Private Equity Fundraising

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THE GUIDE TO PRIVATE EQUITY FUNDRAISING

EDITOR: MVISION PRIVATE EQUITY ADVISERS LIMITED

THE GUIDE TO PRIVATE EQUITY FUNDRAISING

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Contents

7

Introduction Allan Cooper and Mounir Guen, MVision Private Equity Advisers

41 Selecting and working with a placement agent Allan Cooper, MVision Private Equity Advisers Limited

Limited

•

11 Investors in private equity: an overview John Barber, Managing Director, Helix Associates

• • •

Investors in private equity - an abbreviated history Investor profiles Final thoughts

• • • • •

GP objectives: what are the reasons for using a placement agent? How to select the right placement agent The cost The role of the placement agent before, during and after the fundraising Different types of placement agent So, who selects whom?

21 Selection of a lawyer Josyane Gold, Partner, SJ Berwin

45 Ten things to expect from a placement agent Christoffer Davidsson, Principal, Campbell Lutyens & Co. Ltd

• • • • • • •

Why do you need a lawyer? Which law firm? Selecting a law firm Due diligence on the lawyer and by the lawyer Objectives and terms when mandating a lawyer Raising the fund Conclusion

27 Private equity fund structuring Jason Glover, Nigel Hatfield and Matthew Judd, Private Funds Group, Clifford Chance LLP

• • • • •

Introduction Basic structuring considerations Types of vehicle Specific investor issues Conclusion

• • •

Overview Deliverables Summary

51 Notes to a placement agreement Private Equity International

• • • • • • •

Introduction Key sections Compensation Confidentiality Conflict of interest Other items Annexes

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The offering memorandum

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Bridget Barker, Partner and Stephen Sims, Senior Solicitor,

Preparation of the Limited Partnership Agreement Jonathan Blake and Jeanette Thompson, SJ Berwin

Macfarlanes

• • • • •

67

Presenting the proposition: planning and executing the fundraising

73

• • •

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Importance of the Limited Partnership Agreement Key clauses in a Limited Partnership Agreement Negotiating issues for the Limited Partnership Agreement Jurisdictional issues Tax issues Information table

When things go wrong

Robert E. Mast, Managing Director, Monument Group

Private Equity International

• •

• • • •

• • •

4

• • •

Introduction Content of the offering memorandum Terms of the offering Verification Regulatory overview

Planning and preparation pay off Executing on the plan - practicalities of the fundraising process Approaching the closing After the closing Final thoughts

Due diligence on the fund Jens Bisgaard-Frantzen, Managing Partner and Vibeke Wounlund,

Market factors People factors Information factors Campaign factors

107 SURVEYS 108 LP attitudes to fund terms and conditions Private Equity International

ATP Private Equity Partners

• • • • • • • • • • • • • •

About ATP Private Equity Partners Investment strategy and fund types ATP PEP’s due diligence strategy and process Five focus areas Investment process Key focus areas: track record, team, strategy, process and terms and conditions Track record From concrete track records to qualitative assessments Strategy, process and philosophy Team Consistency Reference checks Terms and conditions Due diligence and the manager

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• • • • • • • •

Introduction Overview Relative importance of different terms General partner commitment levels Management fees Transaction fee and other income Carried interest provisions Keyman

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122 LP attitudes to investor relations and reporting

151 DIRECTORY

Private Equity International

• • • • • • • • •

Introduction Levels of contact Channels of communication Benefits of contact Importance of contact The annual limited partner meeting Other contact Reporting The dedicated investor relations officer

135 CASE STUDIES

• • •

Private equity software providers Other technology providers Fund administrators and outsourcers

165 CONTRIBUTOR BIOGRAPHIES 171 APPENDICES 172 Appendix One: Private Equity International on fund administration and technology

186 Appendix Two: Private Equity International on fundraising

136 “The new concept fund”: Accession Mezzanine Capital LP Christiian Marriott, Director, Investor Relations, Mezzanine

204 Appendix Three: Private Equity Manager on fundraising

Management UK Limited

217 Appendix Four: 138 “The first time fund raise”: Altor 2003 Fund

PrivateEquityOnline.com on fundraising

John Barber, Managing Director, Helix Associates

224 Appendix Five: 140 “The debut US mid-market fund”: Arsenal

About Private Equity International

Capital Partners LP Terry Mullen, Co-founder and Managing Director, Arsenal Capital Partners

225 Appendix Six: About Private Equity International Books

142 “Fundraising for the semi-captive”: The HSBC Private Equity European LP Vince O’Brien, Director, Montagu Private Equity Limited

145 “The mezzanine fund”: Indigo Capital IV LP Christopher Howe, Director, Indigo Capital Limited, London

148 “The biotechnology fund”: HealthCap IV Anki Forsberg, Partner, HealthCap

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Chart Two: Strategic Allocation to Private Equity by Type of Organization (North America) Organization (North America) 16% 13.8%

14%

% of Total Assets

12%

14.4% 14.2%

12.8% 10.9%

10% 8%

6.7%

7.3%

7.1%

7.7%

6.3%

5.6%

6% 4.3%

6.1%

5.9%

4.9%

4% 2% 0% Endowment/Foundation

Corporate

1995

1996*

1999

Public

2001

2003

* Arithmetic average of 1996 strategic allocations of 1999 survey respondents Source: Goldman Sachs International / Russell Investment Group "Report on Alternative Investing by Tax-Exempt Organizations 2003"

Chart Three: Strategic Allocation to Private Equity by Region 6% 4.8%

% of Total Fund Assets

5%

4.5% 4.2%

4.0%

4%

3.6% 3.7%

4.2%

3.6% 3.4%

2.8%

3%

2.5% 2.2%

2%

1.9%

1% 0%

N/A N/A

1996*

1999 All

2001 UK

essarily lead to top-notch results. Given the importance of careful manager selection, a private equity fund portfolio needed to be properly run, either by dedicated in-house professionals, or with the advice of external consultants or asset managers, all with sufficient experience to ask the right questions about nontraditional offerings.

2003

Continental Europe

* Arithmetic average of 1996 strategic allocations of 1999 survey respondents Source: Goldman Sachs International / Russell Investment Group "Report on Alternative Investing by Tax-Exempt Organizations 2003"

2005 (forecast)

In practical terms, many institutions in the mid-to-late 1990s decided they could therefore afford to increase private equity exposure to levels not thought possible before – ranging up to 25% of assets in some endowments’ case, but settling on a typical aspiration of 5% of assets for a mainstream institution with a conventional asset-liability profile. At the same time, institutional investment staffs began as a matter of routine to include full-time private equity fund selection specialists. Established fund of funds managers also benefited handsomely through growth in their assets under management, as institutions concluded that private equity was either too demanding or timeconsuming a business for them to handle in-house. Many new fund of funds businesses responded to market opportunity and started life in this period. Chart Two (drawn from the Goldman Sachs / Russell report) shows the growth in private equity allocations among North American institutions from 1995 onwards, broken down by type of institution. Endowments and foundations in the survey, taken as a whole, recorded by the turn of the 21st century an allocation to private equity of over 14% of assets (up from 10% in 1995), taking advantage of their ultra long-term investment horizons. Corporate pension plans demonstrated less rapid growth, but nonetheless had allocations to private equity approaching 8% by 2003, well above the 5% considered necessary for an impact to be felt on overall results. Public pension plans, which controlled the lion’s share (68%) of the capital among survey respondents, provided the real growth in absolute amounts committed to the asset class. By lifting private equity allocations by about 50%, from just above 4% in 1995 to nearly 6% in 2003, public pension plans were the major drivers of the market’s growth, supplying tens of billions of dollars of incremental financing for private equity funds.

