Pushing Diversity April Evans Wants More Women in Private Equity

Issue 166 • November 2018 • www.privatefundsmanagement.net

FINANCE • LEGAL • COMPLIANCE • OPERATIONS • TAX

PUSHING DIVERSITY APRIL EVANS WANTS MORE WOMEN IN PRIVATE EQUITY

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Editor Dominic Diongson Tel: +1 646 795 3277 [email protected]

Reporter Brian Bonilla Tel: +1 212 633 1455 [email protected]

Senior Editor, Private Equity Toby Mitchenall Tel: +44 207 566 5447 Leading from the top [email protected]

Production Editor Julia Lee Tel: +44 207 167 2030 [email protected] April Evans is on a mission to get more As chief financial officer for a mid-mar-

Contributors women into private equity (p. 12). ket firm, Evans talks about outsourcing Adam Le Isobel Markham And she’s being proactive about it. This and points to information technology as Andy Thomson Nathan Williams month, she’s taking part in the Women’s an important area, because it’s “the smart Association of Venture and Equity forum thing for all of us to do when we are not Design and Production Manager Carmen Graham in New York City to encourage women large enough to command the expertise Tel: +44 207 167 2036 [email protected] to learn from each other on how they of the chief technology officer.” can develop, and potentially take up se- Data security was a key concern of our Head of Marketing Solutions Alistair Robinson nior management roles in a field that is roundtable of private equity executives Tel: +44 207 566 5454 [email protected] overwhelmingly male. There is no com- and service providers (p. 18). How can

Marketing Solutions Manager prehensive data set by gender on private you stay on top of cyber-risk manage- Anthony Hackett Tel: +44 207 566 4273 equity in the US, but if the UK is any ment? How do you thwart the stealing [email protected] indication, the gender gap is wide. A re- of data and information? Do you have an Subscription Sales EMEA port from the lobby group British Private incident response plan to follow in case of Chris Grant Tel: +44 207 167 2035 Equity and Venture Capital Association an attack to your systems? Our roundta- [email protected] and Level 20, a non-profit advocating ble participants discuss how preparation Asia-Pacific Andrew Adamson for women in private equity, found only is important in response to an incident Tel: +852 2153 3848 [email protected] 6 percent of senior investment team roles and how everyone within a firm top-

Americas in the UK are held by women and wom- down – from the chief executive to the Yasmine Givehchi Tel: +1 646-795-3271 en comprise just 29 percent of the private lowest-level employee – needs to work to- [email protected] equity workforce. gether and stay informed. Customer Services Fran Hobson Some firms are addressing the situa- Elsewhere, Sweden’s top court has Tel: +44 207 566 5444 [email protected] tion. The Carlyle Group created the posi- ruled that carried interest will be taxed as An Nguyen tion of chief diversity officer to develop a ordinary income (p. 36). Read on why it Tel: +1 212 645 1919 [email protected] more diverse and inclusionary workplace. happened and whether investors are flee-

For subscription information please visit The numbers are a bit better for Carlyle: ing Sweden for lower tax nations. www.privatefundsmanagement.net in the US, women make up 23 percent of Do you know enough to figure out Director, Digital Product Development its senior positions, which include princi- how blockchain and artificial intelligence Amanda Janis [email protected] pals and partners. figure in private equity? An expert talks Editorial Director As the sole senior woman in an about how analyzing investor portfolios, Philip Borel [email protected] eight-partner firm, Evans understands predicting five years in the future, and Head of Research & Analytics that change takes place from the top and recognizing trends in the market can be Dan Gunner [email protected] is taking steps to make it happen. Our se- done with these new technologies (p. 28). Publishing Director nior editor Toby Mitchenall tackles the Paul McLean [email protected] issue, too (p. 10), and points out that di- Chief Executive versity and inclusion are becoming a real Enjoy your reading. Tim McLoughlin [email protected] issue for private equity firms, and rightly Managing Director – Americas so. The industry will also have to open up Colm Gilmore [email protected] to minorities at the top. Indeed, there are Dominic Diongson Managing Director – Asia challenges, but each small step that’s tak- Editor, pfm Chris Petersen [email protected] en can lead to bigger change. [email protected]

