What is the future for private equity fund structures? Saïd Business School Private Equity Forum March 2015

Transcription

1 What is the future for private equity fund structures? Saïd Business School Private Equity Forum March 2015

2 The rationale for outsourced asset management Requirement for focus versus the need for diversification Focus increases the chances of success Space Knowledge specialisation Access to talent and capital Human constraints Diversification mitigates the impact of failure Volatility of price Structure Fraud Outsourcing is optimal for most portfolio investors, but is not cost-free Price/Incentives Manager-Agent constraints 2

3 Traditional Private Equity model Current model is the best of a bad bunch of options: Cleaner than a corporate structure Separates GP from the cash Neuters co-investors Gives GP the certainty of available capital Gives GP clear decision making powers and control Sensible incentives based on cash-on-cash returns General Partner LP LP LP LP Commitments 2% and 20% 8% hurdle Biggest problems with structure: Requires sale of assets to crystallise value (and pay team) Requires sale of assets to prove performance (and raise another fund) Incentivises larger deals and bigger funds Pressure of fund raising cycle Optionality means biggest loss to manager in bad fund is opportunity cost 3

4 Institutionalisation of Private Equity When a style of investing becomes an asset class: Cost of capital demanded falls (pension fund versus private investor) More capital means potential for alpha generation falls Institutions demand transparency further levelling the playing field Industry develops institutional passive benchmarking culture where there was once an entrepreneurial absolute return culture The business of asset management outweighs desire to invest to make extraordinary returns management fee enriches manager, performance fee is a free option Principal / Agent relationship is distorted further investors have less contact with manager and trust levels between them weaken Massive distortion Reduced chance of making extra-ordinary returns 4

5 Buy and hold Investment Strategy Buy and Sell What are Permanent Capital Vehicles? Corporate/fund structures with an emphasis Listed Liquidity Unlisted on: Long term capital Buy and Hold Cash-flows / Proceeds reinvested ABC Group Stable and aligned management team PCVs have advantages compared to typical closed-end PE funds: Time to build up value in investments No exit pressures from fund raising cycles Flexibility to make long-term strategic decisions The PCV Conundrum: If there are no liquidity events, there are no Carried Interest distribution opportunities How to keep management motivated and aligned? 5

6 Case Study 1: JAB / Reimann Family JAB is privately held, family controlled group, focused on long-term investments in companies with premium brands, attractive growth and strong margin dynamics. JAB currently has meaningful a stakes in 4 businesses: Reckitt-Beckinser, Coty (Ticker: COTY), Labelux and more recently JCF. JAB is currently owned by 4 Reimann siblings, each owning 24% of JAB. The 3 managers of JAB, Bart Becht, Peter Harf and Olivier Goudet collectively own the remaining 4% of JAB. Bart Becht's total compensation package during his ternure 100,000,000 90,000,000 80,000,000 70,000,000 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000 0 Long Term Incentives - Options Long Term Incentives - Performance Shares Other Benefits, such as Pension and other benefits / payments Bonus Base Salary CAAG per year (%) EPS growth over three years (%) % of options and shares vesting Source: Bloomberg and Reckitt Beckinser s Annual Reports and Financial Statements

7 Case Study 2: ABC Group ABC Group intends to buy high-quality, middle-market businesses using the skills, processes, and discipline of a high-quality private equity firm, but in an efficient corporate structure. Its strategy is to buy and keep good companies, without selling them. Equity co-investment: Founder s commitment will be at least 6.5% of the equity capital ($65million), paripassu with shareholders, in order to create alignment with investors. Restricted Shares: Management receives 10% as Founder Shares as a long term incentive plan For the purpose of dividends, distributions and returns of capital, Founder Shares are ranked junior to ordinary shares until NAV plus prior dividends is greater than 1.1x. Founder Shares are not sellable, except to a family member or trust. Founder Shares will be only convertible to ordinary shares (and thus sellable) when NAV plus prior dividends is greater than 1.65x. Base Salary based on budget approved by the Board, and capped at 1.7% AUM. Cash Bonus: Up to 20% at the discretion of the board. Long-term incentive plans: share-based grants to management at the discretion of the board, based on performance (similar in concept to Founder Shares). The amount of shares to grant will represent 10% of the appreciation of the value of the company over 1.0x NAV 7

8 Conclusions Traditional model still works for Institutions Solves the Focus/Diversification dilemma Requires less structural due diligence due to weak co-investor rights Others look to different structures to solves for constraints of existing model Desire for Buy and Hold Fear that success leads to larger funds Are Permanent Capital Vehicles the answer? Maybe, but hard to do with >1 anchor investor. Need to solve for both incentive problem and co-investor risk Berkshire Hathaway and Reimann Family may be holy grails Both started pre-pe explosion Both had strong leaders single person with a lot of control Both started with initial private capital that believed in model Those that are trying to build PCV for >1 investor find themselves tripping up on many these issues. 8