PRIVATE EQUITY IN BRITAIN THE FIRST 25 YEARS PRIVATE EQUITY IN THE UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE UK THE FIRST 25 YEARS 3 Contacts Venture Capital Association or Venture nal capacities and are their sole rior permission of the publisher. rior permission of the publisher. y be reproduced, stored in a retrieval nture Capital Association or Newsdesk p © 2008. The entire contents of this publication are protected by copyright. All rights reserved. No part of this publication ma © 2008. The Newsdesk Communications Ltd of products or services referred to therein. system, or transmitted in any form or by any means: electronic, mechanical, photocopying, recording or otherwise, without the p are provided in the writers’ perso views and opinions expressed by independent authors and contributors in this publication The Equity and Ve does not imply that they represent the views or opinions of the British Private publication Their responsibility. nor be interpreted as such. Communications Ltd and must neither be regarded as constituting advice on any matter whatsoever, Equity and by the British Private reproduction of advertisements in this publication does not in any way imply endorsement The Editor Anthony Hilton Gordon Casey 25 years – the first in the UK equity Private Anthony Editor Group Editorial Director Managing Editor Editorial Assistant Nick Sub-editor Group Art Director Zac Designer Design Consultant Director Production Claire Manuel Group Sales Director Sales Manager Samantha Guerrini Design iUVO Stephen Carpenter – Sales Executives Lauren Rose-Smith Client Relations Director Director Publishing David Cooper Deputy Chief Executive and Chief Executive Publisher Richards Tim Andrew Howard by Newsdesk Communications Ltd Published Laurie Pilate David Friel, UK 130 City Road, London, EC1V 2NW, 5th Floor, +44 (0) 20-7650 1600 Tel: Natalie Spencer +44 (0) 20-7650 1609 Fax: www.newsdeskmedia.com Jim Sturrock Hugh Robinson Alan Spence Hoult Philip and Newsdesk Communications Ltd publishes a wide range of business information please contact Natalie further customer publications. For or Alan Spence, Chief Executive. Client Relations Director, Spencer, Newsdesk Communications Ltd is a Newsdesk Media Group company. On behalf of the BVCA – Capital Association, Equity and Venture British Private The 3 Clements Inn, London, WC2A 2AZ, UK +44 (0) 20-7025 2950 Tel: www.bvca.co.uk Cover Image: Getty Services Repro: ITM Publishing by Buxton Press Printed ISBN: 1-905435-67-3 Contents

Private equity in the UK – the first 25 years RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Forewords The roots of the industry 9 25 years of the BVCA 54 The early days Wol Kolade, past Chairman of Sir Ronald Cohen the BVCA 60 25 years of the BVCA and the 14 A changing dynamic private equity industry Anthony Hilton, Financial Editor, Sir David Cooksey London Evening Standard 64 The role of 3i Key issues Baroness Sarah Hogg 16 The political challenge 68 Enterprising spirit Martin Arnold Anne Glover, OBE 21 Private equity performance Joanne Hart 28 The battle for hearts and minds Anthony Hilton

32 Transforming the UK economy Joanne Hart 39 The rise of institutional investment in private equity Andrew Lebus 44 Individual investors Andrew Cave 50 The funding treadmill Joanne Hart

5 Contents

Impressions of the industry – the How private equity works in practice impact of private equity 91 Developments and challenges 72 A view from outside the industry in buy-outs Richard Lambert, CBI Dr Robert Easton Director-General 97 Developments and challenges in 74 The view from the NAPF venture capital David Paterson, NAPF Head of Jo Taylor Corporate Governance 100 Delivering transformational change 77 A question of image Andrew Cornelius Paul Myners 104 The experience of multiple owners 80 Private equity and economic Sarah Butler and Philip Hoult performance 108 Creating value through

Sir David Walker UK PRIVATE EQUITY INTHE acquisitions 83 Private equity in Europe Helen Dunne Javier Echarri, EVCA 111 Turning point – turnarounds Secretary General Neil Rose 87 The view from the US 114 The road to success – Timothy Spangler, venture capital Kaye Scholer LLP Andrew Cave

117 Developing business potential – THE FIRST25YEARS development capital Derek Bedlow The future 120 Looking ahead to the next 25 years Simon Walker

7 Foreword

25 years of the BVCA RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

The private equity industry is key to Britain’s continued economic competitiveness, says Wol Kolade, past Chairman of the BVCA

Today, Britain is This year, the BVCA – the British Private Private equity directly and indirectly benefits Equity and Venture Capital Association – cele- millions of workers and their families. Over the private equity brates its 25th anniversary. The organisation, the last 25 years it has been the returns that centre of Europe, like the industry it represents, has changed the best-performing parts of the industry and our industry is the immeasurably over the past quarter of a cen- have generated, often far in excess of those second largest worldwide, tury, as the sector has grown into one of the of the stock market, that have been the main biggest success stories in the British economy. reason for its growth. The reason the industry after the US exists at all is because that is the way many Today, Britain is the private equity centre of investors, including public and private pen- Europe, and our industry is the second sion funds, want to invest their money. None largest worldwide, after the US. In those 25 of them is forced to invest in private equity – years we have gone from being little more they choose to. than a cottage industry into part of the main- stream economy. Britain benefits from the industry in other ways, too. For the financial year 2006/7, it is When people think of private equity they estimated that private equity-backed compa- often associate it with buy-outs of big house- nies generated total sales of £310 billion, hold names: AA, Boots, Debenhams. But of exports of £60 billion and contributed nearly course the reality is that we are a much broad- £35 billion in taxes. That’s enough tax to pay er church than that. Private equity and ven- for all the nurses and police officers in the UK. ture capital are behind the medical diagnostic During the same period, financial and profes- services we use in hospitals, the chips in our sional services firms generated an estimated mobile phones, the manufactured compo- £5.4 billion in revenue through the provision nents of our cars, the bioethanol fuels that of services to the private equity community. may run them in the future, as well as the lat- est research into clean technologies that are So, as a driver of the UK economy and of trying to find solutions to some of the envi- Britain’s competitiveness, private equity has a ronmental challenges we face. compelling story to tell.

9 Foreword

The founding of the BVCA in 1983, at capital roots. Of the 1,300 UK companies that the very beginning of our industry’s astonish- received private equity investment in 2006/7, ing period of growth, seemed a bit optimistic more than three quarters received less than at the time. But it has paid off. £2 million, proving that despite the headlines, the industry today is not mainly about multi- The BVCA currently has more than 200 full billion pound buy-outs. members, who represent the vast majority of private equity and venture capital firms oper- Growing businesses by adding value is at the ating in the UK, and a further 200-plus asso- heart of what all the BVCA’s member firms do. ciate member firms, including lawyers, It is what unites the smallest venture firm and accountants and other professional advisers the largest buy-out house. Supporting start- to the industry. ups and university spin-outs with early stage funding remains a critical part of our industry, We have come a long way in 25 years. From and something that the UK economy as a humble beginnings when we had just 34 full whole continues to benefit from. Stories such

members and no associate membership to UK PRIVATE EQUITY INTHE as the one told in this book of Cambridge speak of, we have increased total member- Silicon Radio (p.114), show the role of ven- ship twelve-fold. Total investment by mem- ture capital in taking a brilliant idea or inven- ber firms began at just £190 million, and has tion, turning it into a university spin-out, and in grown to over 100 times that, and total funds this case into a world-leading company. raised have increased by a multiple of 50 since 1983. In the mid-market we take growing business- es and help propel them forward. At this Some of the pieces in this book address stage in a company’s life we can add critical those early days. With its roots very much in

value through strategic advice, as well as the THE FIRST25YEARS venture capital, its founders tell tales of the funds to invest in growth. More recently Growing businesses BVCA being set up when no-one, including there has been a trend for multiple private the financial institutions such as banks and by adding value is at equity owners to be part of the story of build- investment funds, really knew what venture the heart of what all ing and growing companies like Gala Coral, capital was, and didn’t know much Tragus and Center Parcs (p.104). the BVCA’s member firms about early stage businesses or buy-outs. do. It is what unites the Recognising they had much to learn from At the big end we take mature businesses and each other, the joint benefits of educating re-focus and re-energise them. In some cases it smallest venture firm and investors, and the need for a lobbying organ- is about an unloved division of a larger compa- the largest buy-out house isation, the BVCA was born. ny, or turning businesses around, shaking up management and cutting out waste. Being Despite having recently evolved into the brave enough to take tough decisions to build British Private Equity and Venture Capital on strength rather than prop up failure. The Association, better to reflect the full spectrum case studies on transformational change and of organisations we now represent, even turnarounds in the later sections demonstrate today the BVCA remains close to its venture exactly what I am talking about (p.100 and 111).

11 Foreword

This book is a The BVCA celebrates its 25th anniversary in As the economic environment becomes a very different political, economic and tougher, the BVCA will do all it can to protect celebration of how media environment from that in which it the competitive advantage Britain currently far the industry has began life. The changing landscape over the enjoys in relation to other leading financial come, how much it has intervening years, including the fall of the centres of the world. If the UK is to retain its achieved and its aspirations Thatcher government, the recession of the competitive edge, as a place for private equi- early 1990s, the domination of the internet, ty houses to base themselves, the tax and for the future the dotcom bubble, the rise of New Labour, regulatory environment they operate within the development of mega funds, globalisa- needs to be a stable and predictable one. tion, the emerging economies of China and This book is a celebration of how far the India and the credit crunch, have all helped industry has come, how much it has achieved shape the UK private equity story in a variety and its aspirations for the future. It seeks to of ways. capture the effect of the changing economic It is also the case that as we have grown as an and political landscape of the last 25 years on RVT QIYI H UK PRIVATE EQUITYINTHE industry, so the size of our deals has the industry, as well as provide a snapshot of increased, and so the numbers of those the industry today. We have asked industry aware of private equity, and affected by it, professionals, commentators and key stake- have expanded greatly. People’s expectations holders from the wider business community of us today are different and we are having to to impart their perspective on the industry change our own attitudes to transparency and the challenges it has faced. I would like to and communication. extend my warm thanks to all those who have taken the time to contribute to the book. Throughout this period of change the BVCA

THE FIRST25YEARS has been at the vanguard of helping the The book has a second aim, too – to show industry to adapt to its new responsibilities. what the industry does and how it does it. It We led the way by setting up the Walker is important to understand one central fact Review into Transparency and Disclosure in about private equity: private equity is about early 2007. In our 25th year we are continu- making businesses better. The stories here ing to help establish best practice in this area are of real businesses that employ thousands and will ensure the fair implementation of Sir of people and the way private equity works David Walker’s guidelines through the set- with those businesses. That to me is where ting up of the Guidelines Monitoring Group, the real history, the real story, of this industry under its first Chairman, Sir Mike Rake. and the role it plays in the UK economy lies – and that is what we should be celebrating.

12 Foreword Foreword

If private equity has a A changing dynamic single core skill, it is the ability to deliver The skills of the private equity industry are unique transformational change and deserve wider appreciation, says Anthony Hilton RVT QIYI H UK PRIVATE EQUITYINTHE RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE

Diversity can be a strength, but it can also and on small buy-outs – the industry operated The worst of the storm has passed because THE FIRST25YEARS be a challenge. away from the public gaze. There was no dis- the industry, led by the BVCA, has moved to cernible sign of political interest, other than a become more transparent and better under- For the private equity industry, the difficulty general enthusiasm among all parties that capi- stood. For other reasons, the politicians have is that the various techniques it employs and tal should be made available wherever possible also moved on. However, there is a big differ- the differences in approach between houses for the funding of new businesses. ence between a volcano that is dormant and are not properly understood by the public. one that is extinct, and it is only right that this The industry inevitably has its cycles, but In spite of the serious efforts made by the book acknowledges the political dimension, each has led to a higher peak. This was partic- BVCA and several of the leading firms to help and tries to put it in a global context. ularly evident after the millennium, when it people understand the industry, there is still a became possible for private equity houses to The private equity industry is a vital spur to lack of appreciation generally of the range of raise funds of unprecedented size, and there- efficiency and growth, but it still needs its skills and talents that are assembled under after to become significant players in mergers licence to operate. Its activities need to be the generic ‘private equity’ label. and acquisitions. accepted as legitimate and useful by the pub- One of the purposes of this publication, lic if it is to avoid being taxed or regulated out Private equity firms had, of course, taken over which celebrates the 25 years since the of existence. major public companies in the past – most founding of the BVCA, is to show how com- famously when Kohlberg Kravis Roberts took Another challenge for private equity is geog- panies in the UK and beyond have benefited over RJR Nabisco in the US, and in Britain raphy. The industry started in the US, took from the expertise and know-how of private when supermarket group Gateway and home root in Britain and is now making rapid equity practitioners. The book looks back at improvements business Magnet were both inroads in mainland Europe. There are vast the industry’s roots, with contributions from subject in the 1980s to bids from rival houses. opportunities there as businesses restructure pioneers such as Apax Partners’ Sir Ronald Interestingly, though these deals were high to cope with competition from Asia, but in Cohen and Sir David Cooksey of Advent profile and controversial at the time, they still spite of this, it is to Asia that some houses Venture Partners, and analyses the key issues failed to arouse the interest of politicians. already look. going forward. It draws together the views of organisations such as the CBI and the NAPF, This time it is different: the significant increase The pace of change in business is so rapid, the as well as the opinions of leading business in size and number of such bids, and the ten- life cycle of companies so much shorter than figures, including Paul Myners and Sir David dency to pursue well-known targets has in the past, even in Asia there are opportuni- Walker. Finally, a series of articles containing changed the dynamic. The public woke up to ties. For many houses, that is where the future in-depth case studies reveals how the indus- the existence of private equity without know- lies. Perhaps they are right, perhaps not. try really works in practice, whether it is pro- ing what it was. Private equity had to come to To an observer, it matters less than the fact viding development capital, pursuing a buy- terms with public and political scrutiny. that the industry continues to flourish. If pri- and-build strategy, turning around distressed It can be argued, with the benefit of hindsight, vate equity has a single core skill, it is the abil- companies or planning a large buy-out. that it was too slow to adapt. As a result, the ity to deliver transformational change. There A further challenge for private equity is poli- industry suffered from attacks born of political can be no more necessary role in this mod- tics. For much of the early years – when the opportunism in some cases and elsewhere ern, globalised world. focus was on start-ups, on development capital from genuine, though misplaced, concerns.

14 15 Key issues Key issues RVT QIYI H UK PRIVATE EQUITYINTHE RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE

Imagine the scene. British trade unions The poster child for the unions’ campaign Private equity’s THE FIRST25YEARS cheer and the London media howl in protest as against private equity was Damon Buffini, the newly elected Conservative Government Managing Partner of Permira. He played a importance to the fails to convince one of the last big private role in both the £1.75 billion acquisition of the City and ultimately equity houses left in the City to reconsider AA in 2004, when it joined a consortium with the overall British economy moving its head office overseas. CVC Capital Partners, and the £1 billion is surely too great for the takeover of Igloo Birds Eye in 2006. As French President Nicolas Sarkozy wel- Government ever to comes the latest buy-out fund to Paris, he Some buy-out executives claim the initial change radically the tax hails the success of his policy to make union campaign was triggered by an internal France’s capital a global financial centre with power-struggle between the GMB union and and regulatory structure zero capital gains tax and low fiscal rates for the AA staff, which led Paul Kenny, the Union non-doms. Leader, to make Permira and Buffini the scapegoats for his own difficulties. Property prices in London’s Mayfair plummet as swathes of office space and luxury homes Whatever the truth of this, the union cam- are put up for sale. Thousands of jobs are lost paign caught the public’s imagination. as lawyers, accountants and banks cut their Interestingly, this was not just a British phe- UK private equity teams and switch to chic nomenon. new offices on Paris’s left bank. The political challenge Private equity was an issue in the Swedish Alright, now breathe. Don’t panic. This is general election when one candidate pro- Private equity became a key issue in the 2007 Labour deputy leadership unlikely to ever happen. Private equity’s posed measures to curb its freedoms, but election. Now that the election fever has passed, what is the mainstream importance to the City and ultimately the failed to win. The industry came under even overall British economy is surely too great for greater attack in Germany. political attitude to private equity and how is this changing over time? the Government ever to change radically the The root cause in all these cases was the tax and regulatory structure that has fostered Martin Arnold, Private Equity Correspondent of the Financial Times, reports same. It had less to do with private equity as the growth of the industry. a method of finance than with the actions Nonetheless, relations between policymak- taken by private equity owners to return busi- ers and private equity executives reached nesses to profitability. Companies frequently their nadir in 2007. What started as a trade fall into private equity hands because they union-fuelled controversy over job cuts at have underperformed. Sorting them out can private equity-owned companies, such as the require taking tough decisions on plant clo- AA motor services group and Igloo Birds Eye, sures and job losses, which previous manage- the frozen foods group, snowballed into a ment shirked. full-blown political debate about tax, trans- That said, in the British context, last year the parency and the overall economic contribu- buy-out industry arguably did not help itself. tion of buy-out firms. Just as the public mood was turning against it,

16 17 Key issues private equity firms embarked on some of It is also the case that public concern can be the most daring buy-out bids ever seen in short-lived – it now seems the early summer Europe, notably an £11.4 billion bid led by of 2007 was the low point. While the public CVC for J Sainsbury, the supermarket. image of big buy-out firms may take careful nurturing to recover, a combination of events CVC’s bid for J Sainsbury failed. But it was since has served to deflect criticism away soon followed by an £11 billion bidding war from the industry. for Alliance Boots, the pharmacy chain, with competing offers being made by Kohlberg Firstly, the credit squeeze started in July 2007, Kravis Roberts and Terra Firma. With the cutting off buy-out firms’ access to the abun- acquisition of Boots, it seemed no house- dant amounts of cheap debt that had allowed hold-name company was beyond private them to mount their most ambitious bids in equity’s reach, however big it was. the US and Europe. The financial turmoil has shifted attention from the financial structures Another crucial – and perhaps unlikely – of private equity, to the operational improve-

ingredient arrived to take the controversy to UK PRIVATE EQUITY INTHE ments it can deliver. a higher level. The Labour party’s contest to choose a new leader and deputy after Tony The industry also took a significant step Blair’s departure gave British trade unions, towards greater public understanding and wielding their significant voice within the accountability when Sir David Walker pro- Labour party, the opportunity to press the duced his guidelines on transparency and dis- buy-out debate to the fore. closure, which will apply on a ‘comply or explain’ basis to the biggest buy-out firms in The Treasury Select Committee announced it the UK. While the code has attracted criti- would hold an inquiry into private equity and

cism from trade unions and policymakers for THE FIRST25YEARS the Government put pressure on the BVCA not going far enough, it should answer some While private equity to review transparency and disclosure. This of the attacks about lack of transparency as led to the BVCA’s appointment of Sir David investments still private equity firms start to publish more Walker, the City grandee and Morgan only account for information about themselves. Stanley Adviser, to draw up a code of con- about 1.5 per cent of GDP duct for big buy-out firms. While private equity investments still only in the UK, the industry account for about 1.5 per cent of GDP in the The intriguing thing, and one overlooked in UK, the industry has expanded at an aston- has expanded at an the UK at the time, was that a similar debate ishing rate. Like any rapidly growing industry, astonishing rate was happening in, of all places, the US. private equity needs to mature. Buy-out Private equity is a vastly important and long- executives must become more visible, established player in the US economy, but explaining their strategies to workers, suppli- even in that country there was disquiet about ers, customers and the wider public via the the essentially secret nature of much of the media. But these could be no more than the activity. Again, the lack of transparency pro- growing pains of an industry that has grown vided fertile ground for public distrust and faster than anyone could have forecast. political criticism. This is certainly the view of practitioners, none These issues have cropped up for decades, of whom doubt the industry’s resilience. Sir however. Those who undertake the challenge Ronald Cohen, Founder of Apax Partners, of restructuring businesses inevitably come forecasts it will double in size in five years and under fire – witness the attacks on the con- Stephen Schwarzman, Chairman of the glomerates run by Slater Walker or Hanson Blackstone Group, said at the CBI’s 2007 con- Trust in the 1970s and 1980s. The fact that ference: “Private equity is here to stay.” concerns over the pain of restructuring being felt by employees while the gains went else- Not only would most politicians agree, but where existed then, shows that it is not pri- across Europe they are also more inclined vate equity per se, but the pain of restructur- than they were to accept Schwarzman’s other ing which arouses the interest of politicians. point – that it is also a force for good.

19 Key issues

Private equity performance RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Joanne Hart asks where the returns come from – financial engineering, multiple enhancement or by improving the running of the business?

