This is intended for investment professionals, and not for retail use. GP Trends 2017/2018

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1 This is intended for investment professionals, and not for retail use. GP Trends 2017/2018

2 Investec Bank plc This material is issued by Investec Bank plc ( Investec ). The opinions and views expressed are for information purposes only and are subject to change without notice. They should not be viewed as recommendations or investment, legal, tax, accounting or other advice of any nature and recipients should obtain specific professional advice from their own appropriate professional advisers before embarking on any course of action. Investec Bank plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered under Financial Services Register reference Investec Bank plc is registered and incorporated in England and Wales No and has its registered office at 2 Gresham Street, London, EC2V 7QP. February Investec Fund Finance GP Trends Survey 2017/18

3 Contents From each end spring new beginnings 4 Blockbusting buyout funds 8 Commitment, commitment, commitment 14 Room at the top 18 Selling out 22 Gender issues 24 A word of thanks 26 Conclusion 27 Investec Fund Finance GP Trends Survey 2017/18 2

4 More than 90% of participants in this year s study are at least as happy as they were in their careers 12 months ago.

5 From each end spring new beginnings Investec s eighth annual GP Trends survey hits your desk at a time when some of private equity s pioneers have begun to look at retiring, leaving the industry they founded in the hands of a new generation of leaders. Some senior hands have anointed successors and others have already circled the last day in the office on the kitchen calendar, but what does this mean for the industry? The men and women (but mostly men, as we shall see) who built private equity from the ground up are leaving an industry that is stronger than ever, as it enters a new age of maturity and challenges to its traditional classification as an alternative asset class. Yet, as private equity becomes ubiquitous in institutional portfolios and its influence on the economy grows, it has to contend with greater scrutiny, both from politicians and from its biggest supporters: investors in private equity funds. Whilst politicians have, for a long time, eyed financial sponsors with suspicion, Limited Partners (LPs: investors in private equity funds), are increasingly aware of the reputational risks they themselves face if they don t take their fund managers to task over environmental, social and governance (ESG) issues in their portfolio companies and in the General Partner (GP), itself. Investec Fund Finance GP Trends Survey 2017/18 4

6 Despite the upheaval of an oncoming wave of succession issues (in our sample, more than one in eight Managing Partners thought they might leave their firm in the next 12 months) and the pressure of increased scrutiny, individuals working in private equity remain upbeat. Many GPs are expecting to raise significantly larger funds when they next come to market. Some anticipate raising more than twice the amount of their previous fund, and they are expecting to do this within 18 months. Indeed, more than 90% of participants in this year s study are at least as happy as they were in their careers 12 months ago, with 19% much more satisfied (compared with only 9% in the last edition of GP Trends) and a further 30% somewhat more satisfied. However, some issues remain. Particularly in investment and leadership roles, private equity has not done a good job at attracting and promoting female staff members. As Devin Mathews, Partner at Chicago-based technology investor Parker Gale, notes: Male dominated firms are not an attractive place for highly-qualified women. Devin Mathews, Partner, Parker Gale Although there has been resistance, firms are starting to take the issue seriously. The greater sensitivity to issues of gender (and, for that matter, race) has been a factor, but so too has the acceptance that diverse teams tend to make better decisions. In the following pages, we ll cover these topics and more. Where better to start than by looking at the new buyout boom? 5 Investec Fund Finance GP Trends Survey 2017/18

7 Q Which best describes your level of satisfaction with your career in private equity compared to 12 months ago? 19% Much more satisfied 30% Somewhat more satisfied 41% About the same 7% Somewhat less satisfied 3% Much less satisfied Investec Fund Finance GP Trends Survey 2017/18 6

8 The growth of the size of funds doesn t surprise me. The desire for familiar fund managers grows as part of reducing LPs risk appetite. Anne Sheedy, CFO, Vision Capital 7 Investec Fund Finance GP Trends Survey 2017/18

9 Blockbusting buyout funds As can be seen, despite the challenges outlined before, there is a continued positive trend from our first survey in 2009 where 37% of GPs anticipated their next fund to be larger, with the vintage feeling that market conditions are as favourable as they have ever been. An eighth of respondents anticipate that their next fund will be twice the size or larger than their current fund. This number rises to 24% for North American GPs. Astonishingly, Managing Partners globally, are yet more bullish. One in three (32.4%) expects that their firm s next fund will be at least as large as the previous fund. Q What size will your next fund be, in comparison to your current/previous fund? 32.4% 38.0% 44.1% 22.5% 42.7% 6.4% 4.2% 3.6% 2.8% 3.2% Twice the size or larger More than 25% larger Approximately the same size Smaller Don t expect to raise another fund Managing partner or equivalent Partner level and below Investec Fund Finance GP Trends Survey 2017/18 8