Chart Three (again from the Goldman Sachs / Russell report) demonstrates the transformation of private equity in Europe from a position of near-irrelevance (1.9% of all European survey respondents’ assets in 1996) to one requiring attention and influencing returns (4.0% of assets in 2003, forecast to rise to 4.5% in 2005). By 2003, despite the UK’s pre-eminent position as a headquarters for private equity investing activity in Europe, Continental European institutions had outstripped their UK counterparts in their allocations to private equity. While understandably employed in the Report, ‘Continental European’ is too general a term to apply, thanks to significant regional variations in commitments to private equity. Countries in Northern Europe with either mandatory or well-funded pension regimes, such as The Netherlands and those of the Nordic region, contributed disproportionately to the numbers. Meanwhile, the more Latin part of Europe (France, Italy and Spain, with largely state-sponsored provision of retirement income) barely registered as sources of capital for private equity in comparison with their relative GDPs. In other parts of Europe, such as Germany and Switzerland, innovative asset-gatherers designed private equity fund of fund vehicles that utilised capital guarantees and tiering structures to preserve capital, in the process obtaining investment grade credit ratings. They proved more imaginative than many US counterparts, whose appetite for capital could be satisfied by conventional sources, and managed to secure commitments from investors previously considered next-to-impossible to convert to the private equity gospel. These converts included fixed incomeoriented and capital preservation-sensitive institutions such as German insurance companies. These risk-averse players were prepared to commit to these new pooled private equity vehicles because of the promised return of capital they offered, as well as the reassurance of their ratings. In the main, at the time of the Goldman Sachs / Russell report in 2003, North American and European institutions were – and remain – the dominant financiers of private equity funds worldwide, even providing the bulk of capital to those operating in other regions, such as Asia. Private families, banks and quasi-

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Selection of a lawyer Josyane Gold, Partner, SJ Berwin

Why do you need a lawyer?

Raising a fund can be a long and difficult process; a good and experienced lawyer can make that process a lot easier. Your lawyers’ role is to advise on the legal aspects of structuring, marketing, closing and (often) future operation of your fund. This is a wide-ranging role and, to be most effective, your lawyers should be involved at the earliest possible opportunity. Many teams raising their first fund will inevitably start by concentrating on ‘big picture’ issues: what kind of investments the fund is to make, where is the vehicle going to be investing, and what investors to approach when fundraising and how much money to target. Clearly, these are important aspects, but it is also important to identify any legal, tax or regulatory obstacles early on. Doing so will often pay dividends in the long run. Which law firm?

Clearly, your lawyer needs to be familiar with the private equity industry, with fund structuring and the fundraising process. The legal skills required include corporate law, tax law and knowledge of regulatory regimes, often across a number of different jurisdictions. Funds usually raise issues in a number of different countries those into which the fund proposes to invest, those where prospective investors are based and those where the manager / adviser are located - and legal and tax structuring across these various jurisdictions is highly complex. It is critical to ensure that your legal team can cover each of those countries (either with their own expertise, or by working closely with other

firms). Because most funds pose difficult and often novel structuring issues, it is essential for the legal team to have a wide range of fund structuring experience, and to be creative in the way in which they approach your fund structure. Your European law firm (unless they also have a US presence themselves) will also usually need, depending on your investor base, a strong working relationship with a private equity law firm in the United States. A significant proportion of the capital available for investment in private equity and venture capital funds comes from US investors, and many issues arise from their involvement. A European law firm that specialises in private equity will be very familiar with these issues and have no difficulty co-ordinating the advice needed from the US and other overseas jurisdictions. Selecting a law firm

The most obvious choice is to use a law firm with which you have an existing relationship, as you are already familiar with their work. However, the specialist nature of the fundraising process may mean that your existing lawyers do not have the expertise that you require, and so a new relationship will need to be established. It is still the case that relatively few law firms have a particular specialisation and deep experience in the area of private equity fund structuring and raising. Local private equity and venture capital associations will usually have a list of firms with the requisite abilities: these firms will often be members of that association. For example, in most of Europe, the local venture capital association will include law firms among its (associate) members. Many of these, however,

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position of the French tax authorities appears to be to deny tax transparency and therefore to treat foreign partnerships as nontax residents and therefore not treaty protected. The net effect of this is that, for example, French corporate investors investing via this route will be taxed on their portion of the limited partnership’s revenue at the standard corporate income tax rate. However, it does appear from ongoing double tax treaty negotiations between France and the UK as though this may possibly change (i.e. English limited partnerships may, in effect, be treated as tax transparent by the French tax authorities in the future) although it is not currently known if and when such change will come into effect. v It will not be possible for a limited partnership to take advantage of the EU parent / subsidiary directive, although subsidiary companies owned by the limited partnership and individual investors in the limited partnership may be able to do so.

v There is no obligation to disclose publicly the terms of its partnership agreement, the identity of its limited partners or its accounts (but such information may be required to be disclosed by a governmental investor under freedom of information legislation). v There is no need to maintain an office or personnel in Delaware or in the US. v Organising a fund as a Delaware LP can be accomplished quickly and at little cost, and annual Delaware taxes and registered agent fees normally are approximately $300. Specific disadvantages include: v Non-US sponsors may be reluctant to use a US-law vehicle because of concerns about lawsuits (the US courts have tried a significant number of private equity fund related cases, generating a body of case law which is not mirrored in other jurisdictions) or becoming subject to US regulations.

v It will only be possible to rely on double tax treaty protection to the extent that the underlying investor is able to do so. It should be noted, however, that sub-fund structuring (using, for example, Dutch or Luxembourg holdco entities) is usually employed to minimise withholding and achieve other tax objectives.

v Somewhat more restrictive guidelines apply to avoid registration of a Delaware LP and its limited partnership interests with the SEC than apply to non-US entities.

Although it is possible to generalise about the features of limited partnerships as a type of fund vehicle, there are significant differences between the different types of partnership established in different jurisdictions, and it is important to understand these differences when designing a structure.

v A Delaware LP must file US partnership tax returns (but nonUS funds with US investors also often agree to file US partnership tax returns), and will be treated as a ‘United States person’ for purposes of applying various US tax rules to investments in non-US companies.

Delaware LP

Many US brand funds have been structured using Delaware LPs. In addition to the advantages noted above for partnerships generally, specific advantages in relation to Delaware LPs include the following: v The standard form of private equity fund agreement used by US institutions and US investors has been developed for a Delaware limited partnership.

v Non-US investors may be subject to internal investment restrictions which require that the fund vehicle is, for example, an EU entity. English LP

In Europe, one of the most regularly used limited partnership vehicles is an English limited partnership (ELP) established pursuant to the Limited Partnerships Act 1907. ELPs have all of the benefits noted above for partnerships generally. ELPs are tax transparent for UK tax purposes and therefore capital gains gen-

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Presenting the proposition: planning and executing the fundraising Robert E. Mast, Managing Director, Monument Group

The primary job of the placement agent has always been to introduce buyers and sellers of securities and facilitate the execution of the subsequent transaction. In the private equity business, agents have traditionally made use of personal or firm relationships with prospective limited partnership investors to bring them together periodically with the general partners of a fund raising capital. The baton was then passed to the general partners, who were responsible for selling the investors on the attractiveness of the investment proposition. Historically, this was a fairly simple process, with many investors putting their trust in the results of a fairly quick due diligence process, the agent’s recommendation or their relationship with the general partners in question, and hopefully resulted in an efficiently, but opportunistically, assembled limited partner base. Times have changed. Collectively, today’s investors have far more experience with the private equity asset class, and have become far more sophisticated and demanding in their questioning and information requirements, both prior to making the investment decision and in the ongoing monitoring of the investment. As a result, today’s GPs face increasing demands on their time during the fundraising process, in the form of enhanced marketing and due diligence support and multiple meeting requirements, and an increasing investor relations requirement afterward. At the same time, the market itself has become increasingly competitive, with overextended investors having begun to rationalise the structure of their investment programs by pruning the number of relationships they have with GP groups. Combined, these factors have increased the need for careful planning of the fundraising process and diversification of the limited partner investor base, expanding and extending the role of the placement agent.