“Financial To many participants in the public mar- quartile average return was 12 per cent over engineering is well ket, the private equity industry has achieved the period. And even if the data is analysed significant returns purely and simply on on an annual basis, the difference between understood and it leverage. Firms have bought cheap, sold pooled average, median and upper quartile is available to everyone in dear and multiplied the equity return on their returns is substantial. investments by gearing up the balance the market. If it was that “The average is basically meaningless. What sheets. The process has been made even simple, most private equity actually characterises this industry is disper- easier in recent years, thanks to the abun- sion around the average and the fact that the firms would deliver similar dance of cheap money. returns. But in fact, returns more successful firms consistently outperform. That, at least, is the perception from the out- So delivering returns has to be a bit more dif- vary enormously” side. Within the industry, however, opinions ficult. It has to depend on delivering some are rather more varied. Some deny the finan- form of value-added that is not easily under- cial wizardry proposition almost completely. stood by everyone,” Sherwood suggests. “Financial engineering is well understood “Debt is important, but only in so far as it and it is available to everyone in the market. magnifies value that is created by other If it was that simple, most private equity firms means,” he adds. would deliver similar returns. But in fact, Other general partners agree. Most accept returns vary enormously,” says Permira that financial engineering plays a part, but Partner, Charles Sherwood. they stress that success cannot be achieved Sherwood points to data1 which shows that through gearing alone. Many participants in the ten years to March 2007, European claim too that different sectors of the market buy-out funds produced pooled average rely on leverage to a greater or lesser extent. returns of 11 per cent, but delivered a medi- Mega funds, or those firms with funds of an average return of just 3 per cent. In other more than £5 billion, are often accused of words, half the funds in the survey produced excess reliance on leverage, but they them- returns of more than 3 per cent, but half pro- selves believe they have talents the ‘smaller’ duced returns below 3 per cent. The upper firms do not possess. Firms with funds of less

21 Key issues than £1 billion, meanwhile, frequently sug- Most partners, in firms large and small, are con- “Private equity gest that they are the custodians of private fident they will be able to withstand the chang- equity as it should be – they genuinely grow ing environment and adapt to the new era. exploits what businesses rather than using fancy financial Their confidence comes from a fundamental McKinsey coined as techniques to boost returns. belief in private equity’s business model. ‘governance arbitrage’. “For me, the highest quality investment gain “Private equity exploits what McKinsey What that means is that is to do with the performance of the underly- coined as ‘governance arbitrage’. What that successful firms pursue ing business and that means selling more, means is that successful firms pursue a differ- a different governance making higher profits and generating more ent governance model, which creates a real cash. If you run the business better, it grows closeness between managers and owners,” model, which creates a and when you come to sell, it will command a says Sherwood. real closeness between higher multiple, not because of the econom- Clearly, there is a difference between the way managers and owners” ic cycle, but because it is a better business,” listed companies and private equity-owned says Paul Marson-Smith, Managing Partner

companies are structured. In a listed compa- UK PRIVATE EQUITYINTHE of Gresham Private Equity. ny, the Board may own some shares and may Marson-Smith cites Penn Pharmaceuticals, a have options over more, but the vast majority Welsh drugs manufacturer that Gresham of the equity is owned by a wide variety of bought in 2000 for £12 million. At the time, institutional shareholders, who meet the the business, which owned the rights to the company once or twice a year. Thalidomide drug, employed 120 people. In private equity-backed companies, the man- Gresham split off the controversial agement owns a substantial and significant Thalidomide division, sold it to US giant percentage of the equity and so do the gener-

Celgene and built up the remaining busi- THE FIRST25YEARS al partners. Not only that, but there are invari- ness, almost doubling the number of staff, ably one or two general partners sitting on the boosting turnover five-fold, increasing prof- board of the companies in which they have its ten-fold and generating a 12 times return invested. This can create a genuine closeness, on investment. as well as an alignment of interests. Such stories are encouraging – and they may It should also mean that both managers and become a more common feature of the pri- general partners are keen to improve the vate equity landscape, particularly if condi- companies with which they are involved. tions in the lending markets are as tough as they have been in the recent past. For, if debt Sherwood, meanwhile, points to Inmarsat, is less available, leverage will simply have to which Permira and Apax backed in 2003. play less of a role in the industry. Jon Moulton “When we invested in the business, there of Alchemy Partners believes this will hit were 86 different shareholders, each with a large firms in particular. different agenda, including suppliers, “Big funds have made a lot of money out of investors and customers. There was virtually rising debt multiples. Looking forward, we are no alignment of interest between manage- going to see an increase in due diligence ment and owners and there was a poor line of accompanied by a reduction in prices, a command. We changed the management reduction in leverage and a reduction in structure, the business was given a new lease returns,” he says. of life and by the time we floated it, it was a big success,” he says.

23 Key issues

These turnaround stories cannot be achieved Nigel McConnell of Cognetas points out that, “In the past, private by leverage alone. But they do require a at his mid-market firm, more than 60 per cent degree of expertise within the private equity of returns are generated by operational equity made returns firms themselves. improvements in the underlying businesses, from a third leverage, rather than any kind of financial engineering. “You need a broad skill set to interact with a third multiple arbitrage “We never buy a business unless we think we different companies. There is no point having and a third from running can improve underlying earnings,” he says. a seat at the board if you don’t have the right the business better” people to fill it,” says Sherwood. This refrain is likely to become more pro- nounced across the industry. In the early Multiple arbitrage has played a part in private days of private equity, leverage played an equity’s success as well, but that has dimin- undeniably large role and in recent years, ished over time. gearing moved to centre-stage again. Now, “In the past, private equity made returns from the debt multiples of 2005 and 2006 are sim- a third leverage, a third multiple arbitrage ply not on offer – so private equity firms will RVT QIYI H UK PRIVATE EQUITYINTHE and a third from running the business better. have ample chance to prove they are not just Recently, the competitive landscape has financial wizards. turned multiple enhancement into multiple 1 Source: European Private Equity and Venture Capital compression and firms have been forced to Association do more with their portfolio companies to deliver the returns,” says Jacques Callaghan of Hawkpoint. THE FIRST25YEARS

24 Key issues Key issues RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE

It is one of the maxims of public relations with complex issues creates a perfect storm. The venture capital THE FIRST25YEARS that it is what people believe that matters, not Something like this caught the private equity what is true, because – for better or worse – industry has always industry and for a few turbulent weeks it suf- it is beliefs that drive action. invested in public fered, but the storm has now passed. This The private equity industry has learned this does not mean that the need for public rela- relations and has always lesson too, albeit it left it rather late. For much tions has gone with it; but life should not be had a good public image of the period after 2000, when a combination governed by the storm. The industry can now of favourable circumstances came together focus on some longer-term communication, to usher in a period of phenomenal growth, rather than fire-fighting. the industry was too busy managing its The main challenge to the private equity expansion to focus much on what people industry lies within its own ranks, because outside thought of it. under that one label lies a diversity of belief It is no coincidence that mid-way through the and culture which makes it difficult to deliver decade, in the three main areas of private a common programme. equity activity – the US, Britain and mainland The venture capital industry, for example, has Europe – the strain began to show. The always invested in public relations and has industry came under attack from both press always had a good public image. In the UK, 3i and politicians. The battle for hearts and minds had external and internal financial public rela- While the focus was slightly different from tions from the early 1970s – long before it ever The private equity industry has made headway in terms of improving its country to country, the drivers underneath thought of becoming a listed company itself – public profile, says Anthony Hilton, but a number of challenges remain were remarkably similar – people were learn- and, generally speaking, it got a good press. ing to adjust to a phenomenon that seemed to There are reasons for this. The public buy into have the power to change their lives, by taking the idea of risk-taking and backing young over the places where they worked, where businesses and good ideas. They see how it they shopped and where they spent their can benefit individuals and the wider econo- leisure time. But they were not sure who these my. They also intuitively know how difficult it mysterious buyers were, where they came is, so tend not to begrudge the rewards. from, where they got their money, nor what Interestingly, in a straw poll, most critics of their intentions were. Hence their concern. private equity did not associate venture capi- Most public relations professionals will tell tal with the genre – or with their criticisms. you there are times when their job is impossi- For these reasons the public relations imper- ble. There are occasions – though thankfully ative for this part of the industry is quite dif- they are rare – where the combination of a ferent from other parts. It needs to make sensationalist and superficial media, an sure that press and public understand how opportunistic and headline-hungry body fragile the venture capital plant is, and how it politic and an electorate unwilling to engage needs to be protected from toxic shocks – 28 29 Key issues

like sudden, unpredictable changes to the sin of the industry. Senior figures say it is a On the other hand, it remains a mistake to tax regime. consequence of the fact that private equity is convey the impression of effortless profit always conscious of the finite life of its funds, because that will always invite a backlash Buy-outs and the mid-market space have a of the pressing need to invest existing funds along the lines of “if it is that easy, the practi- similar momentum behind them, but less of well because that governs their ability to raise tioners do not deserve the rewards”. it. Again, people intuitively understand that another. The industry trumpets its successes the owner of a business will be more commit- These issues will get bigger not smaller in the because it plays well in the investing commu- ted to its success than an employee, so they coming decade because globalisation will nity and makes it easier to raise new money understand how buy-outs work. increase the pressure on companies and for the next fund. highlight competitive weaknesses far more Where it gets difficult is when success seems But, in focusing on its investors, it risks being rapidly than before. Most businessmen today to come too easily – when a business is trans- blind to wider sensitivities – those who think say they have never known a period where formed within months of completion of a it has made too much profit, or not paid pricing pressure is so intense, where compe- buy-out. This is because most people's expe- enough tax, or achieved its profits at too tition is so fierce and where the penalties for rience of business is that it is quite difficult to great a social cost. Balancing these con- falling behind are so severe. get right. Sceptics will wonder if it could not

RVT QIYI H UK PRIVATE EQUITYINTHE stituencies is and will remain one of the have been improved under its old ownership The companies that survive will be those that industry's major challenges. and whether the current owners manipulated are adept at change. Inevitably, many will not performance downwards to get a better There will always be politicians willing to be. It is then most likely that private equity price. Or they will wonder at the durability of exploit any perceived unfairness. The objec- will come on the scene to make the transfor- an improvement that seems to have been tive for the industry is to instil in the public mational change that a public company board achieved so quickly. mind that it is a force for good, so that when may have failed to deliver. Private equity there is apparent unfairness it will be seen as could be thought of as doing capitalism’s nec- Something the mid-market has going for it is a part of the whole and balanced against the essary, rather than dirty work – restructuring that most of the enhancement of the busi- advantages. When this reaction becomes the and reviving businesses, and taking the deci- nesses in this space comes from operational THE FIRST25YEARS norm, the politicians and press will look else- sions others shrink from. improvement. Getting positive coverage for where for their targets. operational improvement and turnarounds is But it may never be universally liked – in the relatively easy – the concept of restoring The irony in all this is that private equity is same way that people shoot the messenger value through better management is an easy anything but an easy way to make money. when they do not like the message. Society one to put across. has to get used to rapid change, but it is ask- On the one hand, traditional long-only investors ing too much for those adversely affected by This is not the case with ‘financial engineer- have been berated for years because of their it in the short term to relish the experience or ing’, where earnings improvement comes refusal to engage with the companies in which thank those who have delivered it. To some from heavy gearing or from a higher stock they invest and to come down hard on under- extent, private equity will always be seen as market rating when the business refloats. performing management. Private equity profiting from someone else’s discomfort. Both seem like sleight of hand – and therefore solves this problem. It takes over underper- likely to disappear as quickly as they arrived. forming companies and aligns the shareholder Just because it is difficult does not mean that and management interest to the greatest pos- the effort should not be made. Private equity Making it appear too easy, and indeed talking sible degree. It makes capitalism work the way needs to be understood and treated with loudly about success while being very it is meant to work. respect, for it has a vital role to play. uncommunicative about failures, is a wider

It remains a mistake to convey the impression of effortless profit because that will always invite a backlash along the lines of “if it is that easy, the practitioners do not deserve the rewards”

30 Key issues Key issues

Transforming the UK economy Private equity-backed businesses are reckoned to be among the most efficient in the UK. How do they stack up in terms of job creation, export growth and investment? Joanne Hart reports RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE

In 1992, the Queen memorably referred Historically, private equity companies have More than 1,250 THE FIRST25YEARS to the year just gone as her annus horribilis. been responsible for the employment of Only 15 years later, the private equity com- around three million people or 21 per cent of businesses were munity might have used the same phrase to employees working in the private sector.2 backed by private describe 2007. Not only did the industry suf- “Private equity delivers a substantial contribu- equity in 2006 and their fer from increasingly tough markets and the tion to stronger employment,” say consult- annual sales growth over virtual disappearance of cheap credit, but it ants at AT Kearney.3 was also lambasted by the media, the unions the past five years has and the general public. “A typical pattern that can be observed is an been around 8 per cent upturn in the first year after the buy-out and Yet independent research indicates that this additional growth at a less steep, but steady, criticism is invariably unfair – private equity rate over the following two to five years,” firms are fundamentally beneficial for busi- they add. ness. They boost efficiency, boost profitabili- ty, boost growth and boost employment – Across the UK, there are almost 450 private and they have been doing so for many years. equity, venture capital, funds of funds and The industry may have shot into the limelight secondaries investment firms, which together in 2007, but it has been investing in UK com- employ more than 9,300 people. As these panies and helping them to grow for firms use a range of financial, business and decades. Over the past five years, this sup- professional firms, nearly 15,400 profession- port has been particularly marked. als are involved in private equity-related work. Between 2002 and 2007, for example, the Firms operate on a nationwide basis. While number of people employed worldwide by many are concentrated in London, cities such UK private equity-backed companies rose by as Bristol, Birmingham, Edinburgh, Leeds and 8 per cent annually on average. Over the Manchester also benefit from private equity. same period, the number of people In fact, 60 per cent of legal, corporate finance employed by FTSE 100 companies rose and accounting firms operating in the indus- just 0.4 per cent per annum, while the figure try and outside London consider private equi- for the wider FTSE 250 index was 3 per cent ty to be a significant source of revenue.4 a year.1 The sector generates considerable invest- In the UK alone, employee numbers have ment, too. More than 1,250 businesses were risen by 4 per cent a year, compared to the backed by private equity in 2006 and their national average of 1 per cent annually. annual sales growth over the past five years Private equity-backed companies currently has been around 8 per cent, compared to employ 1.1 million people, equivalent to 6 per cent for the FTSE 100 and 5 per cent for 8 per cent of the private sector workforce. the FTSE 250. Annual sales revenue at portfo-

32 33 Key issues lio companies increased from £28 million to “Private equity businesses do well because £36 million on average over this period and, there are some very clever people in the in more than 80 per cent of businesses, industry and because they give management growth was organic rather than acquisition- teams the chance to own their own business- led. Export growth has been robust, growing es. This is particularly effective if change is by 10 per cent per annum, compared to a necessary,” says Nicholson. national rate of 4 per cent. “Ultimately, private equity brings a sharper Overall, in the financial year to April 2007, focus to business and makes sure that things private equity-backed companies generated really happen and happen quickly,” he adds. around £310 billion of sales revenue and A World Economic Forum report published in £60 billion of export sales. 2008 bears this out.6 It found that when a com- Investment has been substantial too, rising pany goes private, a fundamental shift in board 11 per cent annually since 2002, compared composition takes place. “The board size and

to a national level of just 3 per cent. Spending the presence of outside directors are drastically UK PRIVATE EQUITY INTHE on research and development (R&D) has reduced,” the report says, adding that private been robust as well, rising 14 per cent over equity board members are most active in com- the past five years.5 plex and challenging transactions. “Private equity-backed businesses have been Portfolio companies agree with the analysis pretty successful. When you benchmark that private equity ownership brings a sharp- them against listed companies, they perform er focus.7 well on all measures, employment, enterprise More than 90 per cent of those surveyed for value and profitability,” says Harry Nicholson,

the IE Consulting report in 2007 admit that THE FIRST25YEARS Private Equity Partner at Ernst & Young. they would not have existed at all – or grown Ernst & Young compiled a survey of exits in more slowly – without private equity backing. Europe and the US, which revealed that EBIT- This backing does not just come in the form of DA (earnings before interest, taxes, deprecia- capital. Nearly every private equity-owned tion, and amortisation) at private equity- business maintains that their investors have backed companies rose by an average of provided advice on strategy and financing 15 per cent in 2006. Two thirds of this growth and introduced them to useful contacts. was derived from fundamental business expansion, including investment and new Almost 40 per cent of management buy-out product launches. The profitability of these companies also said private equity firms had businesses means that in the UK alone, they helped them become more efficient, while 32 contributed £35 billion in taxes. Over the past per cent of businesses said private equity back- five years, sales revenues from private equity- ing had boosted their R&D expenditure. A sim- backed companies amounted to £1,331 billion ilar percentage said they had spent more on IT, and tax contributions totalled £140 billion. thanks to support from private equity investors. More than 90 per cent of those surveyed for the IE Consulting report in 2007 admit that they would not have existed at all – or grown more slowly – without private equity backing

35 Key issues

Portfolio companies that were not the subject Private equity firms have long maintained that of management buy-outs were even more they add most value to investee companies by positive about the impact of private equity providing support on many levels, not just backing on investment activity. Around 57 financial – and managements seem to agree. per cent said investments had been boosted Firms also maintain that they are encouraged to by private equity support, while 54 per cent create strong, vital businesses because these said R&D expenditure was higher than it are most attractive to potential purchasers: would have been and 41 per cent said they independent data backs up this thesis. had spent more on IT than they would other- Even though private equity has been under wise have done. the spotlight, therefore, accused of failing to Almost 60 per cent of businesses have nurture businesses, on-the-ground research received more than one round of investment tells another story. The industry contributes and most companies believe this is the single substantially to the UK economy and has most effective contribution that private equi- become an integral part of it. RVT QIYI H UK PRIVATE EQUITYINTHE ty has made. 1 Data from IE Consulting 2007 Report: The Investment and efficiency helped companies Overall, the evidence economic impact of private equity and venture to become more innovative. Last year, 65 per suggests that private capital in the UK cent of businesses said they had introduced 2 Data from IE Consulting 2007 Report equity has played new products and services over the past two 3 Private Equity Creates Employment & Value, and continues to play years, an increase of 10 per cent from 2006. AT Kearney 2006 an important role in The World Economic Forum report also 4 Data from Arbor Square Associates 2007 the UK economy backs the role private equity firms play in Report: The impact of private equity as a UK THE FIRST25YEARS boosting R&D and innovation. “Firms that financial service undergo a buy-out pursue more economical- 5 Data from IE Consulting 2007 Report ly important innovations, as measured by 6 The Global Economic Impact of Private Equity patent citations, in the years after private Report 2008, published by the World equity investment,” it says. The report adds Economic Forum that private equity-backed firms bring a 7 Data from IE Consulting 2007 Report greater focus to patent portfolios and con- centrate more on a company’s core technolo- gies, but they maintain comparable levels of cutting-edge research. Overall, the evidence suggests that private equity has played and continues to play an important role in the UK economy. Investee companies tend to grow at a faster rate than other UK businesses in terms of sales, profits and employment. Most of this growth is organically-driven and is acknowledged by the portfolio companies themselves.