10 The more positive sentiment amongst GPs surveyed may well reflect, at least in part, the economic backdrop. At the start of 2017, the global economy appeared to be on the cusp of a firmer and more durable recovery. Growth momentum solidified as the year went on and global GDP growth looks set to be recorded at around 3.7% for 2017; that would be the firmest rate for six years. For 2018, global economic momentum could well be firmer still with the global economy expected to expand by 4%, a rate not seen in the years since That strengthening global growth backdrop reflects a pick-up in emerging market economy growth prospects through last year and has been reflected in many of the major advanced economies too. For one, 2017 Euro area economic growth is likely to be recorded at its firmest pace in the post Global Financial Crisis period and that pace is expected to pick up further still in The US 2017 growth rate also looks set to come in above the 2% mark for 2017 and strengthen further in 2018 with US tax reform set to provide a further foot up to growth. This more solid global environment has been coupled with low interest rates and ample liquidity. Even though interest rates are rising, and are due to increase further, in some jurisdictions this seems unlikely to make a significant dent in what appears to be a benign global economic environment. Victoria Clarke Investec Economics 9 Investec Fund Finance GP Trends Survey 2017/18

11 Naturally, a GP can only raise capital from willing LPs and some see LPs as being the key motivator for ballooning fund sizes in private equity. Anne Sheedy, CFO at UK-based Vision Capital had this to say: The growth of the size of funds doesn t surprise me. The desire for familiar fund managers grows as part of reducing LPs risk appetite. Anne Sheedy, CFO, Vision Capital Maggie Loo, Partner at London-based Bridges Fund Management, responsible for IR and Business Development, expressed surprise at the findings: In our experience, we find that our team will have developed a specific expertise in a certain strategy, and a fund growth of this size [in the same strategy] would lead to questions about whether the proposed investment strategy is still consistent with the skill set and experience of the existing team. Founder and Managing Partner at Nordic investor FSN, Frode Strand Nielsen, illustrated the competing pressures that successful GPs find themselves under, when it comes to raising a new fund: The funds of funds want to keep us small and the institutions want us to grow. Frode Strand Nielsen, Founder and Managing Partner, Nordic investor FSN For FSN, this has meant a natural shift in its LP base away from funds of funds, as its funds have grown from its first in 2000 (at EUR 54m) to its latest 2016 vintage, FSN Capital V, which closed at EUR 1.0bn. This is a strong position to be in, but what of those GPs just starting their fundraising journey as they look to secure capital for their first fund? Investec Fund Finance GP Trends Survey 2017/18 10

12 One emerging markets manager we spoke to told us that, in his view, LPs today are more focused than they used to be : They all have a very particular area of interest so you need to have your fund fit their profile. Loo added further concerns with regards to the size of some LPs appetites: As LPs get larger and larger, they are investing larger sums so their minimum cheque size is growing to a point that precludes small funds from flourishing. If this stifles innovation, the entire private equity industry will be worse off as a result. On average, respondents to the GP Trends survey expected to spend only 15 or so months in the market to raise what might be, for some of them, funds more than twice the size of prior funds. In the UK, the expected time required to reach a final close was as low as just a few weeks more than one year. Q How long do you think it will take you to raise your next fund? UK Mainland Europe 12.8 North America Rest of the World All responses Average months to reach first close Average additional months to final close Average total months to final close Investec Fund Finance GP Trends Survey 2017/18

13 Perhaps one of the reasons for this accelerated timetable for fundraising is down to the professionals engaged to manage the process. Inge Larsen, CFO and Partner at Oslobased Norvestor thinks this may be in part due to a more concentrated effort and more artful Investor Relations function. The IR role has become more professional over the years and we spend much more time on reporting and meeting LPs than we have ever done. Inge Larsen, CFO and Partner, Norvestor And some GPs, of course, hope to close their funds in a shorter period than 12 months. EQT is one of Europe s most in-demand fund managers and Zurich-based Lennart Blecher, Deputy Managing Partner, explains a fundraising timetable of four to five months for funds that may have doubled in size as being simply down to the fact that some funds such as EQT have managed to retain exactly the same investment strategy and consistent returns. John Crocker, Managing Partner, at Matinicus has concerns that some private equity firms are getting too large and that this can affect a firm s culture, significantly: The big are getting bigger, more bureaucratic and with more infighting. Typically, the bigger they get, the lower the return over time. Fundamentally, private equity returns are driven by an entrepreneurial instinct, not bureaucracy. John Crocker, Managing Partner, Matinicus Investec Fund Finance GP Trends Survey 2017/18 12