To make the fundraising process efficient and successful today, the agent needs to play an important role in each step of the process, from planning and pre-marketing at one end to advising the GP with regard to investor retention at the other. Selected details of the agent’s role at various points of the process are discussed in the pages that follow. Planning and preparation pay off

As the prior fund moves within range of full investment and the decision is made to gear up for a new fund, many GPs become anxious for meetings with potential investors in the follow-on vehicle to begin. Time devoted to planning and preparing for the launch of the new vehicle is well spent, however, and will generally be more than paid back through increased fundraising momentum and enhanced efficiency of the process. Key steps in the planning process for a private equity fundraising are outlined briefly below, and several of these topics are covered in greater detail elsewhere in this publication. Development of the marketing plan and timeline

The marketing plan provides a broad outline of key steps in the fundraising process and their anticipated completion dates. The plan sets the stage for what needs to be accomplished, identifying key supporting materials (Private Placement Memorandum, due diligence information, presentation materials, legal documentation, etc.) and assigning responsibility for their completion, and synchronises expectations regarding timing so that all parties are in agreement and expectations aligned. The agent should clearly communicate expectations regarding the time required for fundraising. While some strongly performing funds

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presented to an investment committee, which makes the final decision on whether or not to invest in a fund. Meetings of the investment committee are held fortnightly or as necessary. The purpose of a due diligence is to ascertain whether a fund is in a position to deliver returns in the top quartile in its category. The methodology involves carefully reviewing all information on the fund and in the process of doing this, looking for consistency, investment discipline and value-adding capabilities.

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Both positive factors and risk factors are formulated for each of the focus areas during the due diligence process. This is the nub of the due diligence process, and these factors are continually expanded and deepened before being summarised in the final investment memo. The following looks first at the due diligence process, i.e. the actual process as it unfolds, before discussing each of the five focus areas in depth in separate sections. Investment process

To properly get to grips with a fund and its potential, the due diligence undertaken by ATP PEP focuses on five areas which are intended to ensure that every aspect of the fund is explored and analysed completely. These five key areas are: track record, team, strategy, process and terms and conditions.

The due diligence undertaken on an individual fund is intended to explore and analyse all of the aforementioned five focus areas. The process can take anything from 2-3 weeks to up to 6-10 weeks, depending in part on the availability of information on the fund and how far the fund is into the fundraising process. It is a matter of striking a balance between spending no more time than necessary and ensuring the necessary degree of thoroughness.

Chart One: Investment Process

Investment Committee

Screening Screening

The process is not an aim in itself but rather a way of ensuring that all relevant areas are checked and verified. The

Investment Committee

Due DueDiligence: Diligence: inin three three phases phases

Investment Investment

Negotiations on terms and conditions RESEARCH GUIDE

The market risk of an investment is contributed by the estimated beta times the market return; the uncorrelated risk of the investment is contributed by what is left – i.e. by the volatility of the investment return minus the market return times the investment beta. The return associated with this residual component, alpha, is the holy grail of active investment management.

Role of the investment committee

Five focus areas

A fund must prove its worth in all of these areas. Experience shows that consistency between track record, team and strategy often provides a solid basis for a fund being able to deliver top-quartile returns.

Definition of alpha and beta

v Meets fortnightly or as required v Provides ongoing feedback on due diligence projects v Reaches formal decision on whether to invest in a fund or not

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Chart Two: Breakdown of Realised Multiples

13% 10%

33%

10% 34% <1x

1-3x

3-5x

5-10x

>10x

Chart Three: Individual Track Records 400

6.0x

350

5.0x

300

200

3.0x

150

2.0x

100 1.0x

50 0 $ mio

0.0x Partner A

Partner B

Partner C

Partner D

Partner E

Invested Capital

Partner F

Partner G

Realised Multiple

Multiple

4.0x

250

Approval or rejection

Track record

When the investment committee has seen the recommendation, negotiations regarding the limited partnership agreement, side letters, tax opinion, subscription agreement and so on complete the due diligence process. At this point there will still be some uncertainties about whether or not a commitment should be made. From time to time we turn down funds due to deal-breakers in the limited partnership agreement. At one stage we decided to turn down a fund with a good historical performance simply because negotiations over terms and conditions clearly showed us that the GP was more focused on its management fee income than on aligning interests between it and limited partners in its fund.

Track record is the most objective and readily accessible of ATP PEP’s five due diligence focus areas. Nevertheless, a fund’s track record is based on a series of assessments of the value of the individual companies in which the fund invests.

This is the way it has to be. Every investment must be evaluated many times during the investment process. Some make it, some do not. Even in the final stages funds can be turned down despite the many man hours spent and many miles travelled, but in the end those expenses are nothing compared to a potentially non-performing investment: the price of making bad decisions is much higher than the cost of the time and travel associated with a due diligence. Key focus areas: track record, team, strategy, process and terms and conditions

Chart Four: Investment Pace, 1990-2004

$ mio.

Chart Four: Investment Pace, 1990-2004

700

16 14

600

12

500

10

400

8

300

6

200

4

100

0

2 1990

1992

1992

1993

1994

1995

Amount

1996

1997

1998

1999

2000

2001

Nr. of Investments

2002

2003

2004

0

The due diligence process itself is described above. As mentioned earlier, the process focuses on five main areas – track record, team, strategy, process and terms and conditions – which are explored through research, meetings and reference checks. The following sections present these five focus areas in greater detail, and discuss the challenges in each. The theory is illustrated with practical examples wherever possible. Naturally, these examples have been rendered fully anonymous.

A fund’s track record consists of the following elements: v Realised investments v Unrealised investments – valued by means of their implied valuation (see later) v Partially realised investments v Total investments If a manager has several generations of fund, each generation of fund (Fund I, Fund II etc.) are listed, and each is then broken down as stated above. Charts two to four give an example of the types of data that ATP PEP will gather on all of a manager’s funds when conducting its analysis of the GP’s track record. Even during the initial screening, a fund’s track record plays a key role in whether we proceed with the fund as a potential investment. If there is no track record or only a relatively limited realised track record, the team’s composition, expertise and experience are given greater priority in our analyses. In these situations we also choose to focus on value creation at individual portfolio companies. There may be many good reasons for a limited track record, and this is not to be seen as necessarily a problem in itself. When analysing a track record, we attach great importance to continuity between track record, team stability and a consistent investment strategy (see ‘Consistency’ below). Obtaining information is not without its problems when it comes to stocks that are unquoted and therefore characterised by limited availability or low earnings visibility. The difficulty of getting hold of data leads to asymmetric infor-

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pharma and technology sectors will be needing 2-3 years ahead and can therefore be expected to be interested in acquiring v Deal sourcing v Network v Experience of developing companies from idea to revenue When it comes to the companies in which the fund invests, the important considerations are: v v v v v v

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Ability to spot the potential in a product Insight into future market Go-to-market strategy Business development Organisational development and the need for it later on Entrepreneurial spirit

Fundamentally speaking, the venture capital fund must have good experience of building companies. Building a company can be compared with building a house. You need sound foundations if you are to be able to build at all – and the foundations dictate how large and how tall the house can be built. The taller the house is to be, the more important it is that its foundations are in order. The same goes for a venture-backed company. If it is to grow and create value, it is crucial that its technology (i.e. its foundations) is 100% sound. The company’s organisation, people and business processes correspond to a building’s carcass. The size and success of the company depends on the quality of and interaction between its organisation, people, processes and in particular, its product (technology) as its cornerstone.