36 Key issues

The rise of institutional investment in private equity RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Pension funds in the US initially led the way when it came to investing in private equity, but those based in the UK are now increasing their allocations. Andrew Lebus, Managing Partner of Pantheon Ventures, looks at how institutional investment in the industry has evolved over the last 25 years

While pension funds The American Research and Development were instrumental in paving the way for future and local authorities Corporation is often credited as being the pension funds to invest in private equity. have invested in first professional private equity investor, While pension funds and local authorities having been formed in 1946 to commer- have invested in private equity since the mid- private equity since the cialise new technologies developed during 1980s, it was not until the beginning of this mid-1980s, it was not World War II. decade that the asset class hit the agenda of until the beginning of this In the ensuing years, wealthy families such as almost every pension board trustee. In the decade that the asset the Rockefellers continued to make private UK, the Myners Report, published in 2001, equity investments, but it was not until the was responsible for focusing pension funds class hit the agenda of on the benefits of private equity. almost every pension establishment of the Employee Retirement Income Security Act (ERISA) in 1974, as Further factors that influenced the growth of board trustee adjusted in 1978, that pension funds first private equity participation relate to secular became involved. The ‘prudent man’ rule changes in asset allocation among pension within the ERISA allowed pension funds to funds, following the closure of defined bene- invest in private equity funds, provided that fit funds to new members. These changes led these investments did not endanger the to a reduction in equity allocations and, conse- entire portfolio. This, coupled with the stellar quently, to greater demand for fixed-income returns achieved by some early private equi- investments and alternative assets, including ty funds, ensured that the seeds were sown private equity. Today, private equity is proba- for pension funds to become at first cautious, bly considered by most pension funds. The but increasingly enthusiastic, converts to pri- 2007-2008 Russell Survey of Alternative vate equity. Investments shows 57 per cent of US pension Pioneering public organisations in the US, such funds and 54 per cent of European pension as CalPERS, were the first to participate and funds currently invest in private equity. 39 Key issues Key issues RVT QIYI H UK PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE THE FIRST 25 YEARS It was not until the Development of funds of funds and 1980s as tax-efficient UK investment The extraordinary long-term success of the As the secondary market has matured, a THE FIRST25YEARS In the early years, it was more common that trusts; this marked the beginning of the listed listed private equity market notwithstanding, diversity of transaction types and vendors has 1990s that the private equity advisers would operate segre- market. At this time, capital for private equity there remains an inherent tension between developed. Initially, the majority of secondary European secondary gated accounts as gatekeepers on a largely was quite scarce and these trusts represented the benefits of having a permanent pool of transactions consisted of either an interest in a market really began to non-discretionary basis. As relationships a meaningful source of funding for an industry capital and the burden of managing a pub- single fund or a portfolio of fund interests. To take off, with the creation between advisers and clients developed and operating at a relatively small scale. The first licly-listed vehicle in a market that, for its parcel fund interests with other assets, such as as track records were established, the need crop of private equity investment trusts includ- effectiveness and by definition, depends in direct company interests, was a natural pro- of a number of dedicated for discretionary management services grew. ed Pantheon, Candover, Graphite, Electra part on keeping certain information private. gression, and deals of this type became more secondary funds Funds of funds, which enabled client inter- and HgCapital. prevalent from the mid-1990s onwards. Development of the European ests to be pooled with proper alignment of The growth of institutional allocations to private secondary market More recent evolution has resulted in early interests, were a natural progression. equity, however, ensured that the limited part- The explosive growth of private equity secondaries, secondary directs, spin-outs and The early entrants are now among the largest nership became the dominant private equity investment in the 1980s attracted a broad buy-ins, and stapled secondaries. The global fund of funds managers in the world structure and it was not until more recently constituency of new investors. Some of these process of innovation in the secondary mar- today. As the universe of private equity funds that general partners began to think seriously groups subsequently found the fixed life of a ket continues, giving rise to more complicat- increases, investors need to devote greater about raising capital in public markets. traditional limited partnership fund was not ed structures such as transfers of economic resources to their programmes to conduct sufficiently flexible to meet their strategic or interest and new mechanisms that enable This development reflects the growing appropriate due diligence and secure access. liquidity requirements. vendors to retain a stake in the upside of the prominence of leading private equity fund- Furthermore, the typical minimum commit- assets being transferred. manager brands, which may have broadened In consequence, a market for secondary ment level of $10 million for many individual the appeal of private equity to non-traditional sales of private equity funds soon developed, Institutional investors are becoming more funds predicates a very substantial allocation investors. It may also, in part, reflect acknowl- beginning in the US with the formation of the comfortable with the concept of the transfer if an investor is to achieve diversification edgement of the expected decline of defined Venture Capital Fund of America. of private equity assets – any stigma that may across a number of funds, stages and regions. benefit pension schemes as a source of capi- once have attached to a secondary sale has GT Investment Company (now Pantheon The scope of work required to identify the tal for the industry in the longer term, and the long since evaporated. Secondary divest- Ventures) completed one of the first European best funds globally, to manage these relation- commensurate growth of defined contribu- ment is now acknowledged as a proactive purchases of a secondary interest in 1986. ships and to enable critical investment judg- tion schemes. These cannot easily invest in tool for portfolio management rather than as This was followed in 1987 by the formation of ment to be made, requires skilled resources traditional Limited Partner structures because the last resort of a troubled institution or a the first European private equity secondary not usually available to any but the largest of there is no ability to mark such interests reflection of a fundamental flaw in the quality fund of funds, GT Venture Investment institutions. Funds of funds offer institutions to market. of the assets being divested. Company plc, a quoted vehicle now known as the benefit of significant economies of scale Recent years have also witnessed the listing Pantheon International Participations plc. In many cases, private equity can provide and are, therefore, here to stay. of management companies such as Fortress However, it was not until the 1990s that the companies with a better form of ownership Development of the listed private and Blackstone. It seems likely that other European secondary market really began to than public equity, yet the asset class still equity market managers will come to the market, but in all take off, with the creation of a number of ded- accounts for a relatively small proportion of Listed private equity is one area where probability this route will be suitable only for icated secondary funds, including those of global enterprise value. Despite the ups and Europe, and predominantly the UK, has led the largest groups, with the most visible Coller Capital, HarbourVest, Landmark, downs of private equity cycles, there remains development. The first quoted private equity brands and which have also diversified their Pantheon and Paul Capital. plenty of room for growth. vehicles were established in the late 1970s revenue streams.

40 41 Key issues Key issues RVT QIYI H UK PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE THE FIRST 25 YEARS Venture capital comes in many shapes Capital, which manages Graphite Enterprise First launched in the THE FIRST25YEARS and sizes and a key development in recent Trust. “They are also seen as important tools 1970s, PEITs enable years has been the establishment of organi- in portfolio diversification.” sations and vehicles that allow individual individuals to invest, Each of the 20 listed PEITs – like each private investors to participate directly in some of the alongside institutions, in a equity firm – has its own investment strategy, best private equity opportunities. which may be dictated by geography, size portfolio of mainly unlisted Private Equity Investment Trusts (PEITs), and type of investment and so on. companies selected by which are traded on the London Stock One notable deal involving a PEIT was the a single manager Exchange, are a good example. First £17 million management buy-out of paper launched in the 1970s, PEITs enable individ- diary company Letts in 2000, a time when the uals to invest, alongside institutions, in a sector was deeply unfashionable. Dunedin portfolio of mainly unlisted companies select- Capital provided the funding on that occasion ed by a single manager. Alternatively, they and subsequently backed the acquisition of can invest in a fund of funds PEIT, which Filofax. The combined firm, known as Letts invests in a portfolio of direct investment Filofax, has since become the market leader funds, or indeed a hybrid of the two in branded diaries, supplying 40 per cent of approaches. You do not have to be wealthy all such products sold in the UK and export- either – investors can get involved for as little ing to more than 75 countries. The business Individual investors as the price of a share. was sold for £45 million in 2006. The market capitalisation of London-listed There are increasing opportunities for individual investors to get involved in The Electra Private Equity-led £98.3 million PEITs, which include investment companies buy-out of safety equipment group CSG in private equity deals. Andrew Cave looks at Private Equity Investment Trusts and operated by the likes of Dunedin Capital, 1998 was similarly successful. With Electra’s Electra Private Equity, F&C, Graphite and other specialist vehicles, such as Hotbed and Pi Capital, which make it possible backing, CSG evolved from a company with a HgCapital, is estimated to be about £10 bil- regional focus into an international business lion. Returns have been good too – even with two global brands. The investment trust excluding 3i, the sector has enjoyed an was also able to introduce CSG to another of increase over ten years of 223 per cent in its portfolio companies, which used the com- share price total returns, compared to 82 per pany’s electronic identification system in its cent for the FTSE All Share Index. own products. In 2007, by which stage CSG “Investors are attracted to PEITs because had become a world leader in height safety their historical performance has been strong, equipment for industries such as oil and gas because they give access to a large part of and construction, Electra Private Equity sold the economy that is otherwise closed to most its shareholding for more than £280 million. investors and because investments in PEITs Proceeds from the sale of assets are distrib- are liquid and easy to administer,” says uted to the trusts for reinvestment, rather William Eccles, a Senior Partner at Graphite than to investors. For this reason, holding

44 45 Key issues shares in PEITs is seen as a long-term invest- “The average return is consistently higher ment and less suited to frequent trading. than on conventional assets and it’s a fun investment,” says Robins. “I think it’s even Despite the uncertain beginning to 2008, more interesting for private investors where Eccles believes the sector will continue to they are able to select their own specific perform well. “Most PEIT managers have companies and build their own portfolios, been operating for the past 25 years and we rather than have a fund manager do the have learnt a great deal in all market condi- investing for them. But it’s not for the faint tions,” he says. “This experience should hearted or for people who don’t know what serve PEITs well for the next 25 years.” they’re doing.” Specialist investment vehicles such as As well as participating directly in transac- Hotbed and Pi Capital are also meeting an tions, Hotbed’s members can invest in three increased demand from private investors for Hotbed funds, including Parallel Private alternative investments, as they search for Equity, which invests alongside 3i and

enhanced returns. UK PRIVATE EQUITY INTHE Barclays Private Equity in European buy-outs. With the 2006 relaxation of pension rules, individual investors are now able to consider Pi Capital, meanwhile, was set up in 1998, but alternative assets as part of their pension took its current form as a private investment portfolio. Research by Hotbed suggests that club in 2002, when it was bought by Chief an increasing number of private client portfo- Executive David Giampaolo and other lios allocate about 20 per cent of their invest- investors. It has more than 300 high net worth ments to private equity. members, said to include Marks & Spencer Chief Executive Stuart Rose, WPP Chief

Such clients are normally experienced THE FIRST25YEARS Executive Sir Martin Sorrell, Lastminute.com investors and may not wish to lock their cap- “It’s more interesting Co-founder Brent Hoberman and Alchemy ital into pooled funds over which they have Partners Managing Partner Jon Moulton. for private investors no control. However, they also often do not where they are able have the time to seek out direct investment “We focus on growth equity opportunities, opportunities or to manage their invest- but we do not do seed capital,” says to select their own specific ments personally. Giampaolo. “We don’t raise money for com- companies and build their panies. We invest in companies. We set up Hotbed, set up in 2002 by Chief Executive own portfolios, rather than special investment vehicles to invest in com- Gary Robins, a former Investment Director at have a fund manager do panies and then invite our members to sub- 3i, is the UK’s biggest private investor network. scribe to take part on an opt-in basis. On aver- the investing for them” Its 600 high net worth members, mostly in age, between 40-60 investors participate in their mid-50s with an average of £1 million each deal we do.” each to invest, have invested £127 million in Giampaolo says there are important differ- 36 private equity and commercial property ences between a private investment club like deals with a total value exceeding £500 mil- Pi and a conventional venture capital or pri- lion. It invests about £50 million a year. The vate equity fund. firm offers access to individually-selected direct investments, usually in units of £25,000. While funds are protected by the portfolio approach so that losses from some invest- It set out from the start to differentiate itself ments are offset by gains on others, Pi’s mem- from business angel networks by appealing to bers subscribe for investments on a case-by- what it identified as “passive” private investors, case basis. If the company they invest in fails, who have capital to invest, but neither the time they lose their entire capital. nor inclination to become closely involved with the operation of their investments. Giampaolo says this happens in an average of two of every ten companies Pi invests in. Robins says Hotbed’s investment opportuni- However, it has a high success rate in invest- ties originate through relationships its team ments it makes alongside the likes of Alchemy has built up with other professionals through- Partners, Englefield Capital and BC Partners. out the UK and are mostly unavailable to pri- Its best exit to date has been in biosciences vate investors through other channels. firm Cozart, which produced a five-fold return, Members decide individually whether to and Giampaolo says one investment in Pi’s invest, on a case-by-case basis, and Hotbed current portfolio is very likely to surpass that. does the rest of the work – agreeing a clear exit plan, structuring and executing the On average, Pi takes a stake of between deal, working with management to increase 25 and 40 per cent in direct investments and shareholder or asset value, and regularly nominal levels in larger buy-outs in which reporting back to participating clients. it participates. 47 Key issues

Giampaolo believes Pi can be more flexible and integrated financing operations. Pi is on time limits than some traditional funds also diversifying and recently secured its that are tied into fund cycles. He says there second property transaction. Memberships are some investments in its current portfolio, are still being taken by referrals, but for example, that have made excellent Giampaolo says the club will be limited to progress that could be realised now, but it 400-500 individuals. has decided to wait to exit because the busi- Whether individual investors are motivated nesses are still growing rapidly. by this feeling of being part of a ‘club’, the Pi has been averaging four deals a year, but chance to build their own portfolio or simply recently sold a 19.9 per cent stake in itself to the returns on offer, the success of vehicles Bank of Scotland in a deal that involves like Pi and Hotbed suggest this form of invest- access to a significant number of the invest- ment, like PEITs, is set to be a permanent and ments made by the bank’s growth equity growing part of the private equity landscape. RVT QIYI H UK PRIVATE EQUITYINTHE

The success of vehicles like Pi and Hotbed suggest this form of investment, like PEITs, is set to be a

THE FIRST25YEARS permanent and growing part of the private equity landscape

48 Key issues Key issues

“Investors tend to invest in firms that RVT QIYI H UK PRIVATE EQUITYINTHE RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE deliver, so the whole process keeps you on your toes and helps ensure that the good firms prosper and the not so good ones struggle”

Private equity has been dominated by one have to be sold at particular times during the makes it far less transactional and far more THE FIRST25YEARS particular style of funding for decades. It is rel- funding cycle to show potential investors that long-term,” says Paul Marson-Smith, Chief atively simple, relatively straightforward and returns can be made,” he says. Executive of Gresham. relatively successful. Firms approach investors Fundraising is also a lengthy and time-con- As the industry matures, however, other for ten-year money and spend roughly five suming process. As the private equity market options are appearing. Some firms have cho- years investing and five years divesting. has become more crowded and the search sen to list and gain access to permanent capi- The model was conceived because the for returns has become more intense, tal in that way. industry felt it needed this amount of time to investors have become more demanding – American Capital, for example, has based its make capital work effectively. But money they are providing firms with ten-year money entire model around a full listing. The NAS- starts running out after a few years, so most so they want to make sure that it is going to DAQ-listed firm, a member of the S&P 500, firms try and replenish their stocks every the right home. has spawned an offshoot, European Capital, three or four years. Permira, for example, held 500 meetings over which operates using the same structure. General partners are constantly aware of how six months for its most recent fund, which Both businesses are regarded as successful much money they have in the pot, how much raised H11 billion and has 180 investors. and American Capital, with $20 billion in cap- they might need in the future and where they “They all had access to our senior managers ital resources under management, is one of might find that new capital. This means there and to detailed information on every single the largest providers of capital on the private is a constant pressure to deliver the returns company we own,” says Chris Davison, the equity landscape. that make their firms look attractive and make firm’s Director of Communications. “It is a The funding treadmill Others have meanwhile used a listing to pro- limited partners keen to invest in them. slightly protracted process, but it provides vide an additional source of capital – transparency and comfort for investors.” The structure of the private equity industry is in many ways dictated But a number of general and limited partners Blackstone listed on the New York Stock by the ten-year life of funds and the need to deliver performance feel the limited lifetime fund structure can Some firms argue that the funding cycle Exchange in June 2007, raising $4.1 billion in lead to bad decision-making – if they are in imposes a discipline on the private equity the process, while Kohlberg Kravis Roberts has to raise new capital. Is this a necessary discipline or a source of fundraising mode, for instance, they may industry that actively contributes to its suc- been preparing for an IPO since last summer. make exits unwisely. cess. “The ten-year model works for firms inefficiency? Is permanent capital the answer? Joanne Hart reports While a listing is clearly an interesting option, with the track record to attract new money. This pressure has been particularly acute it requires favourable market conditions and Investors tend to invest in firms that deliver, recently. Limited partners have been looking is principally open to large funds with such so the whole process keeps you on your toes for returns and this has encouraged private established track records that investors will and helps ensure that the good firms prosper equity firms to do deals. As a result, there is a be prepared to back them in this mode. and the not so good ones struggle,” says one feeling among some in the industry that cer- general partner. In a related development, meanwhile, the tain deals should not have been done and London Stock Exchange (LSE) seems to may not have been done if the funding cycle This seems logical and it encourages firms to have endorsed the idea of investment vehi- were different. focus on effective and pro-active communica- cles for professional asset managers, with tion with investors. “Our view of investor rela- This is a view held by Jacques Callaghan of the creation in late 2007 of the Specialist tions is that it should be a continuous affair. Hawkpoint. “[It is possible] more value could Fund Market. You are fundraising the whole time, which be created for investors if companies did not

50 51 Key issues

This is intended for highly specialised invest- market. Six or seven years ago, if limited part- “It is particularly challenging for the last asset ment entities that wish to target institutional, ners wanted to sell their exposure to a fund, in a fund. You have to make sure it is acquired professional and highly knowledgeable they would have to accept a discount of 30 to in the first five years or you may pop up investors only. The LSE hopes that it will 40 per cent. Now the situation is more devel- against the end of the fund. The key point is appeal to a variety of different types of oped. When conditions are stable, investors that most firms could return more value most investment managers, including those man- in good quality funds can sell their holdings of the time, if they were not under pressure aging private equity funds seeking admission quickly and at a premium. to sell,” says one private equity adviser. to a public market in London. Some private equity advisers believe the tra- Although most industry participants believe Some firms, such as Alchemy, have opted to ditional ten-year funding model will come the ten-year funding model will continue to create an entirely new structure, offering under increasing pressure as the broader eco- play a dominant role, there is a feeling never- investors the chance to put £5 million or nomic environment changes. theless that we are now entering a new era. more into a fund with a £400 million annual While up to 90 per cent of investors are still “The competitive landscape has created mul- capacity. Investments are made on an annual putting their money into private equity for ten tiple compression and that has forced firms to basis and there is a 12-month notice period years, it can be very difficult to raise money focus on performance enhancement of their

RVT QIYI H UK PRIVATE EQUITYINTHE from Alchemy or its limited partners. within this framework. Some firms may ulti- portfolio companies. As that takes longer, the mately be forced to do things differently. “This is simple and easy to understand. average holding period should get longer, so Investors were after a fairer model and this having the flexibility to circumvent fundrais- structure offers fees that are lower than the ing cycles would be helpful,” says traditional funds, but without any of their Hawkpoint’s Callaghan. hurdles. You can get out any time you feel The private equity industry tends to say that like it and the arrangement goes through to portfolio companies are held for between 2047,” says Jon Moulton, Managing Partner three and five years. In the past few years, at Alchemy. Some private equity THE FIRST25YEARS however, holding periods have come down to advisers believe A couple of firms in the UK and the US have between two and three years in many cases, copied the Alchemy model. Others have as firms sought to take advantage of the the traditional opted for so-called evergreen funds, which, benign economic cycle. If firms now find ten-year funding as their name suggests, do not have a limit- themselves obliged to hold onto their invest- model will come under ed lifespan. ments for longer, to achieve the returns increasing pressure as demanded by their limited partners, they may These vehicles work well, practitioners say, begin to regard the ten-year funding model as the broader economic provided there is a functioning secondary a hindrance. environment changes

52 The roots of the industry The roots of the industry

The early days The UK’s private equity industry may be thriving now, but 25 years ago it was a struggle to get investors interested in the sector. Sir Ronald Cohen, Founder of Apax Partners, details the persistence of the country’s first venture capitalists and the key role played by the early Chairmen of the BVCA RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE

The first modern venture capitalist was ed with high distinction. His paper was, in We tried to think THE FIRST25YEARS probably General Georges Doriot, who was a effect, a draft business plan for MMG, the visiting lecturer at Harvard Business School name of which he had coined. We launched out of the box. In when I was there. He had been responsible MMG to provide advisory services to entre- the first year of our for an investment of US$70,000 to help preneurial companies. One of my colleagues professional partnership, launch DEC back in 1959. DEC floated in was going to be based in his home town, 1972, we considered 1968 at a valuation of US$125 million. Chicago, two were going back to Paris and I Doriot’s firm, American Research and would be in London. what would have been Development, made an annualised return on one of the first private We tried to think out of the box. In the first its investment in excess of 100 per cent: it year of our professional partnership, 1972, equity buy-outs in Europe doubled its money each year. we considered what would have been one of It was among innovative companies such as the first private equity buy-outs in Europe, of DEC that the US turned out to have crucial the French crane manufacturer Potain. For advantages over Europe. One advantage was the deal to make financial sense, the equity in education, especially in the area of new investment had to be leveraged with a signif- technology. A second was in the business icant amount of debt (just as one mixes equi- culture, which admired success in business, ty and debt when one raises a mortgage to welcomed innovation and encouraged com- buy a house). petition and risk-taking. A third was in easy But in those days it proved impossible to raise access to capital. Start-ups and early stage the necessary debt for that kind of a transac- companies in the US were soon to find back- tion. We had the idea, but not the means. We ers in the growing community of venture were a decade too early. We made little capital investors, and among institutional as progress and when, as a result, two of the well as individual investors in the shares trad- founding partners indicated that they wanted ed on the NASDAQ stock market, which was to drop out of MMG, and Maurice Tchénio created in 1970. told me that he would prefer to operate more My first move into this area was with a com- independently, I knew that in order to reverse pany called MMG. It had its origins in a the difficult turn of events I needed to find a Harvard Business School project written in new partner in New York. Whom did I know 1970 by one of my partners, Maurice in New York who could replace our departing Tchénio. Maurice was a brilliant student – top partner? Alan Patricof. of the class, a Baker Scholar – who graduat-

54 55 The roots of the industry

I had met Alan a couple of years previously MMG continued as an advisory business, and we had got on extremely well. He was with a New York office for which Alan was one of the pioneers of American venture responsible. Our London office was to capital. He had set out a few years before become the British arm of the expanded pri- me, in 1969, when he raised a $2.5 million vate equity firm, Alan Patricof Associates, fund from wealthy individuals in the US. when we raised our first venture capital fund Among his investors were two leading fig- in 1981. ures in American business, Bob Sarnoff and The French office, under Maurice Tchénio, Edgar Bronfman. likewise used the Alan Patricof name when it He had also set up a corporate finance advi- raised its first venture capital fund in 1983. sory business to supplement the revenues of The names MMG and Alan Patricof his venture fund. I telephoned Alan and Associates co-existed for some years, then made him an offer. “Our Chicago-based part- we changed the name to MMG Patricof and ner is leaving. If you want to become our finally, in 1991, as the firm expanded geo- partner, we could help you in corporate graphically and we felt the need to create a UK PRIVATE EQUITY INTHE finance in the US and you could help us to unified, international brand, the name in bring venture capital to Europe.” Europe was changed to Apax Partners. Alan is the most careful of people; he does With the benefit of Alan Patricof’s example in not often make commitments on the phone. the US, we set our sights on being venture But on this occasion he immediately said yes. capital investors. But since there was no ven- We soon agreed on a fee-sharing arrange- ture capital industry in Europe, and since ment for the corporate finance business we none of the financial institutions, whether

would do initially, and the deal was done. they were investment funds, lending banks or THE FIRST25YEARS Since none of the financial institutions really knew anything about early stage businesses or buy-outs, we found that we had to get the venture capital industry going ourselves

57 The roots of the industry RVT QIYI H UK PRIVATE EQUITYINTHE THE FIRST25YEARS

investment banks, really knew anything We organised meetings where we could We organised about early stage businesses or buy-outs, we pitch the case for venture capital to prospec- found that we had to get the venture capital tive investors. The first such meeting was meetings where we industry going ourselves. held in London, at the Grosvenor House could pitch the case Hotel, in 1977. William Casey, the Head of In this respect we were no different from for venture capital to the Securities and Exchange Commission, many of the current generation of entrepre- prospective investors which regulates US stock exchanges, spoke. neurs who start new firms in a new industry: He had been invited by Alan Patricof, who you find that considerable effort is needed to was also a speaker. build up the sector at the same time as you build up your firm. A lot of my energy went Leading financial institutions came, but into making the case for venture capital. nobody was really interested in investing in Some of my colleagues thought it was a small businesses. Private equity, venture cap- waste of my time. But I did not think we ital, small-company investments: these were could be successful without this effort. not on the agenda at that time. I was not the only one to realise it: some of our We persisted nevertheless, and in the early competitors recognised the same necessity. 1980s we organised annual forums in hotel Among those who were very active in those conference halls at each of which about early years were Michael Stoddart of Electra; 30 entrepreneurs would stand up one after Sir David Cooksey, Tony Lorenz, Colin Clive another to expound, in four minutes each, the and Lionel Anthony, who were Chairmen of virtues of their businesses to potential the BVCA; Dick Onians, who was Chairman of investors. We began to create a feeling that the European Venture Capital Association; perhaps there were worthwhile entrepre- Roger Brooke of Candover; and Nick neurs and ventures in Britain after all. Ferguson of Schroder Ventures.