November 2018 • Issue 166 • private funds management.net 1 CONTENTS • NOVEMBER 2018 • ISSUE 166

features commentary

12 On a mission to get more women into private equity 4 Watching and waiting for April Evans is doing her bit to redress private equity’s problem with diversity Volcker reform The regulator has opened up a debate on 16 Texas fights to claw back terms what a covered fund is GPs are pushing fund terms in their favor, and it’s up to LPs to walk them back, according to Texas Municipal Retirement System’s PE director 6 Five things to expect from ILPA’s restructuring guidance 30 A wake-up call on GP-leds The guidance will be thorough, nuanced The Securities and Exchange Commission will act on fund restructurings if and focused on conflicts of interest it believes investors haven’t been given full information 8 Why lawyers are urging lenders 32 The holy trinity of terms to get aggressive The three economic terms at the heart of the relationship between manager Documentation is strongly in favor of and investor borrowers, so financiers are being told to look for reasons to redress the balance of 36 The chill around Sweden’s tax decision power Funds are considering their future in the country after the nation’s top court ruled carry should be taxed as income, not capital gains 10 Diversity is the new ESG GPs may be reluctant to think about diversity in their own teams; at some point special report: cybersecurity they will not have a choice

18 How to manage cyber-risk Protecting data and information is a key focus for private equity firms, but also in this issue how do they stay ahead of the hackers? 38 ‘No-deal’ preparation required: Proskauer p.18 38 Jersey fast tracks fund approval 39 SEC personnel changes

New York: 130 W 42nd Street / Suite 450 New York / NY 10036 / +1 212 633 1919 / Fax: +1 212 633 2904 • London: 100 Wood St / London EC2V 7AN / +44 20 7566 5444 / Fax: +44 20 7566 5455 • Hong Kong: 9F On Hing Building / 1 On Hing Terrace / Central / Hong Kong / +852 2153 3240 / Fax: +852 2110 0372 • PFM is published 10 times a year. To find out more about PEI please visit: www.thisisPEI.com • Printed by Hobbs the Printers Ltd / www.hobbs.uk.com • © PEI 2018 • No statement in this magazine is to be construed as a recommendation to buy or sell securities. Neither this publication nor any part of it may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage or retrieval system, without the prior permission of the publisher. Whilst every effort has been made to ensure its accuracy, the publisher and contributors accept no responsibility for the accuracy of the content in this magazine. Readers should also be aware that external contributors may represent firms that may have an interest in companies and/or their securities mentioned in their Cybersecurity: requires constant vigilance ® contributions herein. • Cancellation policy: you can cancel your subscription at any time during the first three months of subscribing and you will receive a refund of 70 per cent of the total annual subscription fee. Thereafter, no refund 28 Using AI to make portfolio decisions is available. Any cancellation request needs to MIX Paper from be sent in writing (fax, mail or email) to the responsible sources Find out how advances in blockchain and artificial intelligence will drive subscriptions departments in either our London FSC® C020438 efficiency and business decisions in private equity or New York offices.

2 private funds management • Issue 166 • November 2018 MULTIPLES

By the numbers pfm piles up some of the month’s most eye-catching metrics $326bn Awarded to Balance of power whistleblowers Proportion of women in senior roles at Carlyle

Principal to partner level 80 20 59 Whistleblower rewards

MDs/partner level 83 17

0 10 20 30 40 50 60 70 80 90 100 % $1.7bn Men Women In sanctions based on whistleblowers’ Source: The Carlyle Group information

Source: SEC

Brexit, what Brexit? Staffing up The most popular jurisdication for funds authorized CFOs were asked whether or not an issue was a concern, under AIFMD in Q2 2018 was the UK and employees received the most ‘yes’ votes

Difficulty attracting/ 53 28 retaining qualified 36 26 employees 24 22 32 20 Government policies 35 18 16

% 28 14 Rising wages and salaries 12 34 10 8 27 Regulatory requirements 6 29 4 2 27 0 27 16 10 9 5 4 4 25 Cost of benefits 23

UK Spain 0 5 10 15 20 25 30 35 40 45 50 55 France Ireland Others Germany %

Luxembourg Netherlands US Europe

Source: ESMA 2018 Report on Trends, Risks and Vulnerabilities in the Source: Duke University financial market