IRR is not the only valuation parameter in the assessment of a fund’s track record. In particular, IRR is often used together with a cash multiple figure. The calculations are both retrospective and prospective. Has the IRR on previous investments been acceptable? Is it likely that future investments will yield an acceptable return? In connection with calculating the IRR, we also look at how the companies value their unrealised stocks. As they are not quoted and so do not have any immediately measurable market value, it is important that this is done realistically. As a formula (see box-out), IRR appears relatively easy to calculate. But there are two factors which make its calculation more subtle and to some degree a complex undertaking. Firstly, it is often based on the assumption that a set number of portions are invested over time rather than a single sum at the beginning. Similarly the return is delivered in several portions over time. This means in practice that some of the repayments actually consist of the return on the investment. Secondly, it is important to define when payments are made and when the IRR is being calculated from. Totally different results can be achieved depending on whether a payment is made at the beginning, in the middle or at the end of the calculation period. The two main ways of calculating IRR are pooled IRR and horizon IRR: Pooled IRR

IRR and its calculation

Whilst calculation of IRR is the backbone of a track record and plays an important role in the assessment of a fund’s underlying investments, it is very important for it to be calculated correctly. Our experience is that IRR can be calculated in several different ways and that its interpretation can lead to different conclusions. It should also be noted that

RESEARCH GUIDE

Pooled IRR is the IRR obtained by taking cashflows from a number of companies and aggregating them into a pool as if they were a single company. This is superior to either the average IRR, which can be skewed by large returns on relatively small investments, or the capital-weighted IRR, which weights each IRR by capital committed. The latter measure would be accurate only if all investments were made at once at the beginning of the fund’s life.

Definition of cash flow Gross cashflow (GCF) is used in the calculations because it is easier to reconstruct from annual reports and can be compared across funds. GCF we define as net earnings plus depreciation plus non-cash items.

Investments in a venture capital fund are likely to result in positive value growth/creation if:

v A beta product is launched successfully among test users v A good salesman (or sales force) with market insight and large network is recruited v Contracts are concluded with important distributors or system integrators on sales of the product v Partnership agreements are entered into on joint development and milestone payments from the dominant company in the market v The product is integrated into other software packages

Internal rate of return IRR is the rate of interest where the NPV is equivalent to 0. T NPV = ∑ Pt (1+i)-t t=0 A

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IRR= i NPV = 0

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Vehicle

Tax transparent?

Legal entity?

Can avoid Permanent Establishment issues?

Management charge subject to VAT?

Restrictions on where it can be managed?

Other issues

English limited partnership

Generally yes

No

Yes

No

No

• Most common structure for Pan European funds • Loan / capital split • Removal of 20 partner limit

Delaware limited partnership

Generally yes

Yes

Yes

No

No

• Most common structure for North America funds • Still (occasionally) requested by US investors • Established body of law and responsive legislation • Caught by US reporting requirements

German limited partnership (nontrading for German tax purposes)

Generally yes

No

Generally yes

Generally no

Yes

• Generally only suitable for German investors • Non-trading limited partnership criteria have been revised • New ITA rules generally a move away from KGs • Caught by German reporting requirements

French FCPR

Generally yes

No

Yes

Yes/No

Yes

• Generally drafted in French • Prevalent structure for domestic French funds • Tax transparent for French purposes

Jersey/Guernsey limited partnership

Generally yes

No

Yes

No

Yes

• Generally needs to be regulated and administered in the Channel Islands • Has been used for a number of funds • Some continental European investors still have problem with ‘offshore entity’ • Liability issues in the UK

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star performers within the GP will be highlighted, there is a growing interest amongst LPs to see evidence of meaningful risk mitigation by GPs with regard to its personnel. To quote a UKbased fund of funds investor: “We don’t want to be buying just one guy and we don’t therefore like to see just one person sell a fund to us.” Increasingly private equity groups are appointing a senior, seasoned individual within the firm to be in charge of investor relations. This person will not only be pivotal in terms of nourishing relations with LPs in existing funds but also will be at the heart of the new fundraising. The presence of such an individual has both practical and strategic benefits: they can act as point person during the fund raise (see also ‘Campaign factors’ below) and the presence of such an individual is not lost on investors either (he inference is that your firm takes relations with its investors seriously).

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It is also imperative that the broader fundraising team is appropriately structured and that it operates smoothly. Relations between GPs and their advisors can be highly charged: the significance of raising the firm’s new fund, the intensity of the itinerary and the successive sales presentations all help ensure that a heady mix of adrenaline, fatigue and anxiety can influence interpersonal relations. And if the fundraising is not running as smoothly as hoped then the tension only gets greater. Comments one placement agent: “It’s like a marriage: you’re spending lots – probably too much – time together, you talk about the same things again and again and poor or lazy communication between one another turns a small issue into a big problem.” The lawyers involved in drafting the fund’s documentation are less exposed to the ups and downs experienced on the fundraising trail but they too need to be able to gel with the private equity firm’s team. As commitments begin to be discussed and different lawyers start to get involved on behalf of LPs, so the tension mounts as terms are negotiated. It is vital at this stage that the GP can have total faith in its legal representation and that the lawyers themselves are equally as comfortable with their client.

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All this means that your advisors need to have enough time to get familiar with your firm and your team. If your incumbent legal advisors are not strong on fund structuring, make sure you have started talking to a firm that is well in advance of launching the fund (and don’t assume the first candidates will be your final choice). Possibly even more important is selecting a placement agent – assuming it has been decided that you will have the input of such a firm. There has been an increasing stratification of the placement agent industry with successful placement groups being in considerable demand, enabling them to be highly selective as to which mandates they take on. This could well mean that your first choice agent will not be available; to discover this one month before your scheduled fund launch is due to start will be disastrous. Information factors

Although market and people factors each can have considerable impact on the success or failure of a fundraising, probably the most important elements that shape the final outcome of a fund raise are what can be called information factors. These are the facts and figures that detail the history of the firm and its prior funds; they are the profiles of the individual team members at the GP who are tasked with investing the fund; they are the terms tabled and the terms agreed in the Limited Partnership Agreement (LPA). And they also relate to how such information is managed: how due diligence questionnaires are completed; how existing LPs are fed with timely and appropriate information; and how information is delivered clearly and consistently when marketing the new fund. Prior to officially launching the new fund, a private equity group must devote significant time and effort in preparing its private placement memorandum (PPM). The information presented in this document must be extensive, accessible and – crucially – accurate. And that means the GP and its advisors must repeatedly work through every aspect of the PPM. Bad research and compilation now will return to haunt the fundraisers later in the process. Recalls one GP who had a protracted fundraising: “It was at the due diligence stage that it became clear to us that we

Strategies for dealing with people factors:

• Do you have a Head of Investor Relations? • Maintain a regular, substantive dialogue with LPs in your existing funds. • Talk to your existing LPs first about your plans for a new fund. • Make a point of getting to know new personnel at investing institutions. • Train a team of fundraising presenters – don’t rely on one star. • Make use of your younger/newer talent when presenting. • Select your advisors in good time. • Make sure you get on with your advisory team. • The fund raise will take months – even years – so be prepared to spend lengthy periods with your colleagues and advisors. • Remember raising a private equity fund is not just about numbers. • Tell your family they are going to see even less of you over the coming months.

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Nonetheless, investors are mixed in their views as to whether or not the terms and conditions of US and European funds are converging. Almost half of respondents felt that this was the case, with only 16% stating that in their opinion they weren’t (see Chart Four). However, a substantial proportion (38%) of investors were undecided. This may reflect the fact that many investors in private equity funds remain regionally focused, concentrating largely on domestic managers. It is generally only the larger, more experienced investors that commit to private equity funds on a global basis, and who would therefore have the experience to know whether European and US funds are converging. Chart Four: Are the terms and conditions of European and US

To better understand which terms and conditions are considered by investors to be of most importance, and which are considered to be of least importance, respondents were asked to rank a number of different issues addressed by a fund’s terms in descending order of importance (rank one being the most important, followed by rank two and so on, to rank eight). The topics respondents were asked to rank were: carried interest sharing arrangements; co-investment arrangements; keyman provisions; level of management fee and operation of management fee step-down; no-fault and for-cause divorce provisions; operation of catch-up and clawback provisions; side letters; and timeliness of reporting. Respondents were asked to use each ranking only once.

funds converging? Chart Five: Terms and conditions ranked by LPs as most important

Not sure 38% Carried interest sharing arrangements Keyman provisions

Yes 46% No 16%

Operation of catch-up and clawback provisions

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Level of management fee and operation of step-down No-fault and for-cause divorce provisions Side letters

Rank 1 Rank 2

Timeliness of reporting

Co-investment arrangement

Relative importance of different terms

Private equity and venture capital funds are complicated vehicles. Their terms and conditions cover a broad spectrum; a partnership agreement will deal not only with the fundamentals of management fee and carried interest, but with issues relating to the formation and composition of the fund, the treatment of various fees and costs flowing into and out of the fund, and the rights and redresses given to limited partners, amongst others. Certain issues will be considered fundamental and will concern almost all investors. Other considerations, such as co-investment provisions, will be of importance to some investors but will be considered an irrelevance by others.