58 The roots of the industry The roots of the industry

25 years of the BVCA and the private equity industry Sir David Cooksey, Founder of Advent Venture Partners, looks back at the The early 1980s saw the birth of a truly All of this took place against a rapidly evolv- In the UK, several British venture capital industry. Until then, ing economic backdrop, with Margaret venture capital early days of the industry and analyses its evolution over the last 25 years some UK-based funds invested almost exclu- Thatcher’s rise to power and the free market sively in the US, typically Abingworth and politics that she promoted making the UK a firms were formed Thompson Clive, while 3i (in its former guise much more competitive place to do busi- to invest locally and by of ICFC) mostly lent money in the UK to small ness. Venture capital was perceived to be a the end of 1981 there companies on a long-term basis, but usually flag carrier for this new culture and many were about ten such secured against the companies’ assets. leading investment institutions decided to RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE back the fledgling venture capital firms. firms in London UK PRIVATE EQUITYINTHE Other firms, such as Electra and Charter- Even the Bank of England helped the indus- house, were well established, providing try promote its cause because it saw the development capital to more mature compa- industry filling a void in the financing of nies, but there was nothing in the UK or con- dynamic small firms. tinental Europe to match the equity financing for emerging technology-based companies The culture was further stimulated by the that the US venture capital industry provided London Stock Exchange’s introduction of at that time. the Unlisted Securities Market (USM), a

stock market expressly designed to cater for THE FIRST25YEARS It was a golden age for venture capital, with smaller companies undergoing rapid the developments in semi-conductors, rotat- growth. The intention was to emulate ing magnetic memories and new software NASDAQ in the US, but the growth rates of operating systems enabling the advent of the companies never compared to the US micro computers and so on. Meanwhile, model. The USM later failed in the recession developments in microbiology provided the of the early 1990s, due to a lack of liquidity. driving force behind new biotech companies. In every case, new entrants to the computing, Nevertheless, the leading participants felt telecoms and healthcare industries grasped that their activities were having a substantial the opportunities to dramatically reduce cost impact on the financing framework for small and improve functionality simultaneously. firms and that their Venture Capital Lunch Club should be reformulated as the British Many established businesses struggled to Venture Capital Association. The purpose embrace this rapid change and found that was to provide a representative body to bring they could not compete. The result was the together the entire industry and to act as a explosive growth of many recently-formed lobby organisation when appropriate. I companies, many of which migrated to the became the first Chairman and the first coun- NASDAQ stock market for their further cil members included Sir Ronald Cohen of funding requirements. Apax Partners, Tony Lorenz of ECI and Colin In the UK, several venture capital firms were Clive of Thompson Clive. formed to invest locally and by the end of Most of the venture capitalists set out to 1981 there were about ten such firms in finance businesses using the US model, London. They were a mix of independents, which involved the exploitation of innovative such as Advent and Alan Patricof Associates technologies. They would seek to identify the (now Apax Partners), while Electra and ECI sources of those technologies either already were experimenting with early stage equity being exploited by a company or, more likely, investment, and there were captives, such as residing at a university laboratory. In the latter Citicorp Venture Capital (later spun off as case it would be necessary to form a compa- CVC). Abingworth and Thompson Clive ny in which to spin out the technology. started to invest in Europe as well. British universities obtained the vast bulk of We all had much to learn from each other their funding from the Government, and most and the general partners of these firms met university professors at that time believed that about six times a year for lunch, as the involvement with business somehow Venture Capital Lunch Club. Electra always demeaned the standing of their research. But provided the best hospitality and we would others – seeing some of the extraordinary meet there as often as we could.

60 61 The roots of the industry

developments around Harvard, MIT and because our home market is too unreceptive Stanford universities in the US – decided that or simply too small for the companies to suc- the time had come to be much more open to ceed. There have been outstanding success- involvement with business. This trend was fur- es, but there have been too few of them and ther stimulated when the Government termi- the industry has failed to consistently produce nated the automatic ownership by the National the high rates of return expected of it. Research & Development Corporation of intel- This caused many of those who started as lectual property emerging from Government- pure venture capitalists to turn their atten- financed research at the universities in 1985. tion to more mature companies. The result Over the past 20 years a series of measures was venture capital broadening to private has followed to encourage collaboration equity, with much buy-out activity starting between universities and business. Many in the mid-1980s. Since then, buy-out activ- universities have developed competent tech- ity has burgeoned, embracing every part of nology transfer organisations and much more the economy with very beneficial effect in RVT QIYI H UK PRIVATE EQUITYINTHE spin-out activity has followed. Many success- terms of improving the performance of ful companies have been formed, particularly underperforming companies and the much in the information technology, telecommuni- more efficient use of capital to finance them. cations, media and life sciences industries. As buy-outs have grown and grown, private As a result, Britain has managed to hold its equity has moved from being an alternative own in the knowledge-based industries, asset to being a mainstream asset class. And whereas it had been failing badly 25 years it has attracted much more media and union ago. Even the professors, who 25 years ago attention, too. were often disparaging about the quality of London has developed as a European capital London has THE FIRST25YEARS British management, now gladly participate of private equity and the role of the BVCA developed as a in this process. has grown with the growth in the industry. European capital This is a high-risk process and there is fierce The BVCA’s standing and influence is a trib- of private equity and the competition around the world in the high-tech ute both to those who had the original vision, industries. British venture capitalists have and to those who have ensured it remains an role of the BVCA has found it difficult to identify and grow success- effective mouthpiece for a very important grown with the growth ful technology-based businesses, often sector of the financial services industry. in the industry

62 The roots of the industry The roots of the industry

At about the same time as the BVCA was programmes, its use of quoted markets and launched, a pioneering private equity business its approach to public accountability. But The role of 3i – with the very catchy name of the Industrial sometimes, too – as in the early part of this and Commercial Finance Corporation (ICFC) – decade – 3i has felt the sting of competition Baroness Sarah Hogg, Chairman, 3i, looks at the growth was going through one of its periodic transfor- and has had to transform itself to regain its mations. ICFC, by then 40 years old, under- position, recharge its performance and trans- of the company and the industry over the past 25 years went a massive change programme in the form remuneration to attract the best private early 1980s under the leadership of Jon equity investors around the world. Foulds, who later went on to chair and float Naturally, having started life as an economist, the Halifax Building Society. I am all in favour of competition. In private That was when the ‘3i’ name was born. This equity, as elsewhere, it has helped to grow re-branding of the business was integral to the market and improve the products or serv- its ambition: to capitalise on a wave of entre- ices on offer. The rapid growth of the industry RVT QIYI H UK PRIVATE EQUITY IN THE preneurialism in the UK. But the ambition and the number of competitors in the market UK PRIVATE EQUITYINTHE was broader than that: to deploy 3i’s skills have stimulated innovation in buy-outs and across Europe, to accelerate the develop- growth capital, and most recently in the appli- ment of buy-outs and to make 3i an interna- cation of private equity skills to infrastructure tional name in financial services. In many assets and quoted markets. And it is a further ways, these aims mirrored those of the compliment to 3i that today a number of our BVCA, as it sought to promote the UK pri- competitors, such as Bridgepoint, Barclays vate equity industry. Private Equity and Charterhouse, have been led by 3i alumni. With shareholders’ funds of £461 million, the THE FIRST 25 YEARS management at 3i also wanted to float the The acceleration of the move towards the THE FIRST25YEARS company – gaining independence from the management of external funds in the 1990s clearing banks that had put up the original was another classic example of increased £10 million to found the business and still competition growing a market. The develop- owned it. ment of the European buy-out industry has clearly been dependent upon it; so, today, is Today, funds under management are more the growth of the market in Asia. than £8 billion, approximately 60 per cent of 3i’s assets are outside the UK, and, as a mem- Globalisation has provided a further stimulus ber of the FTSE 100 since 1994, 3i has to growth, as well as creating the need for a become recognised throughout the financial different style of management within private services world. In the past 25 years, 3i and equity firms. The challenges of running multi- the private equity industry have both country operations, dealing with different cul- changed enormously. At times, 3i has led, as tures and markets at varying stages of maturi- in its redevelopment of growth capital, infra- ty, played to 3i’s strengths. The emphasis on structure and its Asian strategy, its people ‘The best team for the job’ and a ‘One room,

The rapid growth of the industry and the number of competitors in the market have stimulated innovation in buy-outs and growth capital

64 65 The roots of the industry RVT QIYI H UK PRIVATE EQUITYINTHE

THE FIRST25YEARS One firm’ approach have enabled 3i to capi- represents approximately 40 per cent of our The economic talise on the diversity of talent inside and out- portfolio and has been a key driver of returns side the company. and growth. Its development has also taught climate looks more us much in terms of organisation and manag- uncertain than for Communications technology has played a ing cultural diversity both within and outside major role in the growth of the industry and some time, and the industry of 3i. Building a truly sustainable internation- its internationalisation, as well as its ability to has been in the political al business depends so much on how people transact at an operational level. The speed interact and support each other. spotlight. However, it is with which our Asian business has grown the challenging times would have been impossible with those early So much has changed over the past 25 years; 1980s phones and faxes. However, some ‘old but not our values or our belief in the impor- that have led to the technology’ has served us well – notably, our tance of investing in relationships. It is these greatest innovation permanent capital that has enabled us to that I believe have enabled 3i to deal with the enter markets before raising funds specific to challenges of economic cycles and the them. It has also been very clear that our changes in the competitive landscape. FTSE 100 status, the 3i brand and our reputa- As this book goes to print, the economic cli- tion for transparency and good governance mate looks more uncertain than for some have helped considerably. time, and the industry has been in the political We have recently celebrated our tenth spotlight. However, it is the challenging times anniversary in Asia and, rather fittingly, ten that have led to the greatest innovation. It is per cent of our assets are now in this region. also at such times that relationships matter the We are learning much from the process of most. For more than 60 years, 3i has been at our rapid development there, and gaining the heart of the private equity industry. We greater benefit for our European and US congratulate the BVCA on its 25th anniver- portfolio companies from our Asian presence sary and look forward to working with it, and than we had anticipated. with others in the industry, in the next phase of private equity development. In 2008 we will also be celebrating our 25th year in continental Europe. This market today

66 The roots of the industry The roots of the industry RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE THE FIRST25YEARS The venture business in Europe has seen be locally focused and local European mar- Recession in the more volatility in its development over the kets lacked the scale and homogeneity of the early 1990s brought last 25 years than any other segment of pri- US market, which resulted in fewer large exits vate equity. and lower overall returns. the first buy-out boom to an end, but both Following the success of a still-young indus- The late 1980s saw an increase in continental try in the US, Sofinnova was founded as the European deals and the advent of the buy-out the boom and the fallout first venture capital company in France in the to Europe. In 1987, established firms were affected venture capital, as 1970s. This was followed in the early 1980s, raising their third funds and by 1989, the funding had shifted to later at the time of the personal computing boom, number of buy-outs exceeded venture stage companies and the by a group of firms in the UK and continen- financings and deals were increasingly cross- tal Europe founded, for the most part, by border, with or without syndication. contraction affected people with some US business experience virtually all segments Recession in the early 1990s brought the first or education. buy-out boom to an end, but both the boom These pioneering firms, which included and the fallout affected venture capital, as Advent, Alan Patricof Associates, Thompson funding had shifted to later stage companies Clive and ECI, backed early stage companies, and the contraction affected virtually all seg- Enterprising spirit only some of which were technology-related ments. A notable exception was biotechnolo- – venture capital has only become closely gy, a sector that produced a cluster of high- Venture capital is still the toughest part of the business to get right, associated with technology investment in profile IPOs and trade sales, including Shire, says Anne Glover OBE, CEO and Co-founder, Amadeus Capital Partners Europe since the mid-1990s. Scotia and Biocompatibles. Venture investing in the early days was local Similarly high-profile and global IT companies and very hands-on, not least because good did not achieve scale until the mid-1990s and managers were hard to find in Europe. The the beginning of the internet explosion, which advent of secondary markets, the Unlisted was triggered by the IPO of Netscape in 1995. Securities Market in the UK and Second Initially, few realised just how critical a phe- Marché in France, stimulated the business by nomenon for business and consumer commu- providing an exit route alongside NASDAQ. nication the internet was. By 2000, this area attracted plenty of interest and prodigious Early successes included HATT’s RACAL quantities of money – representing 90 per Millicom, which owned the Vodafone fran- cent of the total capital raised for IT in the pre- chise and was sold for £35.6 million in 1987, vious 20 years – but in this initial phase, only a and ComputaCenter, which floated on the few profitable business models emerged. London Stock Exchange in May 1998. But in Sadly, many potentially viable young compa- spite of such successes, Europe failed to gain nies were washed away or forced to hibernate the traction of the US. Investments tended to until the downturn was over.

68 69 The roots of the industry The internet boom also stimulated the cre- The growth of successful venture investing The fiscal ation of many new venture firms in Europe. A globally will inevitably encounter further ups number of those disappeared in the wake of and downs because the enthusiasm with environment since 2001-2002, but a small group of home-grown which founders, entrepreneurs and funders 2000 has improved and US entrants, who had backed successful take to new technologies is not always adopt- for founders and owners companies in the late 1990s and invested in ed by the market, at least until a first wave of businesses – and let broad portfolios, survived and are the core of beds down, and inevitably after some failures. the resurgence in ventures we are seeing in Web 2.0 and cleantech may be today’s hot us hope that the UK Europe today. areas, though both are undoubtedly here to remains competitive stay. What we have learned is that new oppor- Although some successful companies, like on the global stage tunities always emerge from change and Lastminute and Kelkoo, weathered the storm in this respect absolute levels of entrepreneurship and ven- of the dotcom and telecoms crash, the ven- ture investment in the UK have systematically ture sector suffered severely. The track increased as global barriers have come down. record of Europe’s ventures was too small

RVT QIYI H UK PRIVATE EQUITYINTHE and too limited to outweigh the excesses of The environment for enterprise today is bet- 1999-2001, and it took exits such as CSR and ter than ever before. The social status of the Skype for confidence to return. entrepreneur this side of the Atlantic has risen; there is wide recognition that multiple What we now see is that the firms that have talents are required to build successful busi- come through this period, much as those that nesses and we now see real collaboration, backed biotech in the 1990s, have a real Silicon Valley-style, between technologists, commitment to supporting young and grow- entrepreneurs, managers and financiers. The ing technology companies. Much of our fiscal environment since 2000 has improved business is no longer just about start-ups,

THE FIRST25YEARS for founders and owners of businesses – and though of course they remain an essential let us hope that the UK remains competitive component, but about seeing companies on the global stage in this respect, lest we lose through several years of growth with several our ability to attract world-class management rounds of finance and support on all fronts. into young companies. What has also changed is that technology is The standing the UK and Europe have now completely global and it does not matter achieved in the creation of innovative busi- where a company is founded, where its nesses will, however, be challenged in the investors are based or into which markets it coming years by the emergence of China and sells products or services. This means that the India, as well as by the US. Levels of competi- US, with its large indigenous market – long an tion for technological excellence and devel- advantage – no longer has an automatic lead opment are greater than at any time in the in building successful technology companies. past 25 years, so we need continuously to Furthermore, with a number of billion-dollar raise our game. companies established in Europe, we have no problem today attracting the best man- agers from anywhere in the world into our young businesses.

70 Impressions of the industry – the impact of private equity Impressions of the industry – the impact of private equity

The wider business community has uidity in the secondary market – becomes solution for publicly-owned companies that looked at the success of the private equity more valuable in tougher times. run into serious difficulties. More recently, sector in recent years with a mixture of envy Northern Rock was attracting interest from Moreover, it would be a mistake to assume and admiration. Business people have envied this kind of finance at a time when publicly- that the sector’s political enemies will become a corporate governance model that allows owned companies were keeping well away. less aggressive in these changed economic executives to concentrate on the job in hand, circumstances. The same voices that so noisi- In addition, private equity firms have been without too many distractions from City ana- ly condemned the profitability of private making much greater efforts to explain how lysts, regulators and the media, and which equity houses will be just as quick to pick on this form of corporate ownership has become offers large rewards for success. any bad publicity from the business problems an increasingly important component of an And they have admired the results that have that could emerge in an economic slowdown. efficient capital market. As Blackstone’s often followed, in the shape of business turn- In these circumstances, as The Economist Stephen Schwarzman told the CBI confer- arounds, strategic expansion and growth. argued last year: “Perhaps the greatest threat ence in November 2007: “Private equity’s to the continued growth of private equity is major innovation is that it blends the best ele- This success has had an impact on the way regulation.” It concluded that: “The new ments of private ownership with public mar- publicly listed companies are managed. For RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE kings of capitalism must try to prevent this ket-sized capital.” UK PRIVATE EQUITYINTHE example, a number of PLCs have placed a from happening by showing that they really greater focus on the efficient allocation of It was not, he acknowledged, the right solu- are a force for good.” capital, and have attempted to get more tion for every company. But it filled a crucial alignment between the interests of managers The sector is well-placed to respond to gap in the corporate governance spectrum, and shareholders. In the case of some big, this challenge. and in so doing it challenged all companies to publicly-owned companies, the growth of For one thing, private equity firms have sub- reach a new level of performance. shareholder activism has added an extra stantial amounts of capital at their disposal, The BVCA has taken a lead over the past year push in the same direction. and continue to raise large sums of new in presenting private equity in its true light, as But this admiration has been tempered by the a dynamic part of the broad business commu- THE FIRST25YEARS knowledge that business conditions have been The BVCA has taken nity rather than a secretive club of specialist just about ideal for private equity houses in a lead over the past investors sitting somewhere on the margins of recent years. Very low interest rates, a plentiful the capital market. It commissioned Sir David supply of credit, rising asset prices, macroeco- year in presenting Walker to produce the guidelines that are now nomic stability – these have been exceptional private equity in its true light, in place to increase the visibility for large pri- times for raising substantial sums of capital, as a dynamic part of the vate equity firms and portfolio companies. and for generating very large returns. broad business community And it is developing a robust database that, The big question has been about how much rather than a secretive club among other things, will permit serious analy- these returns have been to do with manage- sis of the ways in which private equity gener- ment skills, and how much to do with the money. So if they need to, they have plenty of ates its returns, and of how its performance favourable economic cycle. Academic stud- cash to support investments that might run compares with that of quoted companies. ies show that the larger part of private equity into difficulties. The private and publicly-listed sectors are returns over time has been a result of good coming to realise that each has a vital interest management as opposed to financial engi- For another, the success of the sector has in the other’s success, and a shared interest in neering. But as acquisition prices and debt meant that the repayment terms on its loans public policymaking. leverage have both risen in recent years, the have generally become much less onerous question has inevitably gained more force. than in past business cycles. Repayment of Private equity needs large and liquid public principal is often delayed for a good number markets in order to realise its capital gains. A view from outside the industry We are now about to discover the answer. of years, which means that firms have more Public-listed companies need the spur that Credit conditions have changed dramatically time to put things in order if one of their comes from private equity investment, and The 25th anniversary of the BVCA is a milestone in the development of the for the worse since the summer of 2007. As investments hits trouble. the opportunity it provides to reshape busi- a result, the spread between the yield on private equity industry, says CBI Director-General Richard Lambert ness portfolios when necessary. low- and high-risk debt – which had become At the same time, there will still be plenty of unusually compressed – has widened investment opportunities in these tougher Both have a vital interest in the ingredients of sharply. The large European economies are economic conditions. The mega deals may a successful economy, which include a skilled faltering, and the US faces the possibility of be over for the time being. But business con- workforce, proportionate business taxes and a recession. tinues to be brisk at the small to medium- regulation, well-developed infrastructure, sized end of the market, and is likely to energy and environmental security, and a lib- So these are going to be much more testing remain so as big, publicly-owned companies eral approach to the movements of trade, times. There are two particular challenges for adjust their portfolios in response to chang- capital, and people. private equity. One is that loans become ing economic circumstances. harder to secure at a time when banks face So, on the 25th anniversary of the BVCA, the difficulties in distributing the debt they Emerging market activities are proving to be private equity industry finds itself at a mile- underwrite to other investors, such as pen- very successful for some private equity hous- stone in its development in the UK. How it sion or hedge funds. es, and distressed debt funds are attracting responds to the economic and political chal- big inflows. As was shown in the Japanese lenges will be crucial in shaping its future as it The other is that the one big advantage that banking crisis, private equity investment can enters the next quarter century. public equity has over private – greater liq- be the best and sometimes even the only 72 73 Impressions of the industry – the impact of private equity Impressions of the industry – the impact of private equity

