Carried Interest

The Placement Agent . . . helping slay the dragon

 

Photo credit: Wili Hybrid

A reader asks:  what fee does a placement agent charge?

A placement agent helps private equity firms raise an investment fund as quickly and painlessly as possible.  Some well known players include Helix, MVision and Probitas.  In Australia two boutique agents are active, Principle Advisory and Brookvine.

The best placement agents provide their fund manager clients with a wide range of services.  For example, most agents:

• Help define the fundraising strategy and address weaknesses in the story
• Develop the marketing materials such as the presentation deck and the PPM
• Coach the team on presentation skills to ensure the pitch is succinct but compelling
• Pull together fund due diligence materials and set up a data room
• Introduce potential LPs who have been qualified and are seeking to invest.  Importantly, the agent should determine the order in which LPs will be approached because some investors are more likely to lead a first close or bring a "market brand" to the fundraising
• Advise the manager on fund terms and assist in finding a middle ground with the LPs
• Play travel agent by scheduling roadshows, booking flights, and generally ensuring that the process is as efficient as possible.

In answer to your question:  placement agents get paid a lot.  They normally receive a percentage of the money they help raise . . .  2% - 2.5% is the typical range.  The fee paid will be lower if the agent does less for the PE manger (for example, just makes LP introductions). 

The placement fee is usually paid over a couple of years, so the GP can use management fees to cushion the cash pain.  Some agents take a portion of their fee in equity, that is, they reinvest it in the fund as an LP.  This is an increasingly popular model because it minimises the upfront cash drain on the manager and also closely aligns the interests of the agent with the investors that he has introduced.

Fundraising Watch - #3

According to Private Equity Online CHAMP has declared a first closing for their new Fund III at $400m.  I heard the same thing from one of CHAMP's primary advisors, so I'm pretty confident the rumour is true. 

The good news is that they finally got there.  The bad news is that they aren't even close to their $1.5 billion target.  I suspect it will still be a respectable fund raising though.  In this market many LPs are reluctant to participate in a first close, but may well be willing to open their cheque books for a final close in 2010.

CHAMP holds A$400m first close

Siddharth Poddar

Australia- and New Zealand-focused buyout firm CHAMP Private Equity has raised A$400 million ($341 million; €238 million) for the first close of CHAMP III Funds, four sources have confirmed with PEO.

The firm is targeting commitments of A$1.5 billion for the final close of its fund, which is likely to be held in the first part of 2010, a source close to the firm said, adding that the fund has seen strong interest from existing investors.

CHAMP Private Equity declined to comment.

CHAMP III will continue to invest in mid-markets in Australasia, Bill Ferris, executive chairman and co-founder of CHAMP Private Equity, told sister publication PEI Asia in an interview in January. He said the firm's investment focus will be on Australia and New Zealand, but it will have the ability to consider transactions in Southeast Asia, a market where the firm has made investments in the past for its portfolio companies.

CHAMP will look to make about 12 investments from its third buyout fund, Ferris said at the time. In terms of sectors, the fund will focus on health, education, financial services, food and in companies providing services to the minerals sector.

Its predecessor fund, CHAMP Funds II, closed on A$950 million in September 2005. The firm's first buyout fund was an A$500 million vehicle that closed in mid-2000.

The New Private Equity Normal

 

Credit: Marc Johns

Every meeting I attend includes a mandatory conversation about green shoots, share market rallies, the IPO window, and whether banks are open for business again.

I think it's worth stepping back and considering what the "New Normal" means for private equity. Can we identify any fundamental shifts in the model, changes that will last for 3-5 years, not 3-5 months?

I'm confident that The New Private Equity Normal includes:

Fewer firms:  As I've written before, 30%-50% of private equity firms will disappear in the coming years.  Which is good.

Tougher fund terms:  Predictions about the end of the 2/20 model are nonsense, but at the margin we will see a swing in favour of the LPs, particularly for new funds which are still building a track record.  Expect to see movement in areas like the treatment of transaction/monitoring fees, the distribution waterfall and advisory board powers.