14 You don t want your GP overleveraged, however, and worrying about his or her personal cash flows rather than focussing on the day job. Joe Topley, Director, Ontario Teachers Pension Plan 13 Investec Fund Finance GP Trends Survey 2017/18

15 Commitment, commitment, commitment As fund sizes grow, the size of GP commitments to those funds should be expected to increase in lockstep to them but it appears that the traditional 1-2% investment from the management team into its own funds isn t enough to satisfy today s LPs. This makes affordable financing a key tool for those GPs looking to demonstrate the alignment of interest with their investors, in this respect. Close to 20% of participants in this year s study said that they expected to access external debt financing in order to fund their portion of the GP commitment, up from just 7%, two years ago and 36% expect to fund some or all of their personal commitment through anticipated carry payments, rather than current cash. Worryingly, 8% of respondents weren t sure how they would finance their commitments. Investec Fund Finance GP Trends Survey 2017/18 14

16 Q How much, as a % of the fund, do you expect your team to commit to your next fund? 29.0% 25.4% 17.6% 12.9% 4.0% 5.5% 2.6% 2.9% < 1 % 1 - < 1.5 % < 2 % 2 - < 3 % 3 - < 5 % 5 - < 10 % 10 - < 30 % 30+ % As the chart shows, the range of GP commitment varies dramatically. Removing the outliers, we find a modified average commitment, across our entire sample, of 3.3%. What does this mean in practice? Let s use Europe as an example, where the modified average commitment is slightly lower, at 3.14%: 15 Investec Fund Finance GP Trends Survey 2017/18

17 Preqin data puts the amount being targeted by the 73 European buyout funds in the market at 36.6 billion, which would mean an aggregate GP commitment of 1.15 billion. This works out at an average of just under 16 million per fund. Simon Hamilton, Global Head of Fund Finance at Investec, noted the risk inherent on relying on carry to finance GP fund commitments: With just over a third of GPs expected to use funds from carry to fund a proportion of their personal commitment, if exits don t deliver as anticipated, there may not be sufficient capital to finance commitments. He added: In a market that is increasingly characterised by fits and starts, GPs require nimble, flexible, and creative financing from their debt providers to react quickly to market opportunities and maximise returns. Of course, the size of the commitment or how it is funded still doesn t tell the full story. Joe Topley, Director at Ontario Teachers Pension Plan s London office, shared some of the nuances behind an LP s assessment of a GP s team commitment to its fund: A really interesting topic. If you are at 1% then you had better have a very good reason why it s not higher. Joe Topley, Director, Ontario Teachers Pension Plan In his opinion, as a GP, you should be at least mortgaging your house. But he adds: You don t want your GP overleveraged, however, and worrying about his or her personal cash flows rather than focusing on the day job. LPs take a sophisticated view of how the team commitment is split, too: I don t like the situation where there is a team of five, where one partner is putting in 80% of the commitment because he or she is wealthy I actually prefer a more balanced, even if lower, commitment from all parties. Otherwise that one wealthy person can feel that they have more control over the firm than their peers. Joe Topley, Director, Ontario Teachers Pension Plan Of course, liquidity is an issue not just for GP commitments it also affects succession planning. Investec Fund Finance GP Trends Survey 2017/18 16

18 Succession is a misnomer in private equity. We are an industry where, globally, most of the founders of firms are still in place in their 60s and 70s. Brandon Doyle, CEO and Founding Partner, Convergence Partners 17 Investec Fund Finance GP Trends Survey 2017/18

19 Room at the top This year s survey found that 20% of firms expecting a succession event in the next five years don t have a plan in place; our previous survey found that 45% of respondents believe that their investors aren t happy with their succession plans, or lack thereof. According to Nielsen: Two things can bring down a firm; how to divide the loot and leaving succession until it s too late. You see some firms where the Managing Partner clings on for too long and then there is a forced succession if they become ill or have to move on suddenly. But communicating a succession plan is a delicate endeavour and will often have repercussions. According to Topley: Succession is a tough question you actually don t want the GP to announce too early that they are going through the succession planning process if there is a strong leader or founder it can cause problems throughout the organisation. Founders are wary of identifying the next in line too early as it will inevitably disappoint those not chosen who may prefer to leave. Joe Topley, Director at Ontario Teachers Pension Plan Indeed, our survey found that Managing Partners were considerably more likely to indicate that a succession plan was in place than those beneath them in the firm s hierarchy. Investec Fund Finance GP Trends Survey 2017/18 18

