeavor were not triggered by the departures, however. Sources described the key-person provisions in both cases as hard to trigger, a problem that many LPs see as endemic across the industry.

Indeed, Vista’s key-person structure on the mid-market funds is two-tiered: the first tier would trip if both CEO Robert Smith and his former No. 2 Brian Sheth departed; and the second tier, made up of a group of five on Endeavor and six on Foundation, would need a majority of the members of each fund to depart.

An aspect of the key-person provisions that some LPs considered off-market: In the case of a key person provision getting triggered on the funds, LPs would get notified of the event and then would have to affirmatively vote to halt new investments. Other firms have protections that, when tripped, automatically cause a halt in the fund’s ability to make new investments until reactivated by LP approval.

To be sure, reaction to the changes was not uniform among half a dozen limited partners who spoke to Buyouts on condition of anonymity. On balance, the LPs expressed frustration with aspects of the turnover but that was mitigated for some by Vista’s record of consistent strong returns.

“Any time someone goes early in the life of a fund, that stinks, it stinks a lot less here, because it’s a bit of a platform bet,” said one of the LPs, who works for a fund-of-funds that backs Vista funds.

For LPs who spoke to Buyouts, concern was more focused on Endeavor, a newer strategy at Vista that has not quite lived up to the performance of other Vista products.

Endeavor closed its first fund in 2017. In contrast, Foundation raised its first fund in 2010 and has produced a strong track record of performance.

Add to this that Endeavor already went through a leadership shift even before the changes announced in March. Cline took over for James Zubok as co-lead on the Endeavor funds in 2019, before which he co-headed the firm’s Foundation strategy. Zubok, an operating partner who had co-led the fledgling Endeavor strategy since inception, left Vista in December.

Until now, that shift had been viewed as a positive. Three of the LPs said they backed the second Endeavor fund in part because of Cline, who they got to know and trust through his work on the Foundation funds. For them, Cline leaving just two years after the fund close came as a shock.

What happened

LPs in the Vista funds agreed to the key-person provisions when they committed to the funds, so they were aware of the risks, an insurance company LP told Buyouts. “The LPs, if they didn’t get the change (to strengthen the key-person provisions on the fund), if it wasn’t big enough to not invest in the fund, it’s their problem, they took that risk,” the insurance company LP said.

The situation now is that LPs will want to know exactly why the two executives stepped out of leadership. They probably won’t be able to get the full story behind the changes as the executives likely signed non-disparagement agreements that prevent them from disclosing that information, the insurance company LP said.

“If I was a mad LP, that’s what I’d be asking,” the insurance company LP said.

For GPs, deep key-person triggers can help the firm avoid handing over too much power to next-generation leaders. These executives could theoretically hold the threat of a key-person event – and ensuing investment pause – over the firm’s head to negotiate for better economics as they move in to replace departing talent.

The departures on the two funds came as Vista worked to move past CEO Robert Smith’s tax evasion case. Smith last year agreed with the US government that he should have paid taxes on a portion of carried interest he collected on his first fund. Smith will pay $139 million in fines and penalties, forego claims for a $182 million refund for charitable contributions in 2018 and 2019, and cooperate with the government on its tax fraud case against technology entrepreneur Bob Brockman, who seeded Smith’s first fund.

The announcement that Cline and Rogers were stepping back gave rise to fears of the firm leaking talent in the wake of Smith’s settlement with the government, two of the LPs said. Late last year, Sheth left the firm in what he described as a long-term transition out.

“If one of them had decided to leave, I could get comfortable with that … the fact that both [Cline] and Rob decided to become senior advisers, that’s a little surprising,” one of the LPs, who works for a family office, said.

An LP consultant said: “The turnover is the biggest issue facing Vista – they avoided key man, but if deal flow is impacted and turnover ramps up, it could be an issue.”

A person close to Vista said Cline and Rogers did not make their decisions in concert and they were not related to Smith’s tax situation.

“Alan was interested in pursuing a broader role within Vista, and worked collaboratively with firm leadership to identify the right role. Ultimately, it was determined that Alan’s experience largely in smaller, early stage companies was not the right fit for a broader role within the firm given that the vast majority of Vista’s deals are at the flagship level in terms of size,” the person said.

“For each, the decision had everything to do with their own personal goals,” the person said. “Combining the announcement [of the leadership transition] was a factor of timing and the decision to tell LPs well ahead of Alan and Rob moving on to other ventures. Both Alan and Rob, separately, have been explicit in their conversations with investors that the decision of each to move on has not had anything to do with either the resolution of Robert’s personal matter from last year or Brian Sheth’s departure last year.”

Stability

LPs crave stability of teams in the funds they back because they are locking up their money with a specific manager for 10 years or more. Constant team turnover, especially in the leadership ranks, can leave LPs wondering who exactly is managing their money and whether the new leadership’s skills match those of the executives they originally backed.

In 2019, 12-year Vista veteran Marc Teillon was chosen to replace Cline to run the Foundation funds alongside Rogers.