Longer hold periods:  private equity is supposed to be patient long-term capital.  This was forgotten during the equity boom.  5-7 year holds are back, a 3 year hold is the new quick flip.

Much less debt:  50/50 debt to equity is going to be the standard for the foreseeable future.  Not a big change for the mid-market, but it redefines the buyout sector.

Continued development of GP operating skills:  Leverage and multiple expansion are no longer available to drive easy returns.  GPs are going to have to build value through earnings growth . . . and that means (really) helping improve portfolio company performance.  McKinsey predicted this trend years ago, but the credit boom and strong equity markets allowed many PE managers to cheat, to rely purely on financial engineering.  The future?  Look at firms like KKR.  They have a team of 40 consultants called Capstone whose sole focus is on building value within the KKR portfolio.

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What do you think defines the New Private Equity Normal?

(btw, if you're shy you don't have to leave an email address to make a comment)

The Waterfall

 

Photo: Arnar Valdimarsson

A reader has just been hired by a fund-of-funds and asks:  "what does my boss mean when he talks about a European distribution waterfall?"

Simply, the waterfall refers to the sequence in which proceeds from the sale of a portfolio company are distributed.  European private equity funds don't usually pay carry to the fund manager until all capital that has been drawn down has first been returned to the investors. 

European Waterfall

- All drawn down capital is repaid to the LPs (cash that was called for realised and unrealised investments, management fees, other expenses of the fund), then

- The investors are paid a preferred return on all drawn down capital.  This hurdle rate is typically an 8% IRR.  And only then,

- The manager starts to get a 20% share of the remaining proceeds (usually with a catch up). 

An American waterfall is more GP friendly.  Most American private equity managers begin to receive a share of the profits (carry) as soon as they have returned the drawn down capital and paid a preferred return on the fund's realised investments.  They don't have to return capital on investments that still remain unrealised within the fund . . . this difference can bring forward carry payments by many years.

Hope this helps. Enjoy your new job!

Questions Continue about Gresham Model

In a recent post I mentioned that Gresham Private Equity is still trying to raise a new $600m fund.  One reader commented on Gresham's unusual relationship with corporate giant, Wesfarmers:

Gresham model is not sustainable. Wesfarmers are under serious pressure from equity analysts to stop backing the PE fund (or ideally divest the entire Gresham asset) . . . Gresham may not like it, but the PE team may have to spin out to survive.

It looks like he knew what he was talking about.   Wesfarmers reported their financial results yesterday and this is what Merrill Lynch analyst David Errington had to say:

The one aspect of Wesfarmers that we find totally unacceptable is its foray into private equity investments via Gresham Partners.  This year Wesfarmers lost $57m via its investments in Gresham . . . .

Why a large and respected company like Wesfarmers, that not long ago paid $19bn for the underperforming Coles businesses, is still undertaking investments in private equity ventures is totally beyond us.

We just don't understand it . . . and disagree with the strategy to continue investments.  The sooner Wesfarmers exits from private equity investments in partnership with Gresham Partners, the better we believe it will be for shareholders. 

Ouch.

Can Australian Private Equity Still Sell-Down?

Lead managers and underwriters for the hotly anticipated IPOs of Myer and Kathmandu should be appointed within the next week or two.  It's important that these two listings are well received by the market because they will set the tone for a long list of upcoming Australian private equity IPOs.

I'm curious to see what sell-down the market accepts.  Historically Australia has been unusually tolerant of private equity owners that cashed in their equity chips at IPO.  Sell-downs of 70%-100% were the local norm. 

By contrast, in the United States a private equity sell-down of 20%-50% of the fund's shareholding would be more typical and in Hong Kong the sell-down is usually limited to less than 40%.  The balance of the PE fund's shareholding is escrowed for 6-12 months or for the prospectus forecast period.

Fund Raising Watch - #2

Still no first closing announcement from CHAMP or any of the other Aussie fund raising hopefuls.