0%

10%

20%

30%

40%

50%

60%

70%

80%

% of respondents

As can be seen from Chart Five, investors feel that carried interest sharing arrangements and keyman provisions to be of most importance when considering the relative importance of different terms and conditions. Some 67% of respondents placed carried interest sharing arrangements in either rank one or rank two, with 61% of investors doing the same with keyman provisions (see Chart Five). Arrangements governing the level and timing of carried interest payments will exercise investors in private equity funds, as carried interest is the principal method by which a GP is

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Examples of specific GP hospitality events men-

Chart Fifteen: Value placed on hospitality events None at all 16%

tioned by LPs include: v Box at the US Open.

v Cocktail parties and dinners.

A lot 11%

v Golf (varying from outings to entire weekends).

reports?

% of Respondents

v Museum / art gallery visits.

v Night at a sports bar to watch a football game. v Race meetings. v Sailing.

A little 73%

v Shooting days.

v Trips to the Ryder Cup. v Wimbledon.

v Wine tasting.

87%

90% 80%

ences.

v Tours of historic venues.

100%

What value do LPs place on GP hospitality events?

v GP and special advisor co-sponsored legal confer-

v Theatre.

Chart Sixteen: How regularly should GPs provide LPs with

70% 60% 50% 40% 30% 20% 10%

cate that they place only a little value on GP hospitality events (see Chart Fifteen). Only 11% of respondents see a lot of value in them, while 16% state that they see no value whatsoever. What value there is placed on hospitality events revolves around relationship building and networking. Properly staged, a hospitality event can offer opportunities for investors to get to know the individuals at the GP better, which in turn fosters better relationships and helps to build trust. In particular, respondents pointed to the ability to meet with junior members of the GP as a benefit of hospitality events, along with being able to experience how the different levels of staff at the GP interact. Respondents also appreciated the ability to network and interact with other limited partners that some hospitality events can offer. Reporting

When it comes to the frequency of reporting, general partners are broadly in line with the expectations of limited partners. The vast majority of investors want to receive reports on a quarterly basis (see Chart Sixteen), with a small proportion expressing a preference for monthly delivery and the same number selecting bi-annually. Private equity is a long-term, fairly illiquid asset class. For that reason, some investors may find that receiving detailed reports twice per year will be sufficient. Furthermore, this long-term nature means there is little

4%

4%

0% Monthly

Quarterly

Biannually

0% Annually

4% Other

Chart Seventeen: In practice, how regularly are GPs providing

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LPs with reports?

97%

100% 90% 80% % of Respondents

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70% 60% 50% 40% 30% 20% 10% 0%

0% Monthly

Quarterly

1%

0%

1%

Biannually

Annually

Other

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CASE STUDY “The new concept fund” Accession Mezzanine Capital LP Christiian Marriott, Director - Investor Relations, Mezzanine Management UK Limited

Background

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The idea of raising the first independent mezzanine fund for Central Europe was discussed within Mezzanine Management from as early as 1999. However, Accession Mezzanine Capital LP (AMC) itself was not formerly launched until February 2001. That fact in itself says much about what it takes to get a new concept fund off the ground. Any new private equity or mezzanine fund requires planning, but taking a new financing instrument into an emerging private equity market was always going to be a particular challenge. And to top it all, AMC was going to saddled with the dreaded ‘first time fund’ label, something that Mezzanine Management hadn’t had to contend with since it opened its first fund back in 1988. During the planning stage before the fund was launched, several key milestones had to be hit, some of which were specific to AMC, but others common to all new funds that are introducing a new concept to the private equity market. Getting the team together and organising the corporate structure was in many ways straightforward. The rationale for taking mezzanine as a product into this region had been formulated with the two managing directors who were going to be running the fund on a daily basis. One key advantage for AMC was that these two gentlemen were effectively part of the Mezzanine Management ‘family’. Franz Hoerhager had sat on the boards of the firm’s first two funds, while Ben Edwards had been with Mezzanine Management from its inception and, after a short time outside the firm, had returned to be a founding partner in the AMC team. The shared history made this ‘new concept’ seem more familiar to those that would be involved in making it happen.

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Aside from organisation and formulation of the team, the longer job was formulating the investment case for the fund. The desire was for AMC’s investment rationale to be confirmed internally, validated externally, and then fine-tuned and articulated in a way that would allow us to approach the institutional investor community. In this respect the partnership with AMC’s cornerstone investor was key. The concept of a cornerstone investor tends to be over-generalised by the industry, as it can mean different things to different people. For AMC, the cornerstone investor provided more than capital. The European Bank for Reconstruction and Development (EBRD) was vital in validating Mezzanine Management’s thesis that there was a market for mezzanine in Central Europe. There were definite parallels with what Mezzanine Management had achieved when setting up shop in Western Europe: a growing private equity market, a lack of intermediate finance and ongoing macro-economic change. Notwithstanding the similarities, however, if the largest investor in private equity in Central Europe didn’t believe there would be demand for mezzanine in the region, we would probably do well to think twice. One final aspect of the preparations was the legal due diligence in the principal countries targeted by the fund. This involved taking Western European loan documentation, having it translated into both local language and local law, and gaining comfort from lawyers on the ground that key concepts such as subordination would stand up in the local jurisdictions. Marketing the fund

So after months of working with the EBRD and talking to intermediaries and private equity funds in the region it was finally

time to begin drafting the marketing materials and partnership agreement. In the case of AMC, Blair Thompson of SJ Berwin was key in ensuring that the fund’s structure was going to be right for the investment strategy as well as being attractive and workable for potential LPs. A key element as we articulated the case for AMC was to stress that while it was a new concept, Mezzanine Management had a track record of being involved in introducing mezzanine to new markets in Western Europe in the late 1980s and early 1990s. The basic argument was that this element of ‘technology transfer’ was nothing to faze the firm or the members of the team who would be making investments. In practical terms, this meant that there was also a meaningful context for the inclusion of the group’s 15-year Western European track record in the PPM and marketing materials. This feature of AMC’s offering arguably gave the fund significantly more marketability among institutional investors keen to apply some sort of relevant quantitative track record analysis to their investment decision. Having launched the marketing of AMC in Spring 2001, it was clear that the general conditions for raising capital were not ideal. Institutions whose portfolios were suffering from the cyclical downturn were finding it hard enough to commit to any private equity product, let alone something as different as a mezzanine fund focusing on Central Europe. In marketing trips to the US, it was clear that the ongoing accession process, during which the five core countries targeted by AMC would join the EU, was still something that many institutions were either unconvinced by or unfamiliar with. Indeed, Central Europe was, for many institutions, an emerging market like Latin America or the Pacific Rim. Anecdotally, a key milestone that started to resonate with

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CASE STUDY “The debut US mid-market fund” Arsenal Capital Partners, LP Terry Mullen, Co-founder and Managing Director, Arsenal Capital Partners

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Rationale

Execution

Arsenal Capital’s debut fund was founded in 2001 to execute control investments of manufacturing and business services companies. Terrence Mullen, Arsenal co-founder and Managing Director, left Thomas H. Lee Partners in 2000 on the heels of several successful buyouts, including Rayovac Corporation and Transwestern Publishing, in which strong operating leaders played a significant role in delivering above-market returns. In building out the Arsenal team, Mullen sought a strong operating professional to complement his own investment and financial background. This search tapped Barry Siadat, the former Chief Growth Officer of AlliedSignal/Honeywell, who over 27 years at two diversified conglomerates (AlliedSignal and W.R. Grace) held a variety of senior managerial and technical positions in a broad range of industries.