November 2018 • Issue 166 • private funds management.net 3 COMMENTARY • REGULATION

covered fund definition,” the Debev- “We hadn’t anticipated any of those issues. Good thing they had.” Watching and waiting for oise lawyers wrote. “To resolve this in- congruity, the agencies could revise the People who know Private Equity, know BDO. Volcker reform regulations to provide banking entities The regulator has opened up a debate on what a covered fund is flexibility to engage in permissible long- term investing, whether through a private fund structure or otherwise.” One firm surely pleased it didn’t move By ISOBEL MARKHAM The proposal raised numerous ques- too fast is Goldman Sachs. The bank – tions as to what counts as a ‘covered which had roughly $4 billion fair val- t’s been 10 years since the darkest fund’ – the definition of which is at the ue of private investments as of March days of the financial crisis, which heart of the investment prohibitions. As – secured a five-year extension on di- fundamentally changed the private it stands, it refers to both hedge and pri- vestment obligations included in the Iequity industry. vate equity funds; the SEC asks wheth- Volcker Rule last May. On the bank’s A key outcome was the 2010 Dodd- er the agencies should separately define second-quarter earnings call last year, Frank Act’s Volcker Rule, which forces ‘hedge fund’ and ‘private equity fund’ chief financial officer Martin Chavez banks to limit their investments in pri- or restrict the definition of a ‘covered said he was expecting a “recalibration” vate funds to less than 3 percent of Tier fund’ to one or the other. “Would such of the rule. 1 capital. an approach more effectively imple- Significant changes to the Volcker As soon as Dodd-Frank was signed ment the statute? If so, how should the Rule that would allow banks to re-en- into law in 2010, many of the big banks agencies define these terms and why?” ter private equity in a meaningful way began offloading their private equity The SEC also suggests it’s open to the would open up a huge pool of capital to assets in anticipation of its implemen- idea of scrapping restrictions on banks general partners – that is, if those banks tation, spinning out or selling their in- backing private funds, asking whether that paid the cost to comply with Vol- house direct investment arms. We have there are funds included in the ‘covered cker could stomach the thought of po- Volcker in part to thank for One Equity fund’ definition that do not in fact en- tential regulatory yo-yoing in the future. Partners (JPMorgan), Equistone Part- gage in prohibited investment activities. The Debevoise lawyers note that the ners Europe (Barclays) and Graycliff In a July article, lawyers from Debev- SEC proposal includes “few specific Partners (HSBC). In 2014, divestments oise & Plimpton explained that current modifications to the covered fund pro- by banks accounted for a quarter of regulations limit banking entities’ in- visions,” instead asking “open-ended secondaries deal volume, according to vestment in funds that make long-term questions,” suggesting the agencies are Setter Capital. investments in portfolio companies, “relying on the industry to provide feed- Now it looks like some of those banks despite the fact banking entities may back on how to revise the implementing may have been too quick to act. The invest directly on their balance sheet in regulations both to reduce unnecessary Securities and Exchange Commission portfolio companies under various au- complexity and to implement the under- sought comment on proposals to ease thorities. lying statue appropriately.” The Private Equity Practice at BDO restrictions that prohibit banks from “This is an incongruous result and What happens next could shape the More companies are in play, more PE ﬁ rms are competing for each deal, and expectations from investors investing in private equity funds. an example of the over-breadth of the industry for decades. n are higher than they’ve ever been. Your choice of advisory partner matters – now more than ever. BDO supports Private Equity sponsors, funds, and their portfolio companies with a full spectrum of professional Apr 1, 2014 Jul 21, 2015 Apr 20, 2017 May 8, 2017 Aug 29, 2018 Oct 17, 2018 services, from transaction advisory, portfolio management, and regulatory compliance to tax and audit in more than 160 countries around the world. The Volcker Rule Initial deadline for Deutsche Bank Goldman Sachs The SEC releases Comment period goes into effect conforming with AG is fined $19.7 says it has secured proposals on the on SEC proposals the rule million for not a five-year Volcker Rule closes complying with extension on Volcker Rule offloading private fund stakes Accountants and Advisors www.bdo.com © 2018 BDO USA, LLP. All rights reserved. Source: pfm

4 private funds management • Issue 166 • November 2018

SMA 002071 Pub. PFM Magazine Size 8.07 x 10.63 Issue SEP Art Director: sd Copywriter: ac Account Executive: wt Date 07/30/18 “We hadn’t anticipated any of those issues. Good thing they had.”

People who know Private Equity, know BDO.

The Private Equity Practice at BDO

More companies are in play, more PE ﬁ rms are competing for each deal, and expectations from investors are higher than they’ve ever been. Your choice of advisory partner matters – now more than ever. BDO supports Private Equity sponsors, funds, and their portfolio companies with a full spectrum of professional services, from transaction advisory, portfolio management