Week 2 Flashcards
PE Funds / Key Players / PE as an asset class
Limited Partnership Model (Pooled Fund)
Funds of Limited Partners pooled and invested into Portfolio Companies.
Managed by Fund Manager
Private Equity Funds
- Managed by specialist managers
- Pooled funds - managed by third party
- Blind funds - investors have no control over investments
- Investment focus – venture / buyout
- Fixed life
Limited Partners vs. General Partners
LPs are investors
GPs are fund managers
Liabilities:
LPs - limited to capital commitment to fund
GPs - unlimited liability (but setup separate limited company to act as GP)
Fixed life - 10 years
Types of Capital
Allocated - total amount of capital which investor would like to have invested at any one time
Committed - LP legally agrees to provide
Drawndown - committed capital drawn down
Invested - drawndown capital invested in companies
Limited Partnership (Usage and Legal)
- Popular with US and UK investors
- Tax transparent - entity does not exist for tax purposes and LP is treated as investing directly
- Terms and conditions
- Anglo Saxon law
- Not compatible with law in some countries
- Alternatives (covered later)
USA and UK - closed end fund with limited lifetime common
Europe - open end fund (evergreen), however, incentivises managers to force exits and no mechanism to return capital to investors
LP liability for debts and obligations is limited to amount of capital committed, Must remain passive and have no involvement in day-today operations.
The General Partner Relationship
LPs provide bulk of money for fund, liability is limited by committed funds + no say in decision making.
The GP is effectively the fund manager. Unlimited liability but usually set up as a special purpose company –> ring-fenced by VC firm and executives to protect the partners from having unlimited liability.
GP partners expected to add to fund (usually 1-2%, can be as high as 10%). Done through the carried interest vehicle.
General Partner structure
Keep operational infrastructure and investment activity separate from PE funds:
- unlimited liability, tax and regulatory issues
- PE fund – limited duration
- PE firm – investment continues over several fund lifetimes
Carried interest vehicle: contributes capital from GP partners into PE fund ; receives carried interest of 20% from PE fund
GP fund manager (special purpose limited company) – receives management fee from PE fund
PE firm (investment management activities): receives advisory fees paid of out of management fee, pays salaries, lease offices, own VC brand name
PE fund: receives capital; pays 80% of profits to LPs
Types of General Partners
Independent - owned by executives, created as start-ups or acquired as spinout from previous institutional owner
Captives - subsidaries of major financial institutions or banks; invest from parent company’s funds.
Executives are salaried, bonuses rather than carried interest - has led to high profile defections of captive teams. But advantage of no 10 year fund cycle.
Semi-captive - part of larger financial institution but manage funds through limited partnership structure including capital raised from external sources.
Focus of General Partners
- Stage of investment
- Preferred business sectors
- Amount of investment
- Geographical preferences
HANDS ON or HANDS OFF APPROACH
Fund of funds
Managed by team familiar with performance, investment focus and characteristics of private equity firms. Institutional investors invest in fund of funds; fund of funds select individual funds. F of F typically allocates capital to 15 or more separate funds; F of F managers select and manage relationships with managers of each fund.
Gatekeepers
Specialist advisers who assist institutional investors in their private equity allocation decisions. Institutional investors with little experience of the asset class or those with limited resources often use them to help manage their private equity allocation and screen GPs who approach them during fundraising.
Gatekeepers usually offer tailored services according to their clients’ needs, including private equity fund sourcing and due diligence through to complete discretionary mandates. Most gatekeepers also manage fund of funds.
Secondary funds
Route through which investors can sell their holdings before the end of the fund, usually at a discount to their estimated value on realisation.
Placement agents
The traditional role of a placement agent has been to introduce General Partners (GPs) to suitable investors (eg MVision, Helix Associates, Acanthus Advisers).
However, as market conditions have toughened, investors have raised the quality bar and have begun to ask more demanding and sophisticated questions of GPs. The latter have therefore faced heavier demands on their time: preparing sufficient pre-marketing material; attending first, second, third and even further meetings with investors; and fielding manifold and detailed follow-up requests.
The role of the placement agent has therefore broadened to include advice to GPs on how to approach investors; assistance with pre-marketing preparation; and project management of an increasingly complex fund-raising process. Fees based on percentage of funds raised (usually 2%) plus a retainer. Placement arms of investment banks may charge less due to cross-selling opportunity; competition for deals forces fees down.
Advisers
Legal and Financial
Alternatives to typical Limited Partnership model
Evergreen funds (corporate or LP)
- no limit on life of fund (incl. re-invest proceeds)
Deal-by-deal and pledge funds
- funding for each investment as occurs
Listed vehicles
- quoted PE companies
Venture Capital Trusts (UK)
- quoted funds offering private investors tax breaks
Single investor funds
- banks/corporate investors want close control over investment strategy (eg for access to R&D, new markets)
Co-investment
- institution invests directly into portfolio companies alongside PE fund
Private Equity as an asset class
- Superior returns
- Diversification
- Increasing professionalism
- More focus on training
- Greater regulatory influence (eg FCA and Walker in UK)
- Consistent standards:
- Reporting
- Valuation
- Investment performance?
Private Equity Drivers
- Investment Opportunities
- Demand for PE
- Infrastructure for PE
- Exit Routes
Advantages of investing in Private Equity for the investor
Advantages
- Returns outperform markets
- Diversification
- Investment expertise of manager
- Developing markets
- Inside information
- Access to entrepreneurial talent
Disadvantages of investing in Private Equity for the Investor
Disadvantages
- Illiquid; long-term
- Needs specialist expertise / reliance on fund manager
- Blind pool investing
- Fees paid to managers
- Returns not so superior if risk adjusted
Private Equity investor asset allocation ranges
- 0 – 5%: little impact (typical for Europe)
- 5% - 10%: building portfolio
- > 10%: needs:
- specialist investor expertise,
- long-term viewpoint,
- access to best performing GPs
Allocation based on considerations such as:
- absolute size
- relative size
- composition of existing portfolio
Fund Strategy
- Fund size
- Stage of investments
- Sector focus
- Geographic focus
- Investment size
- Target portfolio size (# investments)
- Management approach
- Institutional quality funds versus first-time funds; first time teams
- Market timing – vintage years
- No of funds
- General partner attributes (track record, consistency, management team, succession, style (hands on/off etc), industry expertise)
- Fund differentiators (USPs)
Institutional Quality Funds vs First -time funds (+ teams)
IQ Funds - Financially strong, established brand that works with high-quality LPs. Clear strategy and track record.
First-time funds - run by experienced fund managers, maybe in niche industry sectors.
First time teams - business angels who partner to create a fund. Difficult to get off the ground.
Market timing
Marked differences in performance from one vintage year to another. In order to ensure participation in better years, better to invest consistently rather than predict vintage years.
Fund Strategy - other considerations
- Generation of dealflow
- Financial structuring / use of debt
- Syndication
- Due diligence approach
- Adding value / monitoring investments
- Achieving exits
- Economic, political and regulatory environment