I once attended a National Association of A Greenwich Associates survey in 2006 cal- Disparity between Pension Funds (NAPF) Investment Conference culated that pension fund assets invested in where the then head of the BVCA spoke private equity had increased by 50 per cent the best and worst The view from the NAPF about the attractions of venture capital for over the period 2004-06 to around £9 billion. private equity pension funds. This was a time – before the In addition, the best performing UK private managers can be extreme, Pensions funds are increasing their investment in private equity. Myners review in 2001 – when few funds had equity funds have produced returns that and pension funds must invested much in the sector, even compared exceeded the FTSE All Share over recent five- David Paterson, Head of Corporate Governance at the NAPF, explains why to today’s modest figures. and ten-year periods. be comfortable that due diligence has Returns in the previous few years had not The need for diversification is not the only been that impressive, and the conference reason why pension funds are increasingly been carried out audience was concerned about high fees and investing in private equity, however. It must the lack of transparency around reporting and be remembered that pension funds are long- performance measurement. We were assured term investors, so commitment to private Disparity between the best and worst private that the industry was taking steps to address equity investment vehicles that may take sev- equity managers can be extreme, and pen- RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE those issues. It is interesting that issues around eral years to invest, and which are committed UK PRIVATE EQUITYINTHE sion funds must be comfortable that due dili- transparency – albeit to a wider stakeholder to generate meaningful returns on capital, fits gence has been carried out on potential group – are still being debated today. well with funds’ investment time horizon. investment targets to minimise potential for This is particularly the case as Liability Driven What has also changed in the private equity losses or default. Investment (LDI) – an investment strategy sector since then has been the sheer scale of aimed at establishing a link between a fund’s Private equity investments tend also to be the deals, the leverage and the concern assets and liabilities – becomes more popular illiquid, so immediate access to those funds about the lack of accountability compared to with pension funds. Some 44 per cent of committed at short notice can be difficult to public equity markets. The calls to take funds polled by JP Morgan in 2006 said that achieve and – if possible – would certainly account of the interests of the wider stake- they were either already implementing or attract significant financial penalties. holder group have been addressed by Sir THE FIRST25YEARS considering LDI. The LDI approach fits broad- David Walker’s proposals. In its response to Sir David Walker’s consulta- ly with the investment/return cycle of the pri- tion, the NAPF, along with the UK Investment For pension funds, the concept of investment vate equity sector. Performance Committee, stated that it believes diversification has well and truly taken root In addition, since the Myners Report in 2001, that there was much to be gained from private during this period. Private equity therefore which was tasked with looking at the impedi- equity incorporating Global Investment has not been ignored as a potential asset class. ments to funds investing more in venture capi- Performance Standards, or GIPS, into their Overall, 55 per cent of assets in defined ben- tal and private equity, pension funds have been reporting guidelines. This would benefit both efit pension schemes in the NAPF’s Annual encouraged to look at investing more widely the funds themselves and their investors. Survey 2007 are invested in equities, down than simply in traditional investment vehicles. The NAPF, though, broadly supports Sir from 61 per cent in 2005. A further 29 per However, there are still some obstacles that David Walker’s November 2007 report and cent are in fixed interest assets (up 4 per cent could prevent pension funds directing a high- its conclusions, including the wider remit that from 2005) and 16 per cent in alternatives er percentage of assets towards private equity. the BVCA has been given. The NAPF wel- and cash (up 2 per cent). There remains some scepticism around trans- comes its commitment to greater transparen- In terms of pension fund investment into pri- parency of reporting – for example, on portfo- cy and looks forward to working closely with vate equity, there has been a clear shift – the lio valuations – and the levels of fees charged, the BVCA in the interests of their investors percentage of schemes that invest in private particularly performance-related fees. and our members. equity has risen by 5 per cent to 20 per cent over the last two years. Private equity now accounts for 1.7 per cent of all assets invest- ed, up from 1 per cent in 2005. There is also a split between the public and private sector, with more private equity invest- ment from public sector pension funds (2.4 per cent of public sector assets compared with Private equity/venture capital investment by UK defined benefit pension schemes 1.5 per cent of private sector assets). Pension funds are still most likely to access pri- % of schemes which invest Average % of fund invested % of all assets invested vate equity investment through funds of funds (schemes which invest) arrangements, with 64 per cent of the pension funds surveyed by the NAPF having adopted 2007 2006 2005 2007 2006 2005 2007 2006 2005 this approach, compared to 44 per cent which 20 20 15 3.2 3.2 3.3 1.7 1.7 1.0 have wholly or partly invested via a single pri- vate equity fund. Source : NAPF Annual Survey 2007

74 75 Impressions of the industry – the impact of private equity

A question of image RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Six years on from his review of institutional investment for the Treasury, Paul Myners looks again at private equity as an asset class

Private equity I argued in my review of institutional particular to this form of ownership. I make investment returns investment for the Chancellor in March 2001 this assertion notwithstanding the heat gen- that private equity had tended to be over- erated by intense public scrutiny of private vary over time looked as an asset class by UK institutional equity’s actions, rewards and governance. and between different investors and urged UK pension funds and Private equity investment returns vary over others to take a greater interest. The points I managers, or general time and between different managers, or made then remain valid, particularly the need partners, and between general partners, and between styles and for the private equity industry to increase dis- specialisations. The message here is simple: styles and specialisations closure about its activities and performance investors need to show care and skill in the and for investors to increase their under- selection of managers, the best of whom pro- standing of the relative merits of the public duce stellar outcomes. But this is a sector and private equity markets. where Alpha identification is critical – Beta is Private equity investment can have good and unlikely to be sufficient. bad outcomes, just like other forms of owner- Of late, in the period before the credit crunch ship. The economy benefits from choice as a made its mark, we saw better relative returns consequence of diversity of ownership and from private equity funds, reflecting benign financing models. This is to be welcomed. economic conditions, abundant credit and Private equity owners can and do make favourable exit valuations. Over time, employees redundant, cut back on research investors should expect private equity to pro- and development and default on debt. So do duce superior returns to public equity to com- public equity and other forms of commercial pensate for the higher risk from private equi- ownership, including sole traders, partner- ty’s portfolio concentration, greater use of ships and family firms. In fact, the similarities debt and lack of liquidity. between different forms of ownership are far clearer than the differences. These superior returns are likely to reflect better oversight of management in investee There is little evidence to suggest that private companies. That private equity has not equity poses any economic or systemic risk

77 Impressions of the industry – the impact of private equity

always, on average, produced returns superi- Private equity has many positive qualities but, Private equity-owned or to that of public equity is a source of worry as an investment sub-sector, remains poorly – although I think the general quality of man- understood and suffers from a negative image. companies directly agement in private equity has improved sig- It is in the interests of the private equity indus- employ more than nificantly over the past ten years, which gives try to make greater efforts to explain the sec- 1.1 million people in the grounds for optimism. tor’s activities and the performance of the com- UK, with a significant panies in which they invest. Put simply, private A new feature of private equity that became equity is more likely to prosper if the industry additional number obvious from 2006 onwards was the emer- has a positive image, which will encourage oth- dependent in some way gence of very large private equity funds mak- ers to invest and deal with it and will not cause ing offers or proposals to acquire leading pub- on businesses owned alarm to employees, trade unions, suppliers, licly-quoted companies, lock, stock and barrel. under this model customers, regulators or legislators. Private equity appears to have two distinct Sir David Walker’s proposals set a clear advantages when bidding for public equity: map for progress in this respect, a route

RVT QIYI H UK PRIVATE EQUITYINTHE firstly, its use of debt and secondly, a set of that wise managers will follow with enthusi- less restrictive governance protocols. asm. To my mind, he could have gone fur- Why can it be that one form of ownership ther, but he has made a major and welcome should favour an entirely different level contribution to promoting the cause of pri- of financing risk and approach to gover- vate equity. Those who disregard Walker nance from another, given that both forms of will do so at some risk of seeing restrictions ownership work under the same tax regime placed on the industry’s licence and are ultimately largely funded by to operate. the same beneficial owners, pensions

THE FIRST25YEARS Private equity-owned companies directly and endowments? employ over 1.1 million people in the UK, The answer may lie in the second explanation with a significant additional number depend- for private equity’s competitive advantage: ent in some way on businesses owned under governance. The direct engagement between this model. Many companies and their stake- the private equity general partner and the holders have benefited from this approach. It investee company promotes much greater is not a bad way to own or invest in a busi- confidence and comfort with higher debt lev- ness. The private equity industry has a good els and implicit increase in equity volatility. story to tell and should not be shy about telling it. I also think the weight of corporate gover- nance process and focus has promoted an Paul Myners is Chairman of Land Securities increased risk aversion among the non-exec- Group, Guardian Media Group, the Low Pay utives on many public company boards. This Commission and Tate, and Advisory Board has not always been to the benefit of Member of Englefield Capital. He is also a investors in these companies. And it has cer- Member of the Court of the Bank of England. tainly led to strategies that private equity has identified as suboptimal and capable of improvement.

78 Impressions of the industry – the impact of private equity Impressions of the industry – the impact of private equity

The evidence Private equity and economic performance appears to suggest that employment in Research into the performance of major UK businesses under businesses owned by private equity ownership could pose interesting questions for private equity in Europe quoted companies and their boards, writes Sir David Walker has grown at a faster rate than in comparable quoted companies RVT QIYI H UK PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE

The guidelines now in place in the UK for This is why I have attached such priority and On the basis of valuable but limited analyses THE FIRST 25 YEARS large private equity firms and portfolio compa- importance to construction of an authoritative undertaken so far, the evidence appears to sug- THE FIRST25YEARS nies will increase transparency where, until and comprehensive database for the industry gest that employment in businesses owned by recently, substantial business activity was and the development of a methodology for private equity in Europe has grown at a faster shaded from the glare of the public spotlight. analysing how private equity generates often rate than in comparable quoted companies, The guidelines are both substantial and unique exceptional returns and how its performance that both enterprise value and earnings before in the world of private equity buy-out activity compares with that of quoted companies. interest, taxes, depreciation, and amortisation and the structure now being put in place by the (EBITDA) have grown faster on the basis of The need is to find a rigorous way of analysing BVCA provides for independent monitoring of similar comparisons with quoted companies the weight to be attached respectively to the industry’s compliance. and that a large part of the growth in EBITDA financial leverage, to change in the overall came from business expansion. My hope is that the guidelines and the frame- market environment in the relevant business work of self-regulatory commitment that sector, and to improved operational and If the broader-based, industry-wide analysis underpins them will come to be seen as a prag- strategic performance. Inevitably such attribu- now in train shows results that are broadly matic and workable model that has relevance tion analysis and the integral comparisons confirmatory of these findings, this should for others, as with the original Takeover Code with quoted company performance involve focus attention on major questions for both and, later, the evolution of the ‘London some key subjective judgement, for example quoted company boardrooms and for the approach’ in banking situations. the appropriate comparator index for decid- overall regulatory arrangements that bear on ing on the weight to be attached to market quoted companies. Much of the political, media and wider public developments in quoted companies in similar concern about large-scale buy-out activity Specifically, what would quoted companies business sectors and geographies. focused on how the financial benefits of the need to do differently to achieve business per- large returns generated by private equity are It should be possible to reduce this subjectivity formance levels closer to those achieved by pri- distributed, and the tax regime appropriate to through the development of a reasonably stan- vate equity? And does the regulatory regime them. These are important issues but, as I con- dardised methodology. The priority for now is for quoted companies, in particular in relation ducted my review and the associated consulta- to complete development of a rigorous to their governance arrangements, promote tion process, I have become increasingly con- process and to produce results from it in which the right balance between the capacity of cerned at the inadequacy of our understanding confidence can be dependably placed in the boards to contribute effectively to corporate of the overall economic impact of large-scale whole industry. strategy alongside discharge of their regulatory buy-out activity. and related responsibilities? Substantial work is now in train, building on Of course, many have views as to how and to the review process and research by Ernst and These are difficult issues to be addressed, and what extent private equity generates employ- Young, to create a template that should permit better data and analysis of the performance of ment and improves economic performance, completion of an industry-wide, aggregate private equity in ownership of major UK busi- but the database is partial and insufficient to attribution analysis. It is envisaged that the nesses, hopefully to become available in the support rigorous evidence-based analysis. first report on this work will cover exits by course of this year, should be a major input to This matters because, if private equity is major private equity firms from portfolio com- the debate. indeed more effective in adding real econom- panies in the UK over the three-year period (The author is a Senior Adviser at Morgan ic value than comparable quoted companies, 2005-2007, to be continued on a rolling basis Stanley but is writing in a personal capacity.) why should this be so and what lessons might for later periods. be learned? 80 81 Impressions of the industry – the impact of private equity

Private equity in Europe RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Javier Echarri, Secretary General of the European Private Equity & Venture Capital Association, gives an overview of the way in which the European industry has developed over the past 25 years

The BVCA was founded in the same year established businesses to become globally As we now enter the as the European Private Equity & Venture competitive. When EVCA was founded in second 25 years Capital Association (EVCA). Together, the two 1983, we had fewer than 50 member firms. of this industry’s associations have played a major part in pro- Today, we have more than 1,200 member development, it is more moting and establishing what began in the firms covering Europe’s general partners early 1980s as a new feature on the financial (GPs) and the major US and international important than ever that we and business landscape in the UK and Europe. fund managers investing in Europe, as well as continue our work together affiliated limited partners and intermediaries. EVCA has been closely involved at the to defend and promote European level in all the major discussions Conscious of the increasing globalisation of private equity in and decisions affecting private equity regula- our industry, the EVCA and the BVCA are Europe and beyond tion, fundraising and investment over the developing stronger ties and working closely years, but we could not have succeeded on with the National Venture Capital Association, our own. The 27 national associations in the Private Equity Council in the USA, the Europe, particularly the BVCA, have played a International Limited Partners Association and crucial part in supporting our efforts. national associations in Asia-Pacific and Latin America. In the next few years, I believe we As we now enter the second 25 years of this should, in all continents, harmonise our guide- industry’s development, it is more important lines, data methodologies and self-regulation. than ever that we continue our work togeth- er to defend and promote private equity in The development of private equity in Europe and beyond. Europe has not always been smooth. If we have learned anything from the peaks From seed finance through to the largest through 1997-2000 and 2004-2007 and the buy-outs, private equity is now an estab- subsequent adjustments, it is that this indus- lished asset class in Europe, attracting capital try is highly cyclical and its fund managers from institutions worldwide, facilitating the constantly inventive. creation of new businesses and supporting 83 Impressions of the industry – the impact of private equity Impressions of the industry – the impact of private equity RVT QIYI H UK PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE THE FIRST 25 YEARS Fundraising Fundraising success in the early years was indices; entrepreneurship is no longer derid- current challenge is to find appropriate ways expert groups have since been established to After 25 years THE FIRST25YEARS driven by ups and downs of local economies. ed, but lauded – even when it includes a to communicate to wider audiences, while review other aspects of the industry. of rapid growth, success in the early Today, investors around the world follow degree of failure; world-class managers join ensuring the efficient functioning of the pri- After 25 years of rapid growth, especially in years was driven those fund managers, both individuals and European private equity-backed businesses; vate equity industry. especially in the the past five years where credit has enabled teams, with track records of delivering strong and governments understand the industry’s past five years where by ups and downs of Although we have not succeeded in all our types and sizes of deal never before seen, returns in all stages of the cycle. Such returns role in their economies, though not always local economies. Today, campaigns in Europe to avert regulation that perceptions of our industry have changed. credit has enabled types tend to be achieved by shrewd identification how that role is played. might adversely affect the industry’s develop- This is the main challenge facing us all today. and sizes of deal never investors around the and sourcing of investments, by anticipating What are some of the landmarks at a ment (notably the consolidation of financial Our audiences are wider and more informed. world follow those economic drivers, by looking at the benefits before seen, perceptions of European level since 1983? statements under IAS 27), we have notched At times, our opponents can be politically- of long-term ownership and by exploiting our industry have changed fund managers The associations have battled successfully in up a substantial number of achievements of motivated and quite vocal. We have to work price arbitrage opportunities that occur in a number of countries, including the UK, which I am proud. hard to turn this round, particularly in a less individual sectors or in the wider economy. Spain and France, for fiscal incentives for benign economic environment. With the These include the 1988 European Seed Through the 1980s, the industry in Europe, owner-managers and for appropriate nation- commitment of our members, the EVCA, Capital Funds Scheme and other pro- led by the UK, focused on backing early stage al and EU regulatory frameworks. BVCA and other national associations can grammes to promote private investment in businesses, and investments were not always achieve this. In 1996, leading GPs supported by EVCA innovative, technology-based companies; the easy to find. Most capital came from established a short-lived pan-European exit early 1990s’ Phare programmes, which we European banks and government agencies, market, EASDAQ, following the early suc- led, to create the first funds and to train man- with only a small proportion from US pension cess of the Unlisted Securities Market and agers across Central Europe; the harmonisa- funds and endowments. the Second Marché. These efforts led in the tion of certain tax and legal aspects of fund Today, Europe’s industry is a much larger busi- long term to the emergence of AIM as a structures – though we are not at the end yet; ness. Funds in 2006 came from a much wider complement to venture funding, which, averting the taxation of private equity groups base of investors, led by the largest pension together with Euronext, now offers a real as conglomerates; and the Pension Fund funds and endowments. Investment opportu- alternative to NASDAQ for IPOs. For later Directive of 2003 that allowed pension funds nities, even on the public markets, abound. stage deals, we have seen the emergence of to apply the ‘prudent man’ rule to investment Structuring deals for good returns has become secondary (and tertiary) buy-outs to provide in private equity funds. more complex and managers work hard to exits when public markets and trade sales In 2006, EVCA was asked to nominate repre- improve portfolio companies’ performance. are less accessible. sentatives to the EU’s Expert Group exploring In the early and mid-1980s, EVCA and the On self-regulation, EVCA’s first Valuation the activities of and barriers to success for pri- BVCA spent time and money providing infor- Guidelines were published in 1993, followed vate equity in Europe. The Group, which mation on what our members did and why, in 2005 by the publication of International included leading EVCA members from the UK and on educating entrepreneurs, managers Valuation Guidelines, produced together and the rest of Europe, reported in June 2007. and investors. with the BVCA and the French national asso- It argued strongly for – among other things – ciation – AFIC, which have been adopted by a common private placement regime across Today, our main activity is public affairs and nearly 40 national associations worldwide. the EU for alternative investment funds. This, communication. The case for investment has Guidelines on corporate governance and when it happens, will be a huge leap forward been made through long-term performance reporting have also been published. The for the industry and remains a priority. Other that has exceeded that of public market 84 85 Impressions of the industry – the impact of private equity

The view from the US RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Timothy Spangler, Partner and Chair of the investment funds group at US law firm Kaye Scholer LLP, explains why the British private equity industry matters to America The two leading Private equity enjoyed – or endured, The term itself is commonly used to cover countries for private depending on one’s perspective – enor- numerous investment styles and firms. mous public spotlight last year on both sides However, meaningful generalisations are still equity remain the of the Atlantic. possible and ‘private equity’ can be broken US and the UK, although down into three broad categories: venture In many ways, 2007 can be seen as another capital, buy-out, and turnaround. the history and evolution record year in global private equity. However, of the two markets has challenges to the continued success of the Both the US and the UK have produced been different in certain industry remain unaddressed and, going for- world-class contenders in each category, significant respects ward, many US firms and observers will be although the nature of the domestic market looking to the UK for signs of how to over- has left its mark on each side of the industry. come these obstacles. Many of the same developments – such as the rise of so-called ‘mega funds’ and The relevance of the UK experience to the increased Government concern over the tax- US private equity industry is clear. The two ation of carried interest – have occurred leading countries for private equity remain simultaneously in both countries. the US and the UK, although the history and evolution of the two markets has been dif- US private equity houses have been increas- ferent in certain significant respects. ingly expanding their international operations Despite once being primarily seen as a over recent years, in search of new opportu- uniquely American invention, private equity nities to leverage sector specialisations and is rapidly becoming a global force and ensure their ability to compete against global UK-based firms and professionals have firms for larger deals. When contemplating served, in part, as the international face of such expansion, London is a compelling first the industry. point of call, both due to the language and legal similarities and the success of private Similar to America, the British private equity equity investing in the UK over the past two industry possesses great breadth and depth. decades. With a London base, many US firms Private equity is now quite a broad church.

