Over the summer, two storied European private equity houses were putting the finishing touches on milestone deals. Partners at EQT in Stockholm and BC Partners in London were both lining up an infusion of capital aimed at supercharging growth in their already sizeable private equity franchises.
While the two deals were set to raise similar amounts – both around the €500 million mark – the two firms were pursuing different paths. In what has become an increasingly rare move in modern private equity, EQT confirmed plans to list on the public markets, joining its long-time shareholder Investor AB on NASDAQ Stockholm.
BC Partners, on the other hand, was busy inking a private transaction to sell a minority interest to Blackstone’s Strategic Capital Group. In doing so, BC joined a fast-growing list of firms to have raised permanent capital from specialist investors. The three largest buyers – Dyal Capital Partners, Blackstone and Goldman Sachs’ Petershill Funds – have been linked to at least 32 deals with private capital firms, most of which have happened in the last 18 months, according to research by sister publication Private Equity International. Advisors in this area say the number of such deals is closer to 40 in the last two years.
While these three investors account for a large share of the market, other investors are also active. Wafra, which is backed by the Public Institution for Social Security of Kuwait and partners with other global asset owners, has invested in 16 GPs, according to senior managing director Daniel Adamson, with most of these deals coming in the last three years. Advisors also point to RDV Corporation, the DeVos family office, as being an active participant in this market.
New entrants are currently raising capital to invest in this market: Aberdeen Standard Investments is raising $1 billion for its GP interests program, Bonaccord Capital Partners, while StonyRock – launched by former Blackstone and Carlyle AlpInvest execs – is partnering with Jeffries Financial Group also seeking $1 billion.
What’s the money for?
Typically, these deals involve combinations of both primary capital going back into the business and secondary capital going into the pockets of the selling shareholders. “Most of the time the majority of capital being raised is primary capital to grow the firm, not secondary capital,” says Herald Ritch, the founder of DC Advisory US, who advised lower mid-market firm MSouth on a minority stake sale to Aberdeen’s Bonaccord in June this year.
There are plenty of uses for the primary capital. As fund sizes grow, for example, the need to commit more to one’s own funds – both in relative and absolute terms – becomes more pressing. Research from law firm MJ Hudson this year found that 35 percent of all funds had a GP commitment of 3 percent or more, which is an increase on each of the prior three years.
Then there is the question of transitioning ownership of the firm’s economics to the next generation. As a GP stake sale allows senior partners to monetize a portion of their equity, it allows the next generation of leadership to participate in the transaction – either in the form of loans from the balance or a simple allocation of capital – to buy out the senior partners or increase their participation in subsequent GP commitments.
The other reasons for raising external capital are all about growth, like funding expansion into new geographies and hiring talent. “It brings an extraordinary ability to grow the business,” says Daniel Lavon-Krein, a senior partner in law firm Kirkland & Ellis’ investment funds group. “If you look at the deals that have been done, after every deal the sponsor pours money into new strategies, new offices, new products and they bring in extra operational resource to, for example, raise capital in a new market.”
Lavon-Krein’s team advised on Blackstone’s investment in BC Partners and is understood to have worked on most major GP interest transaction this year. According to sources, Kirkland is one of a handful of law firms to have developed a deep track record in this type of transaction. Other firms cited by market sources include Fried Frank, Simpson Thacher, Wilkie Farr & Gallagher, Debevoise and Holland & Knight. In terms of what gets sold, “the vast majority of these deals have been 20 percent or less at the outset,” says Saul Goodman, head of the alternative asset management practice at investment bank Evercore.
Better call Saul
Few people are better qualified than Goodman to opine on the shape of these deals. He has advised on transactions involving New Mountain Capital, Lexington Partners, Providence Equity Partners, Vista Equity Partners, Silver Lake Partners, Platinum Equity, Leonard Green Partners , Starwood Capital and Bridgepoint, the owner of PEI Media, as well as many others. The firm has been part of 35 minority interest deals in recent years. This summer he added BC’s investment from Blackstone to his credentials. Evercore is the 800-pound gorilla in this space.
The headline percentage of the stake sold in these deals is often less than 20 percent, because it might comprise a 20 percent stake in the management company, “but half of these deals are done with a non-congruent stake of the performance fees,” says Goodman. “When you blend it all together, it might only be 12-13 percent of the overall economics, with many even lower.”
The percentage stake is not really of paramount importance to either the investor or the seller, Goodman adds. “The investors aren’t solving for a minimum percentage ownership, because they are getting the same limited governance protections anyway; they are focused on the strip of economics they are purchasing. The sellers aren’t solving for a percentage either; they are looking at their business plan needs and any secondary proceeds, if desired.”
Advisory sources differ as to how templated these deals have become, but a “typical” deal, if such a thing exists, will involve the acquisition of a percentage of the management company – and the management fee income that comes with it – plus immediate participation in the carry vehicles, as if they had been an investor on day one. These are permanent capital deals, so investors are buying into these income streams in perpetuity. Existing GP commitments can also be thrown into the deal. In some instances, the incoming investor can also pledge to cornerstone future funds as a limited partner.