With Cline stepping back on Endeavor, Vista promoted Rachel Arnold, who has been an operating partner since 2012, before which she served in executive roles at Vista portfolio companies. She co-leads Endeavor with Rene Yang Stewart, who joined Vista in 2007 and has been Endeavor’s co-head since inception.

Stepping into Rogers’ old role at Foundation is Patrick Severson, who joined the firm in 2013.

The LPs lauded Arnold’s and Severson’s performance and leadership, though two expressed concern at Arnold’s lack of investment experience compared to Cline. Arnold has spent years as an operational partner, working inside portfolio companies to drive changes and execute Vista’s investment plans. She was less of a presence on the deal side of the business, two of the LPs said.

“[Arnold] is awesome … when we referenced her with founders before these fund raises, [they’re like] she’s just great, super, super skilled, amazing EQ, seemingly works 20 hours a day, just like everything you could hope for,” the fund-of-funds LP said.

Endeavor’s challenges

Vista launched Endeavor to make sure it could reach into the lower mid-market as its other funds – namely the Foundation funds – grew too large. Other tech-focused firms like Thoma Bravo launched small-cap focused funds as well.

“Most companies in our sweet spot are facing the difficult but fortunate decision of choosing between late-stage venture capital, growth equity and private equity. Each comes with its pros and cons,” Yang Stewart, who helped launch Endeavor, told Buyouts in 2018.

“Frankly, one of the biggest challenges we need to overcome is that many companies at this early stage aren’t familiar with private equity as an asset class,” she said. “So we’re putting a lot of effort into general outreach and education on the benefits of a private equity investor.”

A point of concern for several of the LPs was Endeavor’s performance, especially in relation to other Vista products. Endeavor I, which closed on $560 million in 2017, was producing a 6 percent net IRR as of Dec. 31, 2020, several of the sources said.

The fund has had at least one realization, which isn’t surprising given that it is just four years old. Vista sold down part of its stake in SecureLink to Cove Hill Partners last year. The firm reaped a 3x cash-on-cash return on the sale, according to a person with knowledge of the firm.

“The performance of Endeavor I doesn’t look like it will hold up to Foundation I,” one of the LPs said. To be fair, not many funds would match Foundation I’s performance. The debut Foundation pool, which closed on $400 million in 2010, generated a 36.6 percent net IRR and a 3.5x multiple as of Sept. 30, 2020, according to performance information from California Public Employees’ Retirement System.

Companies in Endeavor’s portfolio include Complysci, which provides regulatory software for financial and professional services businesses; Dispatch, which provides technology for home services and logistics businesses; and business software developer Kazoo, all of which were backed in 2018. The following year it invested in Fusion Risk Management. (Kazoo laid off 33 percent of its workforce last year amid the health crisis.)

Two LPs speculated that Endeavor’s performance hasn’t been as strong as they expected because some of its early deals were too small, explaining why they believe performance has lagged.

“They were smaller than would have been ideal [which] they corrected in the [latter] third of Fund I and now with Fund II,” according to one of the LPs. “What some of these groups have found over time is it’s just harder to layer on the expense that you need to really upgrade a team to drive change, when you’re talking about $5 million or $10 million [annual recurring revenue], there’s just not enough there there.”

Endeavor Fund II, still early in its J-curve period, was generating a negative 10.12 percent IRR since inception as of Sept. 30, 2020, according to performance information from California State Teachers’ Retirement System.

Strong performance

Vista has not heard any complaints about promoting Arnold into the co-lead role on Endeavor, the person familiar with Vista said.

Every LP who talked to Buyouts lauded Arnold’s track record as an operational player on Vista’s team. “They’re super strong … with lots of Vista years behind them,” an LP previously told Buyouts about Endeavor’s new leadership.

“Rachel is an extraordinarily skilled operator with over 18 years of experience at Vista and a track record of performance that would be the envy of anyone in the field of private equity. She was one of the early operating partners in the Foundation Fund, and was tapped as the first and sole operating partner to launch Endeavor,” the person said.

“During her career, she has served in multiple roles with her portfolio companies, even stepping into the role of CEO when needed. The approximately 25 companies she has worked with through realization have returned, on a gross basis, over 4.2x MOIC and 55 percent IRR. Rachel is incredibly qualified to take on this leadership role,” the person said.

Still, three of the LPs said they were concerned about Arnold’s lack of investing experience, especially compared with Cline.

“Clearly she had a seat at the table, and she’s been around for a while, but she doesn’t have the deal experience that Alan has,” said one of the LPs. “She was a little more inwardly focused. That’s not meant in a negative way; that’s just where she was focused.”

The concern being expressed shows how important team stability is to LPs who lock their money away with a GP for a decade or more. They expect the team they backed to be there for the long haul, and when a new person comes in to take the lead, they will be under the microscope until they earn LPs’ trust.

Ultimately, for some LPs, their comfort with the leadership changes, and their future relationship with Vista is built on confidence in the system, rather than on any particular individual.

“From our perspective, you’re not investing in Endeavor, you’re investing in Vista and their platform,” said the fund-of-funds LP.