87 Impressions of the industry – the impact of private equity Impressions of the industry – the impact of private equity

can more easily expand to include a European be able to cover the operating expenses of the access to most private equity funds, their equity firms and funds are regulated and petitors are the British and any steps taken to presence, tapping in to the UK’s proximity to firms that are managing the assets of the fund. indirect exposure has potentially grown sig- taxed. In the UK, Sir David Walker’s working resolve perceived problems locally need to be these countries. They can also benefit from nificantly in the past two years, through both group has proposed a code of conduct to considered in light of the concurrent situation The general partner’s true upside in these the strong calibre of international talent on the increasing allocation of public and private address concerns about transparency in the in the UK. arrangements has continued to be the carried offer in London. pensions to the asset class on the one hand, private equity markets, consisting of guide- interest earned on the profits of the fund, and the increase in publicly-offered opportu- lines and recommendations for funds to fol- The private equity industry is in the process Fortunately – given the strong commercial designed to create an alignment of interest nities to either participate in funds of funds or low in dealing with their investors and of charting its next phase of development. drivers that lead US firms to establish UK with limited partners. There have, though, take positions in a particular private equity their investments. The questions on the table include the appro- operations – US and UK private equity fund been increasing profits made from manage- firm itself. The economically rational driver priate level of regulatory oversight and self- documentation demonstrates a surprising ment fees. In both the US and the UK, the debate over for such exposure increases has been the regulation; the proper level and method of amount of consistency, both intellectually and how best to tax the carried interest earned by The US-UK private equity model remains over-performance of private equity invest- taxation that funds, investors and sponsors commercially. This is despite certain local private equity professionals has been unfold- based on a limited partnership structure used ment compared to investment in the should be subject to; the impact of the recent changes to deal with the peculiarities of ing. The UK announced in October 2007 that to embody commercial and economic public market. ‘credit crunch’ on returns and investor domestic taxation and historical differences in all capital gains – including carried interest – arrangements between an investment team appetite for traditional private equity invest- partnership law. This common base of under- Many British and American investors, legisla- would soon be taxed at 18 per cent instead of RVT QIYI H UK PRIVATE EQUITY IN THE (the general partner) and their investors (the ing; the impact of hedge funds – both posi- UK PRIVATE EQUITYINTHE standing and practice means that American tors, regulators and tax professionals, how- the former rate of 10 per cent, potentially limited partners). This model differs funda- tive and negative – on the private equity firms and professionals can look to their ever, are now thinking about private equity reducing the country’s attractiveness to pri- mentally from the corporate model that has industry; and many others. British counterparts for examples of how funds and the industry as a whole more thor- vate equity funds. In the US, the question of dominated listed and unlisted commercial things can be done differently, or better. oughly and deeply than ever before. In part whether it is right and proper to tax carried For all of these answers, the US will continue businesses for over a century. this has been a result of ever larger and more interest as capital gains is being discussed to look to the UK for insight, examples of suc- Private equity funds, whether British or One driver for the success of American and familiar companies becoming subject to pri- directly, although at this stage it is unclear cess and alternative ways forward. American, are typically established for similar British private equity firms has been the rela- vate equity ownership. What had been of whether such a change is politically palatable periods of time – usually for eight to ten years US and UK private tive legal and fiscal stability that has predom- cursory interest to certain disparate parts of in a presidential election cycle. to allow a series of investments into portfolio equity fund inated over the last decade, thereby fostering the financial markets has in recent years THE FIRST 25 YEARS

companies. They are also structured to have In the post-Sarbanes-Oxley era, governments THE FIRST25YEARS the growth and success of these funds. come front and centre. documentation monies drawn down from investors over simi- realise that the unilateral changes that they demonstrates a surprising lar timeframes – often three to six years, Private equity has historically been focused As ‘mega’ buy-out funds take more high-pro- make with regards to their financial markets amount of consistency, reflecting the time needed to identify suitable on raising investment monies from a limited file public companies private, attention has can have significant repercussions on their targets and deploy the investor’s capital effec- number of sophisticated institutional been drawn to the industry in the mainstream country’s ability to compete internationally in both intellectually tively. In each country, these funds charge a investors rather than retail investors. media. As a result, efforts are underway in the global economy. In the case of private and commercially management fee on the committed capital to Although the general public still lacks direct both countries to reconsider how private equity, Americans realise that their chief com-

In the post-Sarbanes- Oxley era, governments realise that the unilateral changes that they make with regards to their financial markets can have significant repercussions on their country’s ability to compete internationally in the global economy

88 89 How private equity works in practice

Developments and challenges in buy-outs RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

The buy-out industry’s ownership model – which aims to align the interests of a company’s management and shareholders – is central to its success, says Dr Robert Easton, Chairman of the BVCA’s Global Buy-out Committee and Managing Director at The Carlyle Group

In 2002, Firth Rixson was a troubled UK wins and the acquisition of complementary I have seen first manufacturing business listed on the London businesses, annual sales doubled during our hand the different Stock Exchange. During that year, its share ownership to more than £500 million, while approaches to price declined rapidly from 70 pence and headcount remained stable at around 2,000 business management and despite the best efforts of its management employees. As a result, both productivity and team, the business was unable to reverse its profitability soared at Firth Rixson. Oakhill value creation that the fortunes as a listed company. Capital Partners bought the business for £945 private equity and public million in November 2007. But where public market investors saw a market models employ business in decline, struggling with an eco- Having spent seven years driving mergers nomic downturn, Carlyle saw the opportuni- and acquisitions and corporate strategy in list- ty to create real and long-term value. By the ed companies, followed by seven years at time we acquired the business for £106 mil- Carlyle, I have seen first hand the different lion in early 2003, Firth’s share price had approaches to business management and plunged to less than nine pence. When we value creation that the private equity and announced our tender offer, it represented a public market models employ. The transfor- 120 per cent premium to the stock market’s mation that took place at Firth Rixson is a valuation. The shareholders were delighted great example of the advantages that private to accept. equity ownership can bring to a business. Fast forward five years and Firth Rixson is a In the first instance, public markets often world leader in aircraft engine component- undervalue assets, unable to support the making, with 11 facilities across the world and investment of time and capital that can be contracts with every major aerospace engine required for a company to deliver on its full manufacturer. Through customer contract potential. Firth Rixson in 2002 was a prime

91 How private equity works in practice example. Conversely, the buy-out industry is options, the private equity-backed manage- often best placed to realise hidden value ment team, having invested their own capital, from such companies because of the unique has plenty to lose as well as gain – which is way that we own and govern businesses and why the buy-out model is so attractive for hun- our longer-term investment horizons. gry management teams that want to share in the success of the businesses they run. A typical public company will have in the region of 100,000 shareholders, very few of A KPMG survey carried out in 2006 found that which will be able to exert any meaningful the vast majority of private equity-backed influence. Institutional investors in a private management teams believed that their share equity-backed company, by contrast, will of the equity was the surest way to create number in the hundreds at most, and crucially meaningful personal wealth and most would will abdicate control of the investment, hand- have been happy to renegotiate their basic ing responsibility to the private equity firm to salaries and bonuses downwards for a bigger drive the business forward and realise value. equity stake in their business. One of the buy- out industry’s advantages has been its ability UK PRIVATE EQUITY INTHE This closely-held structure results in short to attract top-class management through reporting lines between controlling share- offering attractive equity ownership schemes. holder and management, enabling the buy- out backed business to be fleet of foot. Management is instilled with a renewed sense Decision-making is fast and not confused by of urgency following a buy-out because, while mixed motivations. For example, where a a private company need not concern itself public company may have obligations for with the vagaries of quarterly earnings volatil- capital allocation spread between divisions, a ity, private equity management is working

private equity-backed company is focused within a defined timescale with clear targets THE FIRST25YEARS on investing with one central aim – increas- and objectives. Resistance to change no One of the ing the value of equity. longer holds any rewards, and all eyes in a pri- buy-out industry’s vate equity-backed company are fixed firmly This ownership structure also enables a buy- advantages has on the same medium-term goal, maximising out house to inject debt into a company – a all the owners’ equity value in the years before been its ability to attract much misunderstood financial practice. The a liquidity event is reached. top-class management application of leverage is simply efficient cash and balance-sheet management prac- In many respects, this focus on value creation through offering attractive tice, optimising the cost of capital of any busi- is simpler in a private equity-backed business equity ownership schemes ness, although each case needs to be stress- than a quoted company equivalent. Private tested in order to demonstrate that the busi- equity is single minded in its pursuit of cash- ness will be able to support debt repayments, flow improvement – the ultimate measure of even in the event of fluctuating economic business success – and incentivises manage- conditions or a prolonged downturn. ment teams accordingly, through both the Successful private equity firms have deep equity ownership and annual cash bonus expertise in financial structuring, and the schemes. Where public companies often use a related risk assessment, to make sure their balanced business score card, seeking to take portfolio companies have sufficient head- numerous complex metrics into account when room with respect to their financing banks. measuring managements’ performance, a buy- out-backed business has a very short list of key The nuances of the debt structure have performance indicators, all closely monitored, become more complex as the industry has but with the focus on generating cash. evolved – with the emergence of instruments such as second lien and PIK (payment-in-kind) Private equity-owned businesses also benefit notes – but the basic premise remains the from the release of management time previ- same: that the intelligent use of leverage can ously spent addressing the public markets – increase balance sheet efficiency and help another big attraction for management drive returns to the equity. Interestingly, pub- teams. Before Carlyle came on board, the lic companies are now re-visiting the use of Firth Rixson team was battling to integrate leverage to optimise their own cost of capital. acquisitions and drive productivity, simulta- neously with maintaining quarterly earnings- A key differentiator of the private equity per-share growth and communicating with a model of company ownership is that it aligns broad base of public shareholders. Removed the interests of management with those of the from that kind of short-termism and distract- shareholder – the private equity firm – which ing time commitment, the management team are, in turn, aligned with those of the business. was able to effect real change at Firth Rixson. Where public markets remunerate executives Importantly, while the close governance of with generous pay packages and stock

93 How private equity works in practice

private equity-backed businesses results raised, and the size of the companies that from the alignment implicit in the ownership have been targeted. model, there is also no need to appeal to the But as we enter a more challenging period, it interests of many and minority stakeholders. is important to remember what it is that really This is vital for allowing the boards of buy- makes buy-outs succeed. And for this, it is out backed businesses to concentrate on the useful to look at another Carlyle investment, job at hand. Therefore, it was heartening to Dutch cable company Casema, acquired from see Sir David Walker recognise the success France Telecom in the midst of the last eco- of private equity governance in his recent nomic slowdown. We signed the Casema proposals for the asset class and it is impor- deal over Christmas 2002 after many months tant that heavy-handed regulation regarding of negotiation, during which time several this area of the industry continues to be kept other cable businesses went bankrupt. A club to a minimum. bank deal, by necessity, we had to provide 50 Deals such as Firth Rixson are examples of per cent of the transaction enterprise value in RVT QIYI H UK PRIVATE EQUITYINTHE the fundamental benefits of the buy-out equity and to arrange and effectively under- industry ownership model. However, Firth write all of the debt ourselves – a situation Rixson is not unusual among private equity that may well feel familiar to private equity transactions. Recent research by Ernst & investors looking to buy companies today. Young took the 100 largest buy-out exits in Recruiting a new Chief Executive, we invest- the US and Europe and compared them to ed heavily in Casema’s network and infra- listed businesses based in the same country, structure, transforming the business from a operating in the same industry, over the same utility-like analogue TV provider to the lead- time period.

THE FIRST25YEARS ing triple-play operator in the Netherlands. Enterprise value, which discounts the effect Revenues grew by 10 per cent a year during of leverage, increased by 33 per cent in the our holding period, EBITDA (earnings before US and by 23 per cent in Europe for the pri- interest, taxes, depreciation and amortisa- vate equity-backed companies, compared to tion) doubled and the headcount increased 11 per cent and 15 per cent in their public from 750 to 1,050. market equivalents. Other buy-out houses may do things differ- There is no doubt, of course, that private ently, and those choices are what set the best equity has benefited from a unique set of firms in the industry apart from the ordinary favourable circumstances over the past few firms. But all BVCA member firms benefit years. A benign economic environment, cou- from the ownership structure outlined above, pled with the unprecedented availability of and that is a fundamental advantage for any both debt and equity, has propelled the company backed by private equity. industry to new heights in terms of funds

As we enter a more challenging period, it is important to remember what it is that really makes buy-outs succeed

94 How private equity works in practice

Developments and challenges in venture capital RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Jo Taylor, Chairman of the BVCA’s Venture Committee and Managing Partner of 3i’s venture capital business, looks at how the current challenges in the industry might shape the years to come

In the early 1980s, Over the last 25 years, the UK venture cap- First and foremost, the UK has provided these venture capital, ital industry has helped a vast number of aspir- dynamic companies access to capital – in the ing entrepreneurs and ambitious management initial stages from private investors, then from as opposed to teams turn their dreams and aspirations into selective professional investment firms culmi- private equity, was the successful companies. In the UK, wealth cre- nating in access to a thriving and generally bedrock of the BVCA’s ation and the deployment of capital has been supportive stock market. This vibrant stock membership and activity second only to the US over that period. market has allowed many venture-backed companies access to more significant sums of In the early 1980s, venture capital, as development capital to allow the continued opposed to private equity, was the bedrock growth when required, or when the total of the BVCA’s membership and activity. funding of the business is beyond the Local investors sought to back talented resources of their venture investors. management teams developing disruptive research and technology or innovative serv- The stock market has also enabled early stage ice models that could overturn the status investors to sell on their minority sharehold- quo in their targeted markets. Sums invest- ings to new investors more easily, and gener- ed were modest and the risks were – and ally on more attractive terms, than would still are – high when backing pre-revenue have been the case had the business fledgling companies. That said, the returns remained private. that were made rose as high as 20-30 times The London Stock Exchange (LSE) has sup- the capital invested on the successful ported many venture-backed companies that investments. have gone on to be a great success, compa- So why has the UK provided such a success- nies such as ARM, Autonomy, CAT, CSR, ful environment for venture capital over the Lastminute.com, Shire, and Wolfson Micro- last 25 years? electronics to name a few. However, it is per-

97 How private equity works in practice How private equity works in practice

haps the Alternative Investment Market strong culture of design, research and engi- (AIM), building on the support provided by neering, which has laid the foundation for Ofex and previously the Unlisted Securities significant wealth creation. The university Market, that gives the best prospect for ven- network in the UK, together with significant ture-backed companies to realise their entrepreneurial activity within research and potential over the next five to ten years. This development centres in UK corporates and will certainly be the case if AIM is given more consultancy firms, has created a regular flow of a focus towards high-growth companies, of groundbreaking innovation. with a degree of risk attached, than the LSE. The final ingredient in the successful devel- The other source of capital has been from opment of the UK venture capital industry local and overseas corporate acquirers, has been access to top quality management which have viewed the UK as the first desti- with the requisite skills and entrepreneurial nation to access leading edge technology flair needed to build fragile young companies companies. In the UK this can be done in a into more significant businesses. While there RVT QIYI H UK PRIVATE EQUITY IN THE cultural, linguistic and legislative environ- has been some market cyclicality in the avail- UK PRIVATE EQUITYINTHE ment that is the most supportive in Europe. ability of this management talent, the UK ven- ture industry has been fortunate to source Also vital in creating a successful environ- capable managers to lead companies from ment for venture capital is the availability of inception and then through first- and second- leading edge, disruptive technology that is stage evolution. capable of competing on a world stage. Over the years, the UK has been blessed with a THE FIRST 25 YEARS The final ingredient So, what challenges face the UK venture cap- ness life? At the same time the UK needs a sub-sector can also give a critical edge in THE FIRST25YEARS ital industry, and how might this shape its supportive regulatory and tax regime that will making the right investment choices. in the successful performance in the coming years? While the reward those willing to take the risk involved The outlook for UK venture capital is the best development of the industry was able to provide spectacular in founding a new business venture. it has been for many years, and this alterna- returns at the turn of the century, this cycle UK venture capital industry It would be helpful for the UK to replicate tive asset class should appeal to investors was short-lived. The damage caused on the has been access to top the positive cultural attributes found in the searching for experienced investment teams downward part of that market cycle by high US around entrepreneurship. It would be still able to pick out high-growth companies, quality management with company valuations and ultimate business refreshing if success can always be celebrat- on attractive investment terms, and making the requisite skills and failures hit fund returns for the industry hard ed, and failure seen as personal develop- the most of the more turbulent economic over the last five years. As this has also coin- entrepreneurial flair needed ment. If we can achieve this, then we may environment that I would expect to prevail cided with attractive returns made by private start to create an environment better suited through 2008. equity firms, some UK investors have begun to serial entrepreneurship, and avoid the to question the attractiveness of venture as current social stigma associated with busi- an asset class. Looking forward, I would ness failure. expect the venture asset class to regain favour with investors as the difference in The final challenge facing the UK in a global returns narrows and competition within the age is how early stage investors can continue private equity industry drives prices to less to nurture leading edge technologies and attractive levels. research without the international visibility to judge the flaws and advantages of the com- The second challenge facing the UK venture panies that they support. For years, a vibrant capital industry is a structural one. Many ven- transatlantic bridge has operated between ture funds are more naturally suited to a small the US and the UK for access to investment investing team investing from smaller fund capital, knowledge transfer and market sizes than their counterparts in private equi- access. In the coming decade, UK companies ty. However, many would-be investors in will need to look increasingly to Asia as key these funds now wish to deploy capital in vol- markets for growth and a benchmark of tech- ume and more cost-effectively, and in many nological progress and cost competitiveness. situations the maths does not work so well – particularly when maximum exposures of UK venture investors are getting smarter 10-15 per cent of the fund size is applied. about how to back products and services that The outlook for UK will succeed in a global marketplace. People Another challenge facing the industry is how venture capital is programmes and advisory boards is one solu- best to maintain an environment of entrepre- the best it has been tion, coupled with partnering with sister or neurship in the UK. This begins with our edu- affiliate firms in other geographies to broaden for many years, and this cation system – are we teaching and devel- networks and visibility. Often a more spe- alternative asset class oping the skills that will be needed in busi- cialised investment approach by sector or should appeal to investors

98 99 How private equity works in practice How private equity works in practice

The management team’s objectives were aligned with those of shareholders, so that there was clear accountability and more lucrative rewards for outperformance RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE

RHM, Homebase and Halfords were During the 30 month transformation period all household-name businesses underachiev- that followed, more than half the top 50 exec- THE FIRST25YEARS ing within the confines of bigger groups until utives in the business were changed. This taken under private equity ownership. included the appointment of a new Chief Executive and Chief Financial Officer. The Although RHM is one of the largest food management team’s objectives were then groups in the UK, with brands like Hovis in its aligned with those of shareholders, so that portfolio, it was effectively managed as a fed- there was clear accountability and more lucra- eration of separate businesses by Tomkins, the tive rewards for outperformance. ‘guns to buns’ conglomerate, until Doughty Hanson took control in a £1.18 billion deal in RHM was also restructured, with centralised August 2000. procurement, human resources and finance functions and reorganised so that 18 inde- It took five years of private equity ownership pendent businesses were grouped into three to reorganise and reposition the business core divisions to maximise economies of scale before Doughty Hanson exited via an IPO, and operating synergies. Five non-core busi- which placed a £1.67 billion enterprise value nesses were sold and one closed. The pro- on RHM in July 2005. curement savings alone topped £40 million, The turnrounds at DIY retailer Homebase but there were also further significant savings (after its buy-out from J Sainsbury by Permira) in logistics, administration and group market- Delivering transformational change and of Halfords (from The Boots Company, by ing. At Manor Bakeries, £20 million of savings CVC) were quicker, but both companies were were achieved. re-energised by the increased focus and Private equity firms stand out for their ability to transform underperforming The newly focused business then invested in change in strategic direction after being set product innovation and development and businesses. Andrew Cornelius, adviser to Homebase and Halfords, looks free from their parent groups. increased the marketing support for its key at how three well-known businesses were given a new lease of life Doughty Hanson recalls that “a number of brands, including Hovis. This resulted in mar- businesses were underperforming and a stag- ket share gains, including a 4.5 per cent nant management culture needed to be increase for Hovis over the 30 months, togeth- addressed” prior to its takeover of RHM. er with a 30 per cent increase in its prices. The terms of the pension plan were also renegotiat- The new owner’s first task after buying RHM ed, which helped achieve a reduction in the was to establish a Value Enhancement Group, deficit to £125 million by the time the business which carried out a detailed review of each was sold. business. The Group discovered that each business operated separately from the other, This transformation under private equity own- there was a manufacturing-led culture, per- ership left RHM in a stronger competitive posi- formance and rewards were not aligned, the tion and on a more secure financial footing. Manor Bakeries operation was seriously DIY business Homebase had its fortunes underperforming and there was a £520 million revived in similar fashion. At the time of its pension deficit. 100 101 How private equity works in practice

acquisition by Permira in March 2001, the big shed expansion, head office numbers Halfords’ existing products, including cycles Homebase was entrenched in a battle with its were now reduced as key employees were and car enhancement products, while the larger rival, B&Q (part of the Kingfisher redeployed to the stores. The interests of company began developing its own financial Group), in the UK market, with both compa- employees and shareholders were aligned services business. nies determined to adopt the US model of with rewards for performance and more effi- building ‘big DIY sheds’. cient SAP and CPOS touch-screen equipment Management also embarked on an ambitious was installed in the retail stores. plan to source more product, including cycles But B&Q already had 75 of these big sheds and in-car technology product, direct from and had greater buying power because it In its 22 months under private equity owner- overseas manufacturers, rather than buying owned a sister company in France. It was also ship, before the sale to GUS in November through wholesalers. difficult to envisage how the smaller 2002, Homebase achieved a 17 per cent Homebase business would generate enough increase in like-for-like sales and a four- Like the equally successful restructurings at cash to fund its ambitious plan to compete fold increase in operating profit on a full rent- RHM and Homebase, it was a clear demon- head-on with B&Q. ed basis. stration of how private equity firms can unlock