How much is my firm worth?
“If you are only selling 10-15 percent of the economics and some of that might be going back into the firm, then valuation is not the most important piece of the puzzle,” says Goodman. “This market focuses on long-term cashflow and franchise value; not just putting a multiple on current earnings,” he notes, adding that the management company and carry vehicles are valued differently.
Goodman stresses that these private markets investors do not look to the publicly listed firms for comparables. “The private market is separate and people are looking at a much longer time horizon – not just the next year or two.”
Most advisors are, understandably, reluctant to outline any sort of “back-of-the-napkin” approach to valuing a PE firm. For one thing, they don’t want to publicize commercially sensitive information. “No, no, no,” chides one banker when asked if there is a ready way a CFO can put a valuation on their own firm. “They are valued on a DCF basis – very complicated models – but I don’t want to get into it for competitive reasons. Given the long-life nature of these investments – not just one fund, but multiple fund cycles – these tend to be long-dated models.”
Another advisory source breaks it down more willingly: “Assuming a typical 2-and-20 structure, we would advise that the firm is worth around 10 percent of its AUM, and maybe you would look to sell 5 to 10 percent of the firm.”
“It is a small set of financial and legal advisors who know the deal pricing, deal structures, terms, fit and preferences of the buyers,” says Ted Gooden, head of private markets advisory practice at Berkshire Global Advisers, “so you need to go to someone with multiple reference points of competed deals.” Gooden has advised on a number of GP interest transactions, including Clearlake Capital and Siris Capital.
Am I big enough?
There is no litmus test in terms of AUM or maturity to tell whether a transaction like this will work for you, says Goodman. “Obviously it works better the bigger you are, the longer you have been in business and the more profitable, but it’s not like there is a checklist covering certain metrics which have to cross a certain threshold.”
One restriction on whether your firm will be a suitable target is the size of check that investors are looking to cut. Advisors say that the largest investors in the market will want to deploy circa $150 million to $200 million at a minimum.
Wafra, however, invests across the entire GP lifecycle: “We’ll be the first dollar in, catalyze growth or partner with mature managers,” says Adamson. The majority of its GP investments have been in younger firms. What Wafra is looking for is “defensible franchises in asset classes and strategies that have enduring value for asset owners around the world,” adds Adamson. In other words, if you have proven your ability to invest well in a segment that is in favor with global investors (with which Wafra boasts intimate knowledge), you may be of interest regardless of size.
Where do I start?
Perhaps unsurprisingly, advisors extol the virtues of getting seasoned advisors – both legal and financial – on board. “There are very few people who have actually done these, and you don’t want someone learning by doing on your deal,” says one banker.
There is some structuring work to be done to ready a GP for external investment. “It is a great way of institutionalizing a firm,” says Kirkland’s Lavon-Krein, “because you need to create a neat top holding company. It is basically almost like preparing for an IPO. From a legal perspective, you need to go through a restructuring; any lax documentation needs to be cleaned up. You need to put policies in place and you cannot have any informality about your processes. There is starting to be a well-trodden path in terms of what this looks like.”
With the legal house in order, there is also the economic house to get into shape. A process such as this prompts conversations about key persons and economics sharing within the team, which can either be cleansing or awkward.
Peter Martensen, a partner with advisory firm Eaton Partners, says he has advised on four strategic GP transactions in his career. “It triggers a conversation about the long-term plans: who will be in charge when the boss gets hit by a bus? A lot of times it is cathartic; sometimes it is not. These are conversations that should have happened already but never did.”
There needs to be a clear rationale for the transaction in terms of what the GP will be doing with the proceeds and what they are looking for from a partner. Wafra, for example, will avoid GPs who are “purely looking for a financial transaction,” says Adamson.
These deals are, ironically, about more than just capital. When BC Partners announced its transaction with Blackstone this summer, partner and chairman Raymond Svider said, “We look forward to leveraging Blackstone’s best-in-class resources and exceptional talent.” Those resources were not specifically identified, but likely refer to portfolio company cost savings, back office perks, new platform advice and introductions. GPs considering a deal should know what they want to achieve and what capital and resources they need to do it.
Where to now?
These deals are sensitive subjects. None of the GPs contacted for this article were willing to discuss their own transactions. Speculating on why this might be the case, most contacts attribute it to the optics of what their LPs might be thinking. “It is not as commonly accepted as it should be,” says one banker.
Looking at the roster of names that have undertaken these transactions – and their subsequent fundraising success – there is certainly no evidence to suggest investors are being put off.
The trend is broadening and deepening, says Goodman, with more interest being shown in credit managers, real estate managers, infrastructure funds, mid-market firms, VC firms, as well as a large increase in activity in Europe: “It is becoming commonplace and viewed more as a financing than a transformational event.”
Berkshire’s Gooden is equally positive. “This is a positive and exciting discussion to go through. If you know what you are doing and have the right advisory, you get a chance to look at your firm and scrutinize your strategy, succession planning and long-term capital needs.”