20 Q Do you feel your firm has an adequate succession plan in place? SENIORITY COMPARISON 60.6% 50.0% 41.1% 23.9% 29.4% 30.5% 15.5% 20.6% 28.4% Yes No Unsure Managing partner or equivalent Partner or equivalent Below partner level 19 Investec Fund Finance GP Trends Survey 2017/18

21 The reluctance of the industry s leadership to let go of the reins doesn t surprise Convergence Partners CEO and Founding Partner, Brandon Doyle: Succession is a misnomer in private equity. We are an industry where, globally, most of the founders of firms are still in place in their 60s and 70s. Brandon Doyle, CEO and Founding Partner, Convergence Partners And even if the plan seems sound, succession is a complicated beast. For one, as Investec s Head of European Fund Finance, Jonathan Harvey explains: The challenges faced by individuals needing to finance their portion of GP commitments are magnified when it comes to funding a succession event buying out a significant shareholder will typically require a large amount of capital, particularly if the manager has performed well. Historically, traditional lenders have struggled to grasp all of the moving parts and accurately price the risk, making a smooth transition to the next generation of leaders difficult, if not impossible. Jonathan Harvey, Head of European Fund Finance, Investec Investec Fund Finance GP Trends Survey 2017/18 20

22 One issue with buying management company interests if you are cashing out the founders is: will they have the same levels of incentive and drive as when they started their firm? How will non-founders view free cash flow going to an outside party? John Crocker, Managing Partner, Matinicus 21 Investec Fund Finance GP Trends Survey 2017/18

23 Selling out Succession, of course, is just one of the issues faced by ambitious fund managers in private equity. As investor interest in the value of the management company increases, a number of opportunities may present themselves for the owners to raise some cash and see some liquidity. But as Matinicus Crocker contemplates: One issue with buying management company interests if you are cashing out the founders is: will they have the same levels of incentive and drive as when they started their firm? How will non-founders view free cash flow going to an outside party? As a significant fund investor, Topley s words of caution should also be heeded by fund managers looking at the options: whether to list or make a private sale of a stake in the management company. Topley says that it is all a question of alignment. If you believe that the core of the alignment is the desire to earn carried interest, then listing the firm can make this alignment more opaque and difficult to understand. He continues: If you sell a small minority stake to a Sovereign Wealth Fund (SWF), will that dramatically change the nature of the firm? I don t think it will. It is a succession mechanic a liquidity mechanic. It will make a few people at the top of the firm even wealthier, but the focus on carried interest should be pretty much unaffected. Naturally, the impact of a third party holding a stake in the management company will also be felt inside the firm. According to Matt Hansford, Investec s Head of Fund Finance in the UK, strengthening the management company s balance sheet in this way can have unintended consequences: Selling a portion of the management company to fund investment strategy diversification into, for example, private debt or real estate may damage the attractiveness of the firm to talented juniors. As a rising star in a private equity fund, is rising to a senior position in the firm as attractive as it was? Some may feel that spinning out is a preferable and cheaper alternative. Investec Fund Finance GP Trends Survey 2017/18 22

24 We need to have much more diversity both in terms of a wide range of experiences brought into the industry but also to strengthen our collective voice. Anne Sheedy, CFO, Vision Capital 23 Investec Fund Finance GP Trends Survey 2017/18

25 Gender issues Female employees (41%) were also much more likely than males (26%) to be considering leaving their current firm. Women who were considering leaving their current firm were most likely to look to move to another private equity fund, suggesting that their experiences had done little to turn them off the industry. And they were even slightly more likely than men to be looking to start their own private equity fund. Q On a scale of 1-5, (where 5 is very confident), how confident are you in your long-term career prospects at your current firm? 38.4% 37.1% 28.6% 34.9% 22.2% 13.5% 7.4% 7.9% 6.4% 3.5% 5 (very confident) (not confident) Investec Fund Finance GP Trends Survey 2017/18 24