RVT QIYI H UK PRIVATE EQUITYINTHE the potential of underperforming businesses. Charles Sherwood, the Permira Partner who But Permira and its management team, which ran the Homebase transaction, says that the comprised private equity entrepreneurs John acquisition was complicated by the fact that J Lovering, Rob Templeman and Chris Sainsbury, the company’s owner, had made it Woodhouse, would not have achieved their clear in the City that the asking price for stellar six times return on equity invested for Homebase was £1 billion, leaving little room Permira funds without unlocking the huge for negotiation. “This meant the business was property value hidden within Homebase. being sold on a multiple of 25 times EBIT One part of this was a conventional sale and [earnings before interest and tax] and ten

THE FIRST25YEARS leaseback of the Homebase stores, which gen- times EBITDA [earnings before interest, taxes, erated about £250 million and helped make depreciation, and amortisation], which was Management also the initial challenging numbers less daunting. pretty challenging,” says Sherwood. embarked on an However, the new owners were also able to ambitious plan to Permira’s decision to go ahead with the acqui- extract a price of £270 million from B&Q, nine sition was based on a complete strategy U- times the £30 million book value, by selling a source more product, turn for Homebase. It abandoned the plan to landbank of 30 sites earmarked for Homebase including cycles and compete head-on with B&Q, which Sherwood big sheds. B&Q was prepared to pay to pre- in-car technology product, says was an example of a public company vent US big shed operator, Home Depot, get- direct from overseas focusing more on creating a business on a ting the sites. grand scale than creating shareholder value. manufacturers, rather than Halfords, the third of our trio of unloved com- buying through wholesalers Instead, Permira pushed for a repositioning of panies, was bought from The Boots Company the business at the softer end of the DIY mar- by CVC Capital Partners for £427 million in ket. “Homebase was a distinctive number two July 2002. in the market because its customer base was Jonathan Feuer, the CVC Partner responsible predominantly female,” says Sherwood. “Our for the Halfords investment, teamed up with strategy was to focus on giving a room a new Rob Templeman, who, fresh from the success look rather than building a new room.” at Homebase, chaired the business, again The new team again defied convention by implementing a rapid change in culture embarking on a programme of building mez- as management and shareholder interests zanine floors in the Homebase stores, which were aligned. had been rejected as an idea by the previous This time the new owners decided to unleash Sainsbury management. This changed the the huge growth potential in the Halfords economics of the stores by increasing the sell- business, identifying new sites, including an ing space at no extra rental cost and accelerat- expansion into the Republic of Ireland. They ed the softening of the stores by providing also adopted the now proven strategy of soft- more space for curtains, linens, bathroom and ening stores and unlocking more sales space bedroom fittings. In the meantime, the space by introducing mezzanine floors. allocated for heavy duty and space-consum- ing products like cement was reduced by cut- Stores were re-branded and Halfords used its ting the number of brands on offer. strong position in car audio and entertainment to capitalise on the huge potential of the wider Once the strategy was agreed it was imple- in-car technology market. Additional mezza- mented with dizzying speed. Whereas head nine space allowed better projection of office was scheduled to grow to implement

102 How private equity works in practice How private equity works in practice

The experience of multiple owners An increasing number of companies have had more than one private equity owner. Sarah Butler and Philip Hoult examine how three major UK businesses have used multiple private equity owners at different stages of their life cycle RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE

In the early days of private equity, the tra- tunity to consolidate the fragmented bingo Gala was a struggling THE FIRST25YEARS ditional methods for exiting from an invest- and gambling sector. ment were a trade sale or a stock market business in a deeply Together with PPM, Kelly developed a three- flotation. As the industry matured, a third unfashionable sector. pronged strategy. They aimed to rebuild Gala option emerged – selling the business to by motivating management through new Fast forward a decade and another private equity house. Secondary and incentives, reducing the bingo firm’s heavy it has been transformed even tertiary buy-outs are now a common bureaucracy and its associated costs, and by feature of the market. into one of the country’s focusing capital spending more aggressively biggest privately-owned One household name to have had a series of on areas where it would generate income. private equity owners is Gala Coral. Back in “With private equity behind you there is only companies 1997, Gala was a struggling business in a one stakeholder to answer to and that makes deeply unfashionable sector. Fast forward a decision-making quick, which is what it need- decade and it has been transformed – with ed to be,” Kelly says. the backing along the way of some eight dif- Although the cast of private equity owners ferent private equity firms – into one of the may have changed over the last decade – country’s biggest privately-owned compa- Duke Street Capital, Credit Suisse Private nies, employing more than 19,000 people Equity, Candover, Cinven and Permira are and reporting turnover in the year to among those to have had a stake – Kelly and 29 September 2007 of £1.3 billion. his team have always been backed on the Gala was first bought out from brewing acquisition trail. This culminated in 2005 with group Bass in a £236 million deal in 1997. the £2.2 billion takeover of Coral Eurobet, the Chairman John Kelly, who led the original betting shop business – a transformational buy-in backed by PPM Ventures (now PPM deal, which created Britain’s largest private Capital) and Royal Bank Development equity-backed company. Capital, says it was an obvious target. Profits Neil Goulden, Gala’s Chief Executive since had fallen by more than 40 per cent in the 2004, says the Coral purchase demonstrated three years before Kelly took control, as Gala the flexibility that private equity backers can struggled to compete against the newly- give a company. “There is no way Gala would launched National Lottery. have been able to buy Coral, a company big- The business was not core to Bass and had ger than our firm, if we had been a public gone through four managing directors in five company,” he says. years. Bass had nevertheless ploughed more Goulden adds that Gala’s private equity back- than £100 million into improving Gala’s bingo ers have added value, not just through a will- halls. Kelly thought he could work those ingness to put up funds for acquisitions, but assets much harder and also saw a big oppor- in using their expertise to put together a suit-

104 105 How private equity works in practice How private equity works in practice

able financial structure. Their active interest By contrast, under Scottish & Newcastle’s “They took time to est costs and allowed for additional capital kitchen was built and instead of the restau- in the running of the company and vast expe- ownership, there were layers of approvals expenditure on the villages. Center Parcs is rants being chef-led, most of the food was rience in all types of businesses were also that management had to go through before understand the undertaking a £100 million programme to prepared off-site and only cooked on-site. major advantages. they could implement their strategy. The business model and upgrade its accommodation and improve facil- Other investments, such as a £17 million stock market listing in turn meant a huge ities. It has struck deals with restaurant group refurbishment programme and a new elec- “The business has been brilliantly successful have backed the amount of management time was spent Tragus (another Blackstone-owned business) tronic point of sale system, also paid off. and I am as proud as punch of it,” says Kelly. management all along” explaining the company’s position and strate- and Starbucks, and invested in technology to “It is not down to financial engineering – it is These improvements meant that, during ECI’s gy to the City. While quite enjoyable, Dalby bolster its online booking facility. a mix of organic growth and sensible, value- ownership, turnover at Tragus increased from says, this was a distraction from running the adding transactions.” “We certainly could not have raised [on the £95 million to £113 million and the number of business. “We are a mid-sized business that stock market] the money that has now been employees rose by 5 per cent. Johnstone says Center Parcs, a leading short-break holiday does not have the resources of a FTSE 100 made available,” says Dalby. But it is not just it was a classic example of a successful turn- operator, has had a similarly positive experi- company,” he explains. about funding, he adds – Blackstone has, for around. When the company’s management ence. At the beginning of the decade it was Dalby says Center Parcs’ two private equity example, provided expertise in areas such as felt they had delivered on their plan and a successful but small part of a quoted plc – owners have both created value through their revenue and yield management that has sig- wanted to move on, ECI chose to exit with RVT QIYI H UK PRIVATE EQUITY INTHE Scottish & Newcastle – before being sold to UK PRIVATE EQUITYINTHE financial structuring skills, but adds that their nificantly helped Center Parcs. them, selling to Legal & General Ventures private equity house Deutsche Bank Capital periods of ownership have also been marked (LGV) in 2005 for around £90 million. Partners in 2001. A flotation on AIM fol- by significant investment. With turnover of £253.2 million for the year lowed in December 2003, with the company The business continued to go from strength to ending 17 April 2007, occupancy rates of moving to the London Stock Exchange’s Under Deutsche Bank Capital Partners, the strength while under LGV’s wing. During its over 90 per cent and repeat business of more main market in September 2005. It returned business was able to buy the Oasis holiday two years of ownership, LGV introduced a than 60 per cent, the business continues to to private equity ownership in April 2006, village in the Lake District, its only rival. It also new Chief Executive and promoted a number perform strongly. when Blackstone bought the business for built more accommodation on its existing of members of the operational team to the £265 million. sites and increased the range of services, Center Parcs also received a major boost in main board. Tragus embarked on a major THE FIRST 25 YEARS such as restaurants, on offer. September 2007, when it won approval to expansion plan, which saw 13 new branches THE FIRST25YEARS Martin Dalby, Center Parcs’ Chief Executive develop a fifth village at Woburn in opened, contracts exchanged on 12 and a fur- throughout this period, agrees with Gala’s With Blackstone on board, the investment pro- Bedfordshire. The business, which already ther 35 openings planned. Meals served by Kelly that one of the main advantages of hav- gramme has been even more impressive. Soon employs more than 6,000 staff, expects the the group rose by 20 per cent to 12 million, ing private equity owners is the pace at after it bought Center Parcs, the private equity new village to create a significant number of and plans for a new business offering Spanish which change can be implemented. “Once firm acquired the freeholds to the properties jobs when it opens in 2010. food, Ortega, reached an advanced stage. private equity people make up their minds, where the holiday villages are located. A £1 bil- then you can just get on with it,” he says. lion refinancing in early 2007 has reduced inter- Although Dalby does not rule out a return to Tragus was sold to a third private equity the stock market, he describes both periods owner – Blackstone – in December 2006 in a of private equity ownership as “very satisfy- deal worth £267 million, and has continued to ing”. “In both cases, they took time to under- expand apace. The acquisition of the Italian stand the business model and have backed chain, Strada, for £140 million in May 2007 the management all along,” he says. added another strong brand and a further 55 A third business to have grown substantially sites to its stable. with the backing of multiple private equity ECI’s Johnstone argues that Tragus’ experi- owners is Tragus, the restaurant group. ence of multiple private equity owners shows In 2002, ECI Partners backed a management how the industry has provided additional liq- buy-in of the Café Rouge and Bella Pasta uidity to the market. The firms have also businesses for £25 million from Whitbread, helped the business progress from a time which was keen to dispose of the operations when 3,600 jobs were at risk to a position because of their historic underperformance. where it is now one of the largest independ- “A lot of people in the trade press argued that ent restaurant groups in the country. “The we had overpaid,” says ECI’s Charlie shareholder base may have changed but the Johnstone. “But we saw the potential to business has continued to grow,” Johnstone reposition the business.” says. “It is a fantastic story.” “The shareholder The new management team, with ECI’s back- With more and more companies coming under base may have ing, set about reviving the operation by private equity ownership for a second, third or changed but the returning Café Rouge to its French roots, re- even fourth time, it is a story that is likely to be branding Bella Pasta to Bella Italia and dispos- re-told again and again in years to come. business has continued ing of non-operating sites. A development to grow”

106 107 How private equity works in practice How private equity works in practice RVT QIYI H UK PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE THE FIRST 25 YEARS When Bridgepoint Capital acquired and imaging equipment to hospitals, operat- THE FIRST25YEARS Alliance Medical for £111 million in a second- ed in a fragmented marketplace with huge ary buy-out in January 2001, it recognised the potential for consolidation. This is the ideal potential to expand the presence of the health- backdrop for a buy-and-build model, which, care company. in the majority of cases, involves small-scale acquisitions. Nine of the acquisitions made by Six years and 16 acquisitions later, it has Alliance Medical, for example, involved one become the largest medical imaging compa- or two-man operations. ny in Europe. The number of scanners Alliance Medical operates rose from 31 in Many private equity experts dismiss sectors 2001 to 190 in 2007, while employee num- with dominant market players as unsuitable bers increased from 177 to 690. for buy-and-build strategies. However, this is not a hard and fast rule. Alliance Medical, for Revenues have meanwhile grown six-fold example, was the dominant player in its sec- over the same period to £132 million. tor within the UK – seven of its acquisitions Bridgepoint generated a return in excess of involved market leaders within their country four times its investment when it sold of operation. Alliance Medical for £600 million. It has been a remarkable buy-and-build success story. “The most suitable sector for a buy-and-build strategy is highly fragmented with lots of Creating value through acquisitions “When we acquired Alliance Medical, with operators, where there are many opportuni- the exception of a small joint venture in ties for deals to take place,” explains Steve A private equity-backed buy-and-build strategy can rapidly Europe, 99 per cent of its profits came from O’Hare, Investment Director at Barclays the UK,” explains Bridgepoint Director Jamie transform a business into a market leader. Helen Dunne reports Private Equity. “But the key thing is not just to Wyatt. on the impressive results such an approach can bring identify synergies. It is vital that you have “The first acquisition, in 2002, was to buy out buy-in from the companies involved. that joint venture, and ultimately avoid con- “You have got to have staff that believe in flicts as we used Alliance Medical as a plat- what you are trying to create; you need form for growth within Europe. Each subse- “You have got to hearts and minds to make a buy-and-build quent acquisition helped Alliance Medical strategy work. An acquisition will not work if have staff that grow faster than it could on its own, just pur- executed poorly or if the cultural and strate- believe in what you suing an organic growth strategy. We were gic fit is not as first envisaged.” able to accelerate growth through a buy-and- are trying to create; you build strategy.” There is always a risk in acquiring any compa- need hearts and minds to ny, whether large or small, that it diverts man- In common with other buy-and-build invest- make a buy-and-build agement attention away from the core busi- ments, an incremental fund was set aside from strategy work” ness. As a result, many private equity firms day one to pursue acquisition opportunities. pursuing a buy-and-build strategy set aside Alliance Medical, which provides diagnostic funds to finance an additional management 108 109 How private equity works in practice

resource within the platform company that is which can reduce the timeline for subse- St Quinton was initially given £25 million. “He tasked with identifying potential acquisitions quent acquisitions. had a clean sheet of paper to start with. After and, following a deal, integrating the target. three or four acquisitions, there was enough David Novak, London-based Partner at to start integrating to create a platform com- Sovereign Capital, which typically invests Clayton, Dubilier & Rice, prefers to pany,” explains Davison. “We then refined between £5 million and £20 million of equity describe buy-and-build as “creating value our strategy and carried on acquiring.” to support proven management teams, is through acquisitions”. Subsequent purchases were funded from committed to the buy-and-build model. In Clayton, Dubilier & Rice invests in platform cash flow and new debt facilities. Over five the past three years, for example, the private companies that have the potential for sig- years, 15 acquisitions were made. equity firm has made 14 new platform invest- nificant organic growth, even if it subse- ments and 33 follow-on acquisitions involv- “We built a business, Azzurri Communications, quently proves impossible to identify suit- ing £160 million of equity. that did not exist before,” explains Davison. able acquisitions. “We consolidated a highly fragmented indus- However, its model takes the pressure away Novak oversaw the purchase of Paris-based try, but it is hard work doing it the way that we from management teams to identify and inte- Rexel, a market leader in the wholesale distri- did.” Azzurri’s annual turnover is now in excess grate acquisitions by employing a four-per-

RVT QIYI H UK PRIVATE EQUITYINTHE bution of electrical products, from Pinault- of £100 million. son research and development team within Printemps-Redoute in 2005. It has since Sovereign to do the work for them. “It is hard work pursuing a buy-and-build acquired Dutch rival Hagemeyer and strategy,” concedes Sovereign’s Robson. For a private equity firm the size of Sovereign, America’s GESCO, which doubled its sales, “You take a safe, stable platform company this is a huge investment in personnel and and made bolt-on acquisitions in Australia, and, through acquisitions and investments, demonstrates its belief in the importance of France, Belgium, America, the UK and China. turn it into an exciting new business. But the getting the target company right. “Rexel is a market leader in a highly fragment- returns should be higher on exit.” “The management of our companies may be ed market,” explains Novak. “It had meaning- A successfully executed buy-and-build strat- fantastic at organising their businesses and ful operational efficiency opportunities, but

THE FIRST25YEARS egy creates stronger, better businesses with delivering results, but they may not be the was also in an industry space where there more scope to grow. best corporate financier,” explains Managing were meaningful acquisition opportunities.” Partner Ryan Robson. “Our research and As Bridgepoint’s Wyatt points out: “If There are also benefits for the platform com- development team identifies those business- Alliance Medical had remained as a purely pany in pursuing a buy-and-build strategy. es that they should want to buy.” national business, then it had only got a cer- Efficiencies of scale arise across all aspects of tain bandwidth. The value was created Sovereign’s research and development team the business model. Costs are removed as because we expanded its breadth. It is also will help with integration, although the firm duplication in areas, such as central office now a more diverse company and not may also bring in extra management. “When functions and IT systems, is eliminated. exposed to just one client or market.” you are pursuing a buy-and-build strategy, The platform company also gains greater the platform company needs a much bigger leverage in areas such as purchasing and management team than the initial size of the recruitment. Rexel, for example, is able to business would dictate,” explains Robson. negotiate better rates with global suppliers. “Without that extra investment, any acquisi- tion will fail.” 3i successfully adapted the buy-and-build model, and reaped the rewards when it sold its Wyatt at Bridgepoint agrees. Alliance 75 per cent stake in Azzurri Communications Medical pursued acquisitions across Europe, for £115 million, representing an IRR of 38 per and each market brought different chal- cent and a money multiple of almost five times lenges and characteristics. its initial investment. “You need to have both the infrastructure “We had a clear strategy about what we were and management team right in the first place trying to build, and we worked with sector to grow the business, both through organic specialists who would be successful at achiev- growth and bolt-on acquisitions,” he ing that,” explains Julian Davison, partner at 3i. explains. “Internal controls are a vital part of the buy-and-build strategy, and it is neces- Through its People Programme, the private sary to have appropriate resources available equity firm met Martin St Quinton, former to support management and the acquisitions Chief Executive of Danka’s international A successfully they make.” operations. 3i offered to back St Quinton, executed buy-and- whom they teamed with a Chief Financial The first acquisition does, however, general- build strategy creates Officer, to create a buy-and-build vehicle for ly create a template for further transactions. the telecoms reseller market focused on stronger, better businesses For example, the same legal and accountancy small to medium-sized businesses. with more scope to grow firms are usually used for all transactions,

110 How private equity works in practice Turning point – turnarounds RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Turning around ailing businesses is not for the faint-hearted. Neil Rose speaks to the private equity specialists who thrive on the challenge While poor Saving struggling businesses can take Managing Partner of Rutland Partners. you a long way in life. Having rescued the Darren Forshaw, a partner at regional private management is likes of pizza chain Domino’s, the Salt Lake equity firm Endless, adds: “Just because a usually a feature City Winter Olympics and the finances of business has a structure that doesn’t allow it Massachusetts, Mitt Romney sought the US to trade properly, it is not necessarily the of underperforming Presidency. The Founder of Bain Capital management’s fault.” trumpeted his record of turning around diffi- companies, it is not When Endless bought product design and cult management situations. always the case – it sourcing company Peter Black in July 2006, it His UK private equity counterparts are also took on a company with revenues exceeding can be the ownership set to come to the fore following the credit £240 million, an operating profit of £13 mil- crunch. Jon Moulton, Managing Partner of lion and, Forshaw says, a “grade-A manage- Alchemy Partners, says the lack of cheap ment team”. But there was too much debt in credit will pressurise management actually to the business. A combination of injecting more manage, and that is where turnaround spe- capital and backing the ideas of the manage- cialists come in. ment – changing how the company went to market, as well as some of its products – saw “We positively select for bad management,” turnover grow by 7 per cent and profits by Moulton explains – if the management is 23 per cent. Endless exited 13 months later good, it can sometimes be hard to see what with an internal rate of return of 215 per cent. new owners could add. He also looks for “a business with a viable base somewhere in it”. So, turnaround is not just for companies on When you do a turnaround, you are “buying the brink. Forshaw looks for situations where a dream”. they can make a quick impact, by cutting the cost base, improving the top line or changing One man’s dream has often been another management. “There are a lot of businesses man’s nightmare, but while poor manage- that have significant debt burdens, which ment is usually a feature of underperforming make the bottom line look negative,” he says. companies, it is not always the case – it can “But on an operating level, they’re doing OK.” be the ownership, says Paul Cartwright,

