Presenting a live 90-minute webinar with interactive Q&A Private Equity Fund Formation in 2012 Navigating Capital Raising Under a New Regulatory Landscape: Dodd Frank, JOBS Act, the Volcker Rule, and ILPA Revised Principles WEDNESDAY, SEPTEMBER 12, 2012 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: Scott W. Naidech, Partner, Chadbourne & Parke , New York Adam D. Gale, Counsel, Chadbourne & Parke , New York L. Charles Bartz, Senior Advisor, Berchwood Partners , New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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Strafford Webinar: Private Equity Fund Formation in 2012 Presentation by Scott Naidech, Chadbourne & Parke LLP Adam Gale, Chadbourne & Parke LLP L. Charles Bartz, BerchWood Partners
Goals of Presentation • Describe significant changes impacting private equity fundraising in 2012 • Describe recent market trends, including structural changes taking place in the market • Summarize certain new regulations impacting private funds (including Dodd Frank, Volcker Rule and JOBS Act) • Highlight changes in “market” terms, including ILPA changes and other market impacts 6
1. What do we mean by “Private Funds”? • Any (i) “blind pool” vehicle (ii) invested by a sponsor (iii) who often receives a management fee and profit participation (known as a carried interest or performance fee) (iv) offered to qualified high net worth investors only • For purposes of this presentation, “Private Funds” means “ Private Equity Funds ”. For example, Venture Capital Funds, Growth Equity Funds, Buyout Funds, Real Estate Funds, Distressed Debt Funds, Mezzanine Funds, etc., investing in illiquid securities 7
2. Key incentives for raising a Private Fund? • Key Economic Incentives for Sponsor Raising a Fund: Access to private capital from alternative sources; Carried Interest and Management Fee • Key Economic Incentives for a Limited Partner Investing in a Fund: Access to a diversified pool of investments in a targeted geographic region and/or industry being managed by a specified team of experts 8
Recent changes in key incentives… • Ten years ago, most fund negotiations focused on economics; five years ago…governance; in 2012…back to economics • Impacts on incentives altering the standard “2 and 20” model – economy and fund size. • Volume: currently over 1,800 Private Equity and Real Estate Funds looking to raise capital, seeking roughly $800 billion • Total amount of probable commitments from this pool: only $250 billion/year. • Conclusion: less than one-half of fundraises will successfully raise their target amounts. 9
Changes of key incentives… • Pressure on established managers too • Private Equity International released the “PEI 300” in May 2012: 1. TPG (Fort Worth, TX): raised $49.897 billion in capital for their Private Funds over the last five years 2. The Blackstone Group (New York): $49.638 billion 3. Kohlberg Kravis Roberts (New York): $47.689 billion 4. Goldman Sachs Principal Investment Area (New York): $43.469 billion 5. Apollo Global Management (New York): $34.710 billion 6. The Carlyle Group (Wash DC): $30.741 billion 7. CVC Capital Partners (London): $25.068 billion 8. Apax Partners (London): $21.035 billion 9. Bain Capital (Boston): $21.033 billion 10. Oaktree Capital Management (Los Angeles): $17.633 billion 10
Changes of key incentives… • Larger managers compete for the same capital (from government plan, pension plans, foreign institutions, sovereign wealth funds) • Face same pressures, which increases LP leverage in negotiations • Pace of investment slowed creating “dry powder” • Management fees have provided greatest share of GP economics • Fund sizes are being capped at lower amounts • Greater competition for capital = lower fees and carry, greater LP controls, increased fundraising periods, higher customization • Still, sponsors increase their negotiating leverage through certain key differentiators, including higher performance, strategy diversification, oversubscription, better terms 11
Fee envy… Sponsor Each Fund pays a Carried Interest to the GP (or an affiliated entity) GP GP GP GP GP Investment Adviser Carry US Buyout US Buyout Asia US Mezz US Real Fund I Fund II Fund Fund Estate Fund Management Fees Each Fund pays a Management Fee to the Investment Adviser…can result in large aggregate fees that alter incentives (from carried interest based to fee based); thus downward fee pressure 12
Zombies! • Pressure on smaller and mid-sized managers to reduce fees and fundraise • Given the reduction in commitments and increased pressure, it is possible that a significant portion of existing fund managers will cease to continue meaningful operations, becoming so-called “zombie funds” • Governance provisions in some fund agreements may be inadequate to handle orderly liquidations/terminations/Key Person events/removal events (fund agreements often infer that the team will remain in place to raise a subsequent fund) • While the process may be clear, the cost of implementing may discourage a single LP from pursuing. • There may be little or no economic incentive for the GP to initiate the process. 13
Fee anxiety… Sponsor GP ? ? ? ? Investment Adviser Carry Fund I ? ? ? ? Management Fees For advisers with fewer funds under management, downward pressure on fees by the “market” means smaller budget, leaner staff, harder to pay consultants and advisors…less overall fees to manage the team. 14
Results… • Overall result: • increased LP leverage and lower capital commitments alter dynamics of negotiation • longer fundraising periods • greater investment strategy definition • lower fees and carry • greater LP participation in investment process • co-investment rights • deal-by-deal opt-outs and investment vetoes • (some of these are covered later in presentation from a legal perspective) • “Classes of LPs”: concern that larger LPs have leverage and can therefore negotiate better terms in side letters, or in separate parallel or co-investment funds 15
LP portfolio managers (like sponsors) face pressures too… • Because of the economic turmoil of the past four years, investors are unable to achieve adequate returns from more traditional portfolio allocations, e.g., publicly-traded strategies • Lack of new contributions to trusts • Uncertain performance of North American and European stocks • Levels of distrust in Asian and Indian issuers and political environments • Challenge: where to find new markets/or strategies for investment that can provide one or more: • Current cash flow • Stability in interim valuations • Shorter investment horizons 16
2. Dodd-Frank Act • Dodd-Frank Act, effective as of July 21, 2011: – Eliminates the private investment adviser exemption (formerly 203(b)(3)) – Requires registration unless an exemption is available under new 203(m) and the proposed rules thereunder – Different rules apply depending on whether you manage any of the funds from the US, how much you have under management and amount of investments from US investors – Venture capital exemption: Exemption for advisers who solely advise “venture capital” funds – Real Estate Funds: No specific exemption for real estate ("RE") fund managers, but depending on what the RE fund invests in, and how the investments are structured, the rules may not apply. 17
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