I understand that NAVIS (Malaysian based but with an office in Sydney) has finally reached a first closing of US$400 million.  They were originally targeting US$2 billion for their Fund VI, but cut the target back to $1.25 billion when the GFC hit.  Frankly, with a first closing at $400m you have to question whether they will even come close.

Speaking of NAVIS, here's an interesting interview with Nick Bloy, one of the firm's two managing partners.

It's a Buyer's Market

  

Credit: Natalie Maynor

I had lunch yesterday with one of the top M&A lawyers in Sydney.  We talked about the dramatic decline in prices being offered for assets, and he commented on an equally clear shift he has observed in the deal terms that private equity firms are demanding before they'll invest.

Some of these "buyer's market" changes include:

Earn-outs are becoming more common in PE deals.  This slightly surprised me because earn-outs (where the total purchase price paid depends on the future performance of the company) are notoriously painful to negotiate and their enforcement can do more damage than good.

Escrow of sale proceeds:  PE firms are increasingly insisting that a portion of the sale proceeds be placed in escrow to provide security for potential warranty claims.

Seller liability caps on warranties are increasing, with caps of 50% or more of the purchase price now common.

Warranty and indemnity time periods have lengthened . . . 2-3 years is the new 12 months.  Warranties are also more likely to be given at both signing and completion, and the de-minimis levels for warranty claims have come down.

Material Adverse Change (MAC) clauses are being included in most transactions to protect against a negative event between the time of entering into a purchase agreement and closing the deal.

Non-compete provisions are extending . . . though uncertainty and debate still remains about their enforceability.

Lesson Learned #6 - Great Trade Exits

Great trade sales happen when someone wants to buy your business, not when you want to sell it.  The best trades sales happen when someone needs to buy your business. 

When you think about potential buyers for a portfolio company, an important question to ask is this:  who has an existing revenue-generating relationship that they want to preserve or extend?

For example:  we owned an importer and distributor of an industrial product.  Our business had almost 70% market share in Australia and New Zealand.  The raw material was supplied by one offshore company under an exclusive contract. 

The CEO of our business mentioned that his shareholders were considering an exit . . . and just seven weeks later the offshore supplier owned our company.  They simply weren't willing to take the risk that one of their global competitors might snap it up and lock the market away forever.

Ready to Jump - IPO Watch

 

Photo: DefenceTalk.com

IPO markets around the world began to gently reopen in Q2, and a number of listings were successfully completed in North American and Asia.  Australian equity managers have shown no appetite for IPOs since late 2007, but they certainly haven't been sitting on their hands.  Our equity markets have experienced extraordinary levels of activity driven by de-gearing and de-risking of ASX companies.  In fact, Australian equity issuance represented 18% of global issuance in Q1. . . pretty incredible for a country of just 22 million people.

The Australian recap process is now largely complete, our banks are in good shape, the ASX has been experiencing a sustained rally, and consumer confidence is surprisingly strong.  Many of our superannuation funds and small cap managers missed the recent rally and urgently need to rebalance cash-heavy portfolios. 

It all adds up to a private equity led Aussie IPO boom in Q4.

There's a backlog of IPO quality companies sitting in Aussie PE portfolios and it's been a long time since most of the teams banked a carry cheque.  Is that fresh prospectus ink I smell wafting from office buildings across Sydney?

IPO watch candidates include:

Myer (Australia's largest department store family, TPG Capital)

NDA Group (Stainless steel fabricator, RMB Capital Partners)

Ascendia Retail (Sports stores, Archer)

iNova Pharmaceuticals (old 3m Asian pharma business, Archer)

Healthcare Australia (CHAMP)

Kathmandu (Outdoor clothing and equipment stores, Quadrant and GSJBW)

Link Market Services (Share registry, Pacific Equity Partners)

And in the medium term:  Device Technologies (Medical device distributor, RMB Capital Partners), Mastermyne (Coal mining services, CHAMP Ventures), Hoyts (Cinemas, Pacific Equity Partners), ATF (temporary fencing, Quadrant)