Firm building and fundraising were accomplished through a staged approach of initial fundraising followed by team building, deal execution, and portfolio company improvement. Success in team building and execution created a platform for a rapid doubling of committed capital, and by demonstrating an ability to improve its portfolio companies Arsenal quickly reached an overcommitted first fund.

The founding principal behind Arsenal was to combine financial and operating expertise to make good companies better in ‘growth and productivity buyouts’. Mullen and Siadat believed that this collaboration between investment and operating professionals would result in an ability to source higher quality transactions; quickly and accurately identify business strengths, weaknesses and opportunities; more thoroughly evaluate management teams and conduct due diligence; and actively grow and improve investments. The two decided to invest in industries in which they had prior investing and/or operating experience, including specialty chemicals, specialty manufacturing, and certain sectors of healthcare. The team at Arsenal would be built around these industries, as well as around certain key functional disciplines that would apply to a broad range of businesses, including human capital, quality, supply chain, and technology.

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Mullen and Siadat were able to raise an initial $50 million on the strength of their prior successes, with commitments coming from their network of LP relationships and from other, smaller investors. They had already brought on board a Vice President who had worked with Mullen at T.H. Lee and two Associates with investment banking and consulting backgrounds, and after successfully completing this initial funding in March 2001, brought on an additional Managing Director, James Marden (an operating and investment executive from Merck-Medco and Medical Logistics), as well as another Vice President (also from T.H. Lee) and a third Associate. Siadat also reached out to his extensive network, recruiting a group of Operating Directors consisting of senior operating executives from firms known for their industry leadership and operational excellence, including AlliedSignal, General Electric, General Motors, DuPont, and Bristol-Myers. This Arsenal team had proven track records in executing the various components of ‘growth and productivity’ investments. The individuals comprising the Arsenal team all had experience of investing in basic middle-market companies, driving organic growth while taking advantage of strategic acquisitions, and

Key facts Name of fund:

Arsenal Capital Partners, LP

Launch date:

May, 2001

First close date and amount:

May 30, 2001; $50 million

Final close date and amount:

May 30, 2003, $65 million (total $300 million)

Type of limited partners: Fund of funds, corporate and municipal pensions, banks, universities, high net worth individuals Number of limited partners:

100

Name of law firm:

Kirkland & Ellis

Name of placement agents:

George H. Carter, Zurich, Switzerland; Farrell Marsh & Co, Greenwich, Connecticut, USA

improving competitiveness and productivity, irrespective of the economic cycle. This strategy had resulted in above-market company performance and investment returns at T.H. Lee, at AlliedSignal, and at Merck-Medco. However, the strategy remained unproven by the Arsenal team. After the initial first closing on $50 million, the partners focused on deal sourcing and execution in order to demonstrate the merits of the Arsenal team and model. Over the next year Arsenal

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Fund administrators and outsourcers

Abacus Financial Services Group Ltd. Company name Address Phone Fax Other office locations Website Email

Abacus Financial Services Group Ltd. Tower 42, 25 Old Broad Street, London EC2N 1HN, United Kingdom +44 (0)20 7877 2104 44 (0)1481 728493 Jersey, Guernsey, Edinburgh, Cheltenham, Amsterdam www.abacusglobal.com [email protected]

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Baring Fund Administration Services Company name Address Phone Fax Other office locations Website Email

Baring Fund Administration Services PO Box 71, Trafalgar Court, Les Banques, St. Peter Port GY1 3QL, Guernsey +44 (0)1481 745000 +44 (0)1481 745050 Dublin, Isle of Man, Jersey, London www.bam-fsg.com [email protected]

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Gaining in sophistication June 2005

Having a good IT platform is not just a means of making life easier for a GP’s front and back office teams: these days, it can play a vital role in evidencing ability to add value and can even make a difference to fundraising prospects. Andy Thomson reports on developments in private equity technology.

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If possession of a cutting edge technology platform were ever considered a luxury by private equity firms, that is certainly no longer the case today. Not only do fund administrators need to be using credible systems in order to win business from GPs, anecdotal reports indicate that GPs increasingly need to evidence use of a particular system – whether by outsourced administrators or their own in-house team – when on the fundraising trail. Given the increasing pressures on LPs to obtain regular, detailed information on the funds in which they invest, it could be argued that never before has technology been such a high priority when it comes to investor due diligence. In response to this, private equity firms are more likely to turn to off-the-shelf or tailored software systems rather than the less sophisticated means of gathering and distributing information that they have relied upon in the past. “It’s not that you can’t still use spreadsheets, but that approach is becoming less credible,” says Alan Routledge of eFront Financial Solutions, a private equity software vendor. “You need to respond to new ways of reporting and new fund structures, and it’s hard to see how you can cope with these demands using Excel or manual methods.” Peter Wooster, director of Accounting Frameworks Limited, a private equity and venture capital software provider, says overreliance on spreadsheets means being exposed to the possibility of human error. “Limited partners get very upset, for example, if

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the amount of a capital call is wrong or it’s requested at the wrong time,” he says. “Those who use Excel-based systems do occasionally make such mistakes.”

ual partnerships), but also look through to the portfolio holding companies. That is all incorporated in one system.” Doubling up

Wooster adds that the use of more sophisticated systems has gone hand in hand with more detailed reporting requirements. For example, the traditional method of valuing portfolio companies at cost is being increasingly usurped by the concept of ‘fair value’, as reflected in recent guidelines issued by a number of European private equity associations as well as the Private Equity Industry Guidelines Group (PEIGG) in the US. “Historically, private equity firms have kept valuations low until it comes to realisation, and then the rabbit is pulled out of the hat. Now, accounting standards demand fair value is applied through the life of an investment,” says Wooster. It is not just ‘macro’ developments such as changes to accounting rules that are having an impact on reporting requirements – there is also structural change within the private equity industry itself. Take for example the growth of funds of funds, whose part GP-part LP status brings with it an added layer of complexity: ranging from serving their own clients to fielding reports from their underlying partnerships through to portfolio level data associated with co-investments. They have forced technology providers to rise to the challenge of meeting their unique demands. This is illustrated by the case of LGT Partners, the Swiss private equity and hedge fund manager with $5 billion under management, which outsources its reporting to a technology vendor. Says principal Robert Schlachter: “We not only track the cash flow and valuation between the fund of funds and the (individ-

“Incorporation in one system” is not a phrase that appears to sit easily with the approach of many private equity firms. Wooster says as many of half of Europe’s GPs are running what he calls ‘duplicate’ or ‘shadow’ administrative systems, whereby the GP continues to run its own in-house system even when fund reporting has been nominally outsourced to an external provider. Viewed one way, this may reflect a lack of trust in the administrator and a desire on the part of the GP to retain some control. But there are also practical reasons for such an approach, notably the widely acknowledged but not widely broadcast fact that administrators will normally merely provide a rubber stamp for valuations provided by the GP rather than taking on such a sensitive role themselves. In viewing duplicate systems as a fact of life, Accounting Frameworks is promoting the ASP (application service provider) model as a way of attempting to ensure that the GP and administrator can at least access the same real-time information relatively cheaply. Traditionally, private equity firms have owned and paid for their own infrastructure, and linked the main server to remote offices by means of a series of paid-for connections. The ASP approach, on the other hand, means paying a subscription to access a shared server, thus greatly reducing infrastructure costs. Whilst ASP systems are still in their infancy, the implications may be profound as private equity firms seek to grow interna-

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Fund administration and technology: the A to Z June 2005

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Rather like the private equity industry it supports, the world of fund administration and technology is becoming increasingly more complex and esoteric. Here, we take an alphabetical stroll through some of the defining words and phrases.

tent with basic summaries of fund performance to the cornerstone institutional investor expecting more regular and detailed data than would normally be requested. Systems need to be flexible enough to respond to a wide range of demands.

