Alignment Focus

From over twenty years of investing, we have time and investment tested our FIVE principles of alignment. We set ourselves apart in this regard from the majority views in private equity, and our returns have consistently far exceeded the market due in part to this discipline. Our FIVE tenets since founding are the following:

Incyte believes that the best way to entirely align ourselves with our partners and management is to invest our own capital in size, typically exceeding ten percent of all capital invested. Unless all parties to the investment are equally at risk of capital loss, human nature being what it is, inherent conflict is likely to arise. It is therefore the case that we are not compelled by common practices of alignment in private equity today, such as management fee and carry contributions by GP’s, and the potential loss of reputation and opportunity alone by a GP.

After three decades of finance and corporate restructuring experience with leading Wall Street firms in New York and San Francisco, our founder ultimately concluded that simplicity is the ideal structure. Consequently, we seek, whenever possible, to invest in the same security that management and our partners hold, which is typically Common Stock. Complex Preferred Stock preferences, cram-down equity structures, clawbacks and Convertible Debt instruments with complex strike price formulas, to say nothing of unilateral guarantees, springing liens, and mandatory repayments, etc., can confuse and alienate management and minority investors and lead to awkward and unforeseen outcomes and distorted decision-making, particularly in downside scenarios. These complex structures serve to undermine optimal investment returns and management confidence in our view by pitting the parties in a constant struggle of downside risk and upside reward superiority.

Incyte maintains an absolute commitment to transparency, aided by all our tenets of alignment. Investments are typically made using a single purpose C corp or an LLC, not through a Fund, so that all financial results are at only one level for all investors, and all costs are actual and specific to only the investment, without the need for allocation and other judgments and adjustments. This commitment to transparency reinforces and interacts with our four other alignment tenets to maximize investment results. For example, since we favor Common Stock, the value of an investment for management and all investors is simply the percentage of the Common Stock they hold, without the need for lawyers to interpret Preferred Stock preferences, Convertible Debt conversion rates, Contingent Rights, etc. This kind of clarity for all parties when weighing the risk and reward of various outcomes and strategies provides distinct advantages.

We are surprised to find the number of private equity firms today that invest in a company without requiring or expecting the management team to do the same and share the capital risk. When management makes a commitment of their own money, in addition to their experience, leadership and reputation, the need for real alignment becomes clear because a quality management team rightly requires and expects alignment that is authentic, time tested and can be relied upon.

Incyte finds it odd that a five-year time horizon for private equity investing remains the most common return period. The implicit assumption is that this time horizon somehow perfectly and precisely ties to the optimal time horizon to realize an investment. It is odd because, in practice, it does not. Past activity in PE to PE transactions as well as more recent examples of Continuation Funds that allow GP’s to extend their portfolio holdings far beyond a fund’s initial investment period bear this out. We believe that the most appropriate time expectation to realize a return is the timing specifically dictated by the investment and company at hand. Factors including industry consolidation, economic and capital markets conditions, business model and cash flow dynamics, and even changes in a CEO’s personal circumstances, all play a role in determining, with management, the right time to exit an investment. When these various factors and others are considered, the notion that the optimal time period to exit (it could be shorter or much longer) can be known and set at the time of an investment is nonsensical in our view and often leads to inferior returns.