111 How private equity works in practice How private equity works in practice RVT QIYI H UK PRIVATE EQUITYINTHE RVT QIYI H UK PRIVATE EQUITY IN THE THE FIRST25YEARS THE FIRST 25 YEARS

The UK’s largest pawnbroker, Harvey & many of whom had worked at Uskmouth tier management. Bringing in a new top tier, some things wrong. If you get 70-80 per cent While the arrival of a Thompson Group (H&T), was a profitable before it went into receivership. motivating that second tier, as well as strip- right, you will turn around the business.” private equity owner company that generated cash, but Rutland ping out the costs of being a PLC, have made When assessing potential targets, Mike Forshaw warns that “it always takes longer considered that it was underperforming, with a huge difference to the business. A year brings the feeling Campbell, Managing Director of Ferranti than you think”, a lesson Endless learnt with flat trading, when it bought H&T for £49 mil- later, both companies are in profit and have that at least something is Capital, looks for a strong brand name, well- its first acquisition after opening in 2005: lion in 2004. Cartwright actually worked in a a clear direction and strategy. established distribution channels and ideally Speed Frame, the UK’s largest manufacturer happening, a major store to get to know the business, and out of “a unique or enabling technology or capabili- Though Ferranti has grown the workforce in and distributor of PVC windows. The compa- problem is simply the that came an analysis of the right employee ty”. This is in part driven by Ferranti’s distinc- this case, turnarounds are inevitably associat- ny had long been profitable, and had an levels, resulting in 15 per cent staff savings. perception that an asset- tive exit strategy – either to sell to a Chinese ed with redundancies. It is often under- attractive core business, but a failed overseas stripper is in town He says this created a template for the stores company looking to expand into the West, or appreciated that such cuts may be essential to expansion precipitated a cash crisis. “It need- – which also benefited from developing other merge with a capable Chinese company in protect the long-term viability of the business ed focus, new investment and new manage- lines, such as third-party cheque cashing – the same market and then float. and the jobs of those being kept on. And ment,” he says. and by the time Rutland floated H&T on AIM tears are not always shed if there is a clearout This approach was adopted three years ago – Endless closed the overseas operation, in 2006, there were 12 new stores. There of the bosses who caused the problems. up until then, Ferranti was a conventional strengthened the management and injected have since been further openings and H&T London-based venture capital company. While the arrival of a private equity owner working capital, partly through a refinancing. now employs more staff than it did in 2004. Ferranti was keen to identify a way it could brings the feeling that at least something is The focus was changed from the difficult res- Sometimes the business really is on its knees, exploit the huge economic growth in China happening, a major problem is simply the idential market to new-builds, and costs driv- however. Uskmouth power station in Wales was without the risk of investing in Chinese com- perception that an asset-stripper is in town. en down, mainly through direct material in the hands of the receiver when Rutland took panies. Campbell says: “We found that when This reputation troubles Moulton and is par- sourcing from China. “It will achieve notable the bold step of recommissioning the plant, we visited Chinese companies in the manu- ticularly unjustified in his field, he reckons. profits this year,” Forshaw says. “It took a lot investing £23 million of equity and negotiating facturing and engineering sectors, most said longer and more capital than expected, but Whatever needs doing, speed is often vital – £10 million of bank overdrafts and credit from ‘we don't need your money, but we need help we allowed for that to a certain extent.” “you need the bravery and/or insensitivity to In the first instance, suppliers and service providers. The firm’s to expand into the West’.” make decisions fast,” he adds. Those involved in turnarounds maintain that public markets often appointment of an independent operating and A Ferranti success story is the purchase in there is greater satisfaction in transforming a maintenance contractor – Alstom – to run the Rutland uses a tool it calls a “180-day plan” to undervalue assets, December 2006 of premium brand precision struggling business and the fortunes of the station was key, and within four months the first turn around the business, which is task- and unable to support the engineering companies Jones & Shipman people in it. Alchemy’s Moulton says: “There’s power was sent into the grid. time-orientated (but not necessarily to a strict and Holroyd from Renold. The businesses nothing better. You feel very pleased with your- investment of time and 180-day timescale). Cartwright says: “We The Rutland-owned company behind the were not core to Renold, and both were self and you should be. You’ve done something capital that can be required have a view of the key changes that need to business, Carron Energy, hired 15 manageri- underperforming and suffering from under- very useful.” be made, and come up with a detailed plan for a company to deliver on al and administrative staff, while Alstom investment. They also had a lacklustre senior that supports each initiative. You will get its full potential recruited 120 engineers and operatives – management, but Ferranti liked the second-

112 113 How private equity works in practice How private equity works in practice RVT QIYI H UK PRIVATE EQUITY IN THE RVT QIYI H UK PRIVATE EQUITYINTHE THE FIRST 25 YEARS CSR, the Bluetooth technology group £38 million at flotation, but investors who CSR is not only a THE FIRST25YEARS that started life as Cambridge Silicon Radio remained shareholders also made good in April 1999, has rapidly become that rari- returns, as turnover more than trebled from success for its three ty – a British company that dominates its $253 million to $850 million between 2003 founding directors, global market. and 2007. The shares reached as high as £15 six original engineers and before falling back, due the effects of 2007’s Its silicon chips are ranked number one in the management and 1,000 credit crunch. every segment of the Bluetooth market, with staff who now operate the a unit market share in excess of 50 per cent. Headquartered in Cambridge, CSR now has company – it is also a In terms of products, its market share is even 15 locations around the world and a 20 per higher, with 60 per cent of all Bluetooth prod- cent operating margin. resounding triumph for the ucts containing CSR’s integrated circuits. venture capital industry However, its story dates back five years However, CSR is not only a success for its three before its formation as a spin-out from founding directors, six original engineers and Cambridge Consultants, where founding the management and 1,000 staff who now directors James Collier, Glenn Collinson and operate the company – it is also a resounding Phil O’Donovan and the other six staff worked triumph for the venture capital industry. on developing silicon for clients in the tele- coms, automotive and healthcare industries. After an initial $9 million of funding from 3i The road to success – venture capital Group, Amadeus Capital Partners and the The team came up with radio frequency sili- information technology fund of Dutch ven- con products using complementary metal Venture capital firms provide vital backing for spin-out businesses. ture capital group Gilde, CSR completed oxide semiconductor (CMOS) silicon, with Andrew Cave looks at how their support helped technology group CSR another three rounds of private fundraising, the aim of providing major size and cost effi- backed by the original venture capital firms ciencies in mobile phones. go from start-up to a £240 million stock market flotation in less than a decade and new investors. “Their strapline was that they wanted to When it floated in 2004 on the London Stock democratise radio technology and make it Exchange at £2 a share, valuing the compa- much easier for people to use,” says Paul ny at £240 million, Amadeus and Gilde still Goodridge, CSR’s finance director since had 13 per cent holdings, while 3i held 14 2000. “This was the vision that the venture per cent. capital firms bought into.” Actually, 3i held on to some of its stake until Garrett of 3i agrees. “It was pretty obvious 2007 and Partner Laurence Garrett is delight- early on that they had something we could ed with the investment. “Overall, we made not ignore,” he says. “They were the first peo- about ten times our original investment in the ple in the world to achieve radio frequency at company,” he says. “It’s a very good baseboard on one single CMOS chip. It was a return.” Existing shareholders took out technological breakthrough.”

114 115 How private equity works in practice

Hermann Hauser, Co-founder of Amadeus, European standard called Bluetooth was the In addition, the venture capital backers were adds: “People ask me why we invested in right approach. able to use their industry knowledge and something that had not been done before experience to help CSR grow, recruiting John “Were there difficult moments and times and was completely new. But the answer is Hodgson, a highly experienced Briton in the when we doubted whether we should be that if you have the chance to do that, this is US computer industry, as Chief Executive. doing it? Absolutely. But every time, we and where the big wins are. Living in Cambridge, the other two venture capital firms made the Later, Garrett introduced CSR to three of 3i’s you learn to recognise a five-star wizard decision to move forward and believed that other investee technology companies, which when you see one and James Collier is a five- the team would be able to pull it off.” CSR ended up acquiring. star wizard.” Bluetooth took some time to take off. By “The venture capitalists were not just there to Amadeus, 3i and Gilde provided $9 million in 2000, less than ten million Bluetooth units look after their money at board meetings,” the 1999 fundraising and were joined by Intel had been shipped worldwide. Now, howev- says Goodridge. “They were able to bring Capital in a $7 million second round in 2000. er, this figure is more than one billion. skills to the table as well.” A third round later that year raised $48 mil-

RVT QIYI H UK PRIVATE EQUITYINTHE “Back in 2001, the technology marketplace CSR’s experience has been “an example lion and saw nine more investors, including was a very hard one to be in and Bluetooth of private equity working really well,” the venture capital arms of electronics was just not happening,” says Goodridge. “But Carlisle concludes. groups Philips, Siemens, Compaq and Sony, we presented a very strong story about why join the shareholder register as part of a con- “This was plainly a high-risk start-up that was we should continue to invest as a company certed move to not just get financial well-backed by venture capital. The company and recruit quality engineers while they were investors, but also build relationships with has been properly managed at every level.” available. The venture capital backers stayed commercial partners. invested and continued to support us.” Then in 2002, a fourth fundraising brought in Hauser says the turning point came when

THE FIRST25YEARS Scottish Equity Partners and LDC to take CSR CSR’s CMOS chips were used in a through to flotation. Sony phone. “Everybody was excited by the enthusiasm, “The phone was a total flop,” he says, “but a energy and intelligence and skills of the orig- total flop in the mobile phone business inal team,” says Goodridge. “James Collier, in means you sell six million products. particular, had this real vision for where the “It was fantastic to show that the product company could go with its technology and he could do what we said it could do all along. It has a very good commercial brain as well as was an early success and then the product great technical expertise. started being designed into phones. When “The three Founders saw that Bluetooth was that happens, it becomes very profitable going to be a huge market, but they were because so very many mobile phones are also highly competent managers and were now sold worldwide.” able to elucidate what would make CSR into CSR’s chips are now used in the mobile a significant business.” phones of Motorola, Nokia, Panasonic, The founders did not develop their technolo- Samsung and Sharp, the wireless headsets of gy for Bluetooth and originally toyed with Hutchison ‘3’ and Logitech, almost all new using it on short-range wireless or wireless models of laptop personal computers with local area networks. However, after Bluetooth capability introduced since 2003, Bluetooth was adopted as the European stan- and the communication systems of Saab, dard, they decided to focus on it. Audi and BMW cars. Hauser recalls: “With hindsight everyone Tony Carlisle, the Chairman of financial PR says that of course we went with Bluetooth, firm Citigate Dewe Rogerson who joined “Back in 2001, but it was a pretty gutsy decision. There was CSR as a Non-executive Director in 2005, the technology no Bluetooth market at the time and the gives credit to the CSR management for marketplace was Americans said we were crazy and there was devising a business strategy that sought to a very hard one to be in zero chance of success because there was no add value to the products. Fierce price pres- room for another wi-fi standard. We had to sure was offset by production improvements and Bluetooth was just believe that making an investment in this that cut costs. not happening”

116 How private equity works in practice

Developing business potential – development capital RVT QIYI H UK PRIVATE EQUITY INTHE THE FIRST25YEARS

Private equity firms supply much-needed development capital to growing businesses. But, writes Derek Bedlow, their wide experience of helping to build companies is equally in demand

The real crunch If you’re not growing, you're slowing. ple to do it. ISIS persuaded them otherwise comes when it Securing seed capital and getting a business and bought a minority stake for £3.5 million. off the ground is only the beginning of the “We saw that the founders were still is time to take story for most companies – having got air- extremely able to contribute to the business advantage of its market borne, the real crunch comes when it is time over the next few years and one of our key to take advantage of its market position and position and move the roles with Fat Face was about giving the move the business up a level. business up a level Founders the confidence to keep growing,” This is where development capital comes says Mark Advani, Director of ISIS and for- into play, funding the expansion of the busi- mer Non-executive Director of Fat Face. “The ness and diversifying some of the risk for the other option for them was to sell the compa- founders, while allowing them to retain an ny outright, but we persuaded them that interest in the company when the time they could remain involved so that they comes to seek fresh funding. could continue to grow it.” This was very much the story of Fat Face, an This faith proved to be justified. By the time activewear brand and retailer which started that ISIS made its exit in 2005, selling its stake life in 1989 as a T-shirt printing business to Advent International, the Fat Face empire designed to fund the ski-bum lifestyles of its had grown to 97 outlets, complemented by a founders, Tim Slade and Jules Leaver. By the burgeoning mail order business, and grown time that ISIS Equity Partners came on the its turnover eight-fold to £60 million. scene in 2000, the pair had developed the “When we invested, it was a business that company into a £7 million business selling a had grown quickly, but was still a bit of a range of branded clothing from a chain of secret,” Advani says. “We saw that the brand 25 shops. It had, nonetheless, reached the had developed a really good relationship with point where significant development was its customers and that there was an opportu- vital to maintain its growth and Slade and nity to roll it out further and to expand into Leaver were far from sure they were the peo- mail order.”

117 How private equity works in practice How private equity works in practice

Development capital is also invaluable when In many respects, bringing this kind of expe- Perhaps the most valuable feature of develop- “The business plan couldn’t take into account growing companies look to expand through rience to the deal is as essential as the capital ment capital, however, is the time and flexibil- how much the business needed to change,” acquisition. This was the experience of private equity houses supply to growing ity that it provides for companies to find their he says. “Having expanded from 150 to 1,600 Software Solutions Partners (SSP), a software companies – it provides private equity with a feet compared with other sources of finance. people during the period of our investment, house focusing on the insurance industry, distinct advantage over other forms of Private equity investors are a long-term part- the organisation was almost unrecognisable which teamed up with Lloyds Development finance available at this stage of develop- ner rather than a short-term investor. by the end. Capital (LDC) in 2004 by exchanging a 30 per ment, whether bank debt, a trade sale or an For example, although Fat Face hit all the “Private equity is absolutely fantastic in the cent stake for an investment of £11.3 million. AIM listing. right notes financially, it did not do so in quite early years of a business like this, where you “We had a very good business,” says David For sandwich chain EAT, the prior experience the same order as originally envisaged in its need all the shareholders to take a longer- Rasche, who co-founded the company with of its main investor Penta Capital in helping business plan. Advani argues that the com- term view and be prepared to invest in peo- Laurence Walker in 2001. “We were enjoying restaurant chain La Tasca to grow from pany may not have enjoyed its ultimate suc- ple and systems and infrastructure. No other it and we thought we could add more value. 14 outlets to 67 is certainly proving to be as cess had it raised capital by another method. form of finance could have achieved for Fat We wanted to take some of the risk off the valuable as its money. When Penta bought its Face what private equity did.” table for the founders.” stake in August 2005, EAT had 42 outlets, but RVT QIYI H UK PRIVATE EQUITY IN THE The money enabled SSP to finance a series of had plans to develop a further 100 shops and UK PRIVATE EQUITYINTHE strategic acquisitions worldwide, which expand its production capacity to supply allowed it to distribute its core product, the them. Already, it now has 85 shops and 2,000 ‘insight’ software package, on a global basis. staff, and profits have risen three-fold. The business was also able to significantly “Growing a business rapidly can be quite a diversify its generic client bases into other dangerous venture if you don't have the right areas of the financial services industry. As a people and infrastructure in place – you can result, when the company was floated on overtrade quite easily,” says Penta Capital’s AIM in 2006, its value had risen to more than THE FIRST 25 YEARS

Torquil Macnaughton, who serves as a Non- THE FIRST25YEARS £70 million. Perhaps the most executive Director on the company’s board. “Private equity is valuable feature of “The track record of the management was “The more experience you have in a sector, absolutely fantastic development capital, strong, they had developed strong contracted then the more you can help with forward in the early years of revenues and we could see significant growth planning – you know what happens when however, is the time and potential in their insight product,” says LDC you reach certain levels. In this business, suc- a business, where you need flexibility that it provides Senior Director John Swarbrick. “They had cess is down to micro-management, making all the shareholders to take for companies to find their identified opportunities to promote their prod- sure that you get the best deals from your a longer-term view” feet compared with other uct by building on their relationships with suppliers and minimising costs. It's concen- insurance companies and intermediaries.” trating on the small details that ultimately sources of finance deliver the bottom line. EAT has grown rapid- LDC brought more to the deal than just ly, but without losing control.” money. Swarbrick joined SSP’s board as a Non-executive Director and his, and his col- A common issue for companies at this stage leagues’, experience of corporate acquisi- of development is moving away from the tions proved to be invaluable as the company owner-manager mentality to develop an expanded. “The key question for companies organisational structure that can bear the at this stage is: does this acquisition enhance weight of a growing business. At Fat Face, for shareholder value? Our experience of buying example, the input of ISIS proved to be and selling companies is very helpful in this invaluable when it came to creating the senior regard. We were able to contribute to the management roles necessary to oversee the debate over which companies to pursue and company's expansions – and finding the right provide the benefit of our experience when it people to fill them. came to the execution and structuring of the “The real issue for Fat Face was that the busi- acquisitions,” Swarbrick says. ness was expanding by 50 per cent per annum More generally, LDC was able to provide and, as a result, was constantly outgrowing its advice on managing a growing business, organisational structure,” says Advani. “The based on its experience of investing in com- real difference we made was to help them panies at similar stages of development. judge when to recruit new organisational “John Swarbrick and others at LDC gave us heads and helping them to do that. We also very good non-executive advice,” says helped them to appoint a chairman and, ulti- Rasche. “They were objective in their advice mately, advised them on when it was the right and weren't just looking out for their own time for the founders to take a step back.” interests. We got a contribution from LDC that was very fair.”

118 119 The future The future

Predicting the future is a notoriously prepared to take risks with their own capital. dangerous business. History is littered with People who know how to take a business people who looked into a crystal ball and from start-up and help it to expand into new got it wrong. The man at IBM who said markets. People who can take existing busi- there would only ever be demand for three nesses and help re-energise them, taking computers worldwide. The Parliamentary tough decisions to focus on areas of growth, Committee which said that there was no empowering management to drive the busi- future for electricity. The man in the 1870s ness forward and take a longer-term view on who said that telephones would never investment decisions away from the glare of catch on. the public markets. So, it is a tall order to predict what the world In an era of globalisation and consolidation, it of private equity will be like in 2033. What also seems a safe bet that economies will seems a safe bet is that given the way that increasingly have to concentrate on their everything is speeding up, the changes areas of strength. When you look at the UK, RVT QIYI H UK THE FIRST 25 YEARS PRIVATE EQUITY IN THE between now and then will be even greater financial services is one of the relatively few UK PRIVATE EQUITYINTHE than the changes we have seen in the last areas where we have a genuinely world-beat- 25 years. ing industry. So we need to build on that, making London as attractive a place a possi- Back in the early 1980s, we didn’t exist as an ble for private equity and venture capital. industry. Today, we have come from That’s the only way in which we will continue nowhere to play a central part in the world’s to attract the brightest and best from all round industrialised economies. And yes, there’s the world to come and work here. no doubt that the speed of our growth has brought controversy. But while I think the future for private equity should be very bright, it is by no means in the THE FIRST25YEARS I predict that 25 years from now, we will be While I think the bag. If the wrong political decisions are taken playing an even bigger role, but with one in the US, the UK and in Europe, there is an future for private important difference. We will no longer be alternative future. A future where private equity should be very seen as something mysterious or controver- equity is so tied up in regulation that it sial. We will be an accepted part of the eco- bright, it is by no means in becomes indistinguishable from other forms nomic mainstream, just one form of owner- the bag. If the wrong of ownership and so loses the focus and rela- ship among others which makes a vital con- tive freedom which has been the very reason political decisions are taken tribution to the overall well-being and pro- for its success. in the US, the UK and in ductivity of the economy. And where, if you work in the private sector, it will be just as That’s why it is so important for us to win the Europe, there is an normal to work for a company owned by pri- argument that is currently being waged alternative future vate equity as it is to work for one which is between those who believe that the right publicly listed. response to globalisation is protectionism and regulation, and those, like me, who believe That will partly be simply because of greater that in the long-run, open markets and compe- familiarity. But I think it will also be because, tition will serve society best. Win it, and we as the pace of globalisation and economic should see faster growth, increased productiv- change hots up, so the disciplines and skills ity, more innovation, and a higher tax take to that private equity and venture capital offer Looking ahead to the next 25 years help fund our public services. Lose it, and we will increasingly come into their own. will see falling productivity, worse pensions, Private equity has come from nowhere to play a vital role in the UK Why am I so sure? Because we know that lower investment and a sclerotic economy. economies in the developed world are going and world economies. Its importance will only increase in years I am confident that we will win that argument to have to find ways of becoming more pro- because the facts will increasingly speak for to come, predicts Simon Walker, Chief Executive of the BVCA ductive. There will be more of a premium themselves. The result, in 25 years’ time, will than ever on intellectual capital and the abili- be an industry which will be even more ty to develop new technologies. The compa- important than it is today, but one that will nies that flourish will be those who are first to have become boring in that it will be as much spot new opportunities in world markets, to part of our national life as public companies keep fleet of foot and retain entrepreneurial are today. flair. There are going to be fewer and fewer hiding places for businesses that duck diffi- cult decisions or trade on past glories. So where are we going to find these skills and attributes? They are, of course, to be found in all sorts of businesses, but I do believe that there is a concentration of them in venture capital and private equity. People who are 120 121