L is for limited partner. Never upset one. Anecdotal reports indicate that while having a good back office system may not exactly be make or break on the fundraising trial, it is edging up most limited partners’ list of priorities.

A is for administrator. Increasingly, firms are outsourcing parts, if not all, of their fund administration to outsourced providers. Start-ups and spinouts in particular look to offshore administrators for all their fund reporting requirements.

G is for guidelines. How should portfolio companies be valued? Less a straightforward question than a cry for help over the years due to the absence of a single set of valuation guidelines. But thanks to the recent efforts of industry associations such as the EVCA in Europe and the PEIGG in the US, the promised land of harmonised valuation techniques seems to have come a step closer.

M is for mobile working. As the private equity industry continues to expand into new territories, more and more investment staff are working from remote offices, often with a minimum of local support. GPs need to ensure that an increasingly mobile workforce remains in permanent contact with support systems.

H is for high-tech. The high-tech nature of today’s fund administration and reporting systems is replacing the Excel standard and allowing for electronic communication between GP and LP rather than the mailing of heavy binders of paperwork.

N is for numbers. You can provide as much detailed, strategylevel information as you like, but the bottom line is that it’s the numbers that count. Chronological, quarter-by-quarter numerical updates on portfolio company performance and clearly stated valuations speak more than a thousand marketing words.

B is for back office. Regardless of what the rainmaking deal doers say, this is where it’s at … ok it’s not really, but without a robust, reliable system (and team) behind them, the deal teams would struggle. C is for choice. Five years ago, such an entry might also have contained the words “or lack thereof”. Nowadays, with more options, more systems and more suppliers, it’s worth researching the marketplace in depth before making a long-term commitment. D is for detail. As limited partners become increasingly sophisticated, so too do their information requirements. Funds of funds in particular can require layers of detail that a top line quarterly report may not be able to provide. E is for email. Email, internet, web-based reporting, online interaction. The future is here and it’s on the web. No more rainforest-destroying reports every quarter, all you need is a log-in name, password and away you go. F is for flexibility. Different types of fund investor have very different requirements, from the high-net-worth individual con-

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I is for in-house software systems. Many private equity funds of funds develop such systems to handle the complexities of their reporting: as LPs, they field reports from underlying general partnerships, but as co-investors, they may be even reaching into portfolio-level data. J is for Jersey. The offshore jurisdiction of choice for European private equity funds, Jersey recently enacted the Expert Funds category, which includes key regulatory changes designed to give the island the edge over its offshore rivals. K is for knowledge-led delivery. A buzz phrase much loved by fund administrators. Another way of saying it’s not much use having state-of-the-art systems if you don’t have people who know how to get the best out of them.

O is for Outlook. New information management systems must be compatible with Microsoft’s industry-leading email program if any firms are going to be interested. In addition to working with the email program, jet-setting front office professionals also want systems that are able to sync with their newest appendage – the Blackberry. P is for package. There is now a wide range of software packages available on the market and all are designed to allow the user to standardise, collate and make accessible relevant information. But ownership of a package is one thing: how central you make it to the way your business is run will determine whether or not you can boast a successful IT operation.

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Nice work if you can get it April 2005

The current increase in fundraising activity is good news for placement agents. But intense competition for mandates and a sharpened focus on professional standards means a shakeout in the industry is likely to occur, writes Philip Borel. Global private equity is in fundraising mode. After 24 months of intense capital deployment driven by an unprecedented push on the world’s M&A markets, droves of general partners are going back to institutional investors to refill their coffers. In the world’s key money management centres, the airport lounges are playing simultaneous host to numerous fundraising GPs. Even in more remote locations, sightings of private equity managers looking for fresh commitments are increasingly common – as long as you happen to be in the hometown of a US state pension headquarters, a Scandinavian insurance company or a family office in the Middle East. On the buy-side, investors are surveying the host of new funds coming their way with just as much intensity. Yield-hungry institutions are betting that private equity can provide at least part of the answer to their performance-related difficulties. However, the positive inclination towards the asset class does not mean money is being thrown at private equity groups indiscriminately. According to practitioners familiar with the current institutional investor mindset, limited partner due diligence on new funds is as detailed and scrupulous as it has ever been. “Limited partners have never been busier,” says John Barber, a director at London-based fund placement advisors Helix Associates. As a result, queues of managers are forming outside limited partner offices. Fund raising general partners are all too aware of

this, and they also recognise that the process as a whole is becoming more and more complex. LPs are developing a more differentiated understanding of how they want to participate in the asset class and which types of – as well as how many – manager they want to work with. Gone are the days, therefore, of general partners being able to take a cavalier approach to their fund raise and, more broadly, to their investor relations. For a number of years now, the trend amongst the bigger private equity groups has been towards building dedicated, in-house fund placement and investor relations capabilities, headed by senior members of the partnership who have deep knowledge of the theory and practice of the fundraising process as well as the inner workings of their firm. At face value, this trend appears to be a threat to placement agents, those middlemen (and women) making a living out of helping to persuade investors to entrust their capital with specific funds. The less knowledgeable of the fundraising process their clients are – placement agents get paid by the managers they represent – the greater their need for billable services. Disintermediation, arising from this growing number of general partners busily honing their DIY fundraising skills, is eroding the ground on which many a private equity fund placement business model has been built. Or as one head of IR at a recently fund raising partnership put it: “Why buy a dog and bark yourself?” Are placement agents an endangered species then? At first glance, there is no evidence of them disappearing from view. Of the many new campaigns being launched every year, only the very largest LBO groups (Bain Capital, Permira, Providence and BC Partners to give some recent examples), uber-popular North

American venture funds (Sequoia and Kleiner Perkins come to mind) and the doyen of multi-strategy, serial fundraising, The Carlyle Group, appear confident enough to brave the market entirely on their own. And even some of these firms have been known to deploy an external fund placement specialist on a particular mission – such as tapping a new community of investors. The high flyers aside, most managers still retain the services of outside advisors, regardless of how much in-house resource they may already have put in place. The challenge is to how best segment this market of potential clients. One fund placement veteran describes his universe of prospects as comprising every private equity group on the planet minus the top 10 percent of indemand partnerships that are able to raise any amount of institutional capital more or less at will, as well as the 30 percent of managers who the buy-side will refuse to back; the remaining 60 percent will require hard work that will ultimately pay off – which is where this particular agent sees his profession’s sweet spot. The reason why the majority of GP groups still favour using an agent is simple: even the most dedicated investor relations professional at a private equity firm is unlikely to be as permanently engaged in dialogue “with the market” as a placement agent looking after a portfolio of client relationships. As a result, the in-house specialists may find it more difficult to keep track of exactly how a given limited partner’s attitudes and investment requirements are shifting over time – especially if the limited partner in question is not an existing client but someone the manager would like to bring into a future partnership. Access to a placement agent’s first-hand knowledge of the shifting patterns amongst the buy-side can be a powerful supplement to in-house relationships and know-how.

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The loneliness of the long distance fundraiser August 2004

It was the trip back in the cab from the airport early Saturday morning that gave the IR manager time - too much time - to assess the likely outcome of the many meetings he and the managing partner had squeezed into the past four days (and three different cities). It’s not as if any of the sessions, many of them with existing limited partners in the firm’s earlier funds, had been bad. But none seemed to move beyond the pleasantly vague. All of these prospects had received the placement memorandum and had then taken the meeting: shouldn’t that indicate serious interest?

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But several of the current LPs had new people running their alternatives programmes now, and there was a clear sense that no GP was going to be able to assume an automatic re-up from these investors just because of history. As the managing partner hissed as they walked back into the lift from one such session: “This guy has got something to prove: and we’re going to be the proof.” All of which depressed the IR director. The nuances of modern fundraising were becoming starkly obvious to him now: how much pre-marketing one needed to do; how the timing of the subsequent “official” launch of fundraising set the clock ticking so that every day before the first close mattered; how the investment partners at the GP clearly wanted the buck to stop with him. Perhaps the decision not to use a placement agent had been premature? But when the new fund was being planned, those meetings with agents had turned out to be less than satisfactory. Several had politely declined to take the conversation forward. The top tier ones who had been involved in over-subscribed, rapid raisings were clearly able to be ultra-selective - and the GP’s track record had to be stellar.