26 Vision s Sheedy remarked: We need to have much more diversity both in terms of a wide range of experiences brought into the industry but also to strengthen our collective voice. Jeff Keay, Managing Director of HarbourVest, sees things improving, albeit slowly: In our generation there is little diversity but that is because 20 years ago the only people going into private equity were white males. Now we are recruiting a wide variety of people by gender and ethnicity and so over time it will improve all the way through the organisation. But it will take time. Jeff Keay, Managing Director, HarbourVest 25 Investec Fund Finance GP Trends Survey 2017/18

27 A word of thanks: We re grateful to the 292 private equity professionals who participated in this edition of the GP Trends survey. We re particularly thankful to the individuals listed below, who participated in longer conversations, during which they provided additional insights on the results and the market, in more general terms. Thank you all for your considerable contribution. Lennart Blecher, Deputy Managing Partner and Head of EQT Real Assets, EQT John Crocker, New fund, formerly Capital Z, Matinicus Llc Brandon Doyle, Chief Executive Officer & Founding Partner, Convergence Partners Jeff Keay, Managing Director, HarbourVest Partners Inge Larsen, Partner, Risk and CFO, Norvestor Equity Maggie Loo, Partner, IR and Biz Dev, Bridges Fund Management Devin Mathews, Partner, Parker Gale Anne Sheedy, CFO, Vision Capital Frode Strand-Nielsen, Managing Partner, FSN Capital Pol Thielen, Managing Partner, Emerald Peak Joe Topley, Director, Ontario Teachers Pension Plan Investec Fund Finance GP Trends Survey 2017/18 26

28 Conclusion This eighth edition of the Investec Fund Finance GP Trends survey highlights increased optimism in the market, with regards to the achievable targets for fundraising, coupled with an expectation that these larger funds can be raised on a timetable comparable with pre-financial crisis vintages. Despite the shadow of succession issues and consequent key man clauses, the industry is upbeat. In exchange for backing their favoured managers, LPs are exerting pressure on GPs, however, asking them to put more skin in the game, by increasing the amount they commit to the funds they raise. If the next generation of Partners and Managing Partners are going to need to commit larger percentages of, in turn, larger funds, without the benefit of the years of wealth creation enjoyed by their departing founders, the solutions we provide to private equity funds, GPs, and the professionals that staff them are more important than ever. As the market evolves into new levels of maturity, if not stability, we at Investec are in constant contact with the industry, developing new ways to help our clients take advantage of unexpected opportunities and mitigate unwelcome risks. Female participation in private equity, particularly in leadership and investment roles, is nothing to shout about, and this edition of our survey throws light on some of the challenges faced by women in private equity, with many less confident in their long-term career prospects than their male counterparts. It would be a shame if it took pressure from LPs to address this imbalance. Simon Hamilton Global Head of Investec Fund Finance 27 Investec Fund Finance GP Trends Survey 2017/18

29 About Investec Fund Finance Investec Fund Finance is a specialist finance provider focused on lending to funds and fund management teams. We aim to build lifelong relationships with our clients. We offer flexible finance solutions at each stage of the fund cycle, which can enhance returns, maximise the efficiency of the fund s equity and increase competitiveness in an aggressive market environment. Innovation is at the heart of our thinking and our global team has the vision and the resources to create unique financing structures for unique financing requirements. About Investec Fund Solutions Committing to and making overseas investments can bring unintended FX exposures to a fund. We support clients through identifying and resolving these exposures with our Fund Solutions team. Our sector experience allows us to tailor nuanced solutions to specific client needs around uncertain exit timings and values. On desk credit, our legal and market knowledge allows us to explore structures that remove the need for cash collateral or regular hedge settlements. The team was formed in 2017, working in synergy with our Fund Finance team to offer supplementary and complementary solutions on a global basis to fund clients, as well as manager- and investor-level clients. About the research Research for this edition of the GP Trends report was conducted in conjunction with MJ Hudson, a leading provider of research and other services to the private equity industry. 292 GPs from across the globe took part in the project, this year, and an additional 11 individuals contributed further insights via longer conversations. More information on MJ Hudson can be found at Investec Fund Finance GP Trends Survey 2017/18 28

30 Contact us To find out more about our research or about how we can support you, please get in touch. Simon Hamilton Global Head of Fund Finance Jonathan Harvey Head of Fund Finance: Europe Matt Hansford Head of Fund Finance: UK Grant Crosby Head of Fund Finance: Emerging Markets Simon Beissel Investec Australia Michael Slane Head of Fund Solutions Gregg Kantor Head of Fund Finance: US