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And talking of reputational hazard: no one at the GP wanted to be mandating an agent perceived as representing second or third tier funds. It was like a Saturday night dance: lots of wallflowers, plenty of eye contact but only the golden couples out on the floor. Neither agent nor fund wanted to be seen out with the wrong partner. People would talk. Then there was that particularly edgy session with one agent who told the managing partner that they were raising the new fund too soon, implying that a hunger for fresh management fee income was driving a premature launch. That was a rapid no. Time seemed not to be on the firm’s side either. Increasingly investors were wanting to see others commit before moving to a decision themselves, and as the pre-committal phase was dragging on, the mood seemed to change - at the GP as well as amongst the LPs. Previous decisions (who to see, what to say, when to say it) were revisited back at the office. Meanwhile investor attention drifted, no doubt because other eager fundraising GPs were lining up outside the LPs’ office. The IR director paid the cab and walked up the steps of his townhouse. Just time enough to sort some fresh laundry before Sunday’s flight to Asia. Would he still be on the road in a year’s time he wondered?

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Appendix Six: About Private Equity International Books

Our expanding range of in-depth market reports, research guides and directories cover the issues and trends shaping the asset class on a global basis. They offer private equity and other alternative asset professionals, investors, advisors and others involved in private equity and real estate the quality research, indepth analysis and insightful comment they need. Directories

These practically orientated, comprehensive and detailed publications profile investors in the private equity and real estate asset classes, as well as advisors, service providers and private equity firms. • The Global Limited Partners Directory The most comprehensive international guide to investors in private equity funds. This 990-page directory provides detailed, in-depth profiles of the private equity investment programs of over 870 institutional investors and advisors from around the globe. Built from the ground-up by a team of multi-lingual researchers, this directory is the most comprehensive, extensive and user friendly guide to current and active investors in the asset class available. An indispensable fundraising tool for those raising and marketing private equity and venture capital funds. • The Global Directory of Investors in Private Real Estate

tory is the most comprehensive, extensive and user friendly guide to current and active investors in the asset class available. An indispensable fundraising tool for those raising and marketing private real estate funds of all types. Market Reports

These highly specialised and targeted reports are aimed at covering technical issues or particular areas of the private equity industry in an incisive manner, providing readers with a valuable primer on these issues. • A Guide to Private Equity Fund of Funds Managers The definitive guide to the global private equity fund of funds market. This 276-page Market Report consists of indepth editorial from leading fund of funds managers, placement agents and advisors, along with the results of a survey into the dynamics and future of the fund of funds market undertaken with fund of funds managers, placement agents and LPs. Also contains the most comprehensive directory of fund of funds managers available, profiling more than 150 managers from around the globe, including contact details, investment remits and previous funds backed. This report is an essential purchase for anyone interested in understanding and raising capital from this increasingly important area of the private equity market.

• The UK LBO Manual A practical guide to structuring private equity-backed buyouts in the United Kingdom. Written and researched by leading international law firm Ashurst, this is the first in a series of country-specific guides that address all aspects of private equity-backed buyouts. Topics covered include: the development of the UK buyout market; the structure of leveraged buyouts; documentation; taking equity; debt and security; taxation aspects of LBOs; the impact of EC and UK merger control and anti-trust rules; public to privates; structuring equity incentives for management; insolvency; and more. This 156-page report is an essential resource for all those involved in UK private equity buyouts. • Private Equity Technology: Assessing the Alternatives An assessment of technology solutions and how they apply to private equity firms. This 222-page Market Report covers the importance and risks of technology, how technology specifically applies to the modern private equity firm and includes a detailed analysis of the technology solutions currently available to private equity firms. The guide is supported by a survey of investors’ use of and attitudes towards technology, along with a unique directory of private equity technology providers and their products/services. This guide is essential reading for anyone involved in developing a private equity firm’s technology infrastructure.

Funds

The only guide to investors in private real estate funds. This directory provides detailed, in-depth profiles of the private real estate investment programs of over 500 institutional investors and advisors from around the globe. Built from the ground-up by a team of multi-lingual researchers, this direc-

Contributors include Adams Street Partners, London Business School, Mowbray Capital LLP, O’Melveny & Myers LLP, Partners Group, Probitas Partners, SCM Strategic Capital Management, Standard Life Investments (Private Equity) Ltd.

• A Guide to Private Equity Fund Placement Specialists The definitive guide to private equity placement agents, this 120-page Market Report combines in-depth editorial with a global directory of agents and the results from surveying both LPs and GPs about their views on the role and contri-

THE GUIDE TO PRIVATE EQUITY FUNDRAISING

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bution of agents in the fund raising process. The book is filled with information and comment relevant to anyone involved with private equity funds and fund raising.

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Research Guides

It combines expert editorial from leading market practitioners with the results of two surveys of limited partners on the topics of fund terms and conditions and investor relations, alongside a number of unique case studies of actual recent fundraisings.

Cover the broader issues, themes and trends that are helping to shape the development of the private equity asset class. Consisting of in-depth analysis and comment, along with the results of surveys into the attitudes and opinions of private equity professionals and investors, these research-rich, multi-contributor studies provide readers with some of the most authoritative and substantive comment available on private equity.

Contributors include Arsenal Capital Partners, ATP Private Equity Partners, Campbell Lutyens & Co. Limited, Clifford Chance LLP, Helix Associates, Indigo Capital Limited, Macfarlanes, Mezzanine Management UK Limited, Montagu Private Equity Limited, Monument Group, MVision Private Equity Advisers Limited, Odlander, Fredrikson & Co AB, SJ Berwin.

• The Guide to Private Equity Fund Investment Due Diligence A detailed study into performing due diligence on private equity and venture capital funds and managers designed to assist institutional investors in making investment selections in this inefficient asset class. This 212-page Research Guide includes contributions from leading institutional investors in private equity funds, placement agents, fund managers and investment consultants and advisors. It combines indepth editorial with a global directory of consultants providing specialised private equity advice to institutions, along with the results of a in-depth survey into limited partner attitudes towards fund investment due diligence.

• Routes to Liquidity A detailed study of how liquidity is being brought to the asset class. This 224-page Research Guide includes contributions from leading players in the liquidity field, combining in-depth editorial with a global directory of secondary buyers and advisors, along with the results of a unique survey into the attitudes towards the secondary market of buyers, sellers and GPs.

Contributors include AlpInvest Partners N.V., Cooley Godward LLP, Dow Employees’ Pension Plan, Key Capital Corporation, Mark Weisdorf Associates Ltd., Pacific Corporate Group LLC, Pantheon Ventures, Pension Consulting Alliance Inc., Probitas Partners, Proskauer Rose LLP, SJ Berwin, VCM Venture Capital Management GmbH, Watson Wyatt & Company. • The Guide to Private Equity Fundraising A complete and in-depth examination of all the issues surrounding private equity fundraising. This Research Guide includes contributions from leading general partners, private equity placement agents, legal advisors and limited partners.

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Contributors include Camelot Group, Campbell Lutyens, Capital Dynamics, Cogent Partners, Coller Capital, Debevoise & Plimpton, Deutsche Bank, Goldman Sachs, Greenpark Capital, Landmark Partners, Lexington Partners, LGT Capital Partners, London Business School, New York Private Placement Network, Pantheon Ventures, Partners Group, Paul Capital Partners, Pomona Capital, Probitas Partners, Schroder Ventures International Investment Trust, SJ Berwin, Standard & Poor’s and Vision Capital.

If you have any queries about Private Equity International’s current and forthcoming research publications please contact: Nick Gordon Head of Research Publications Private Equity International Second Floor Sycamore House Sycamore Street London EC1Y 0SG United Kingdom +44 (0)20 7566 5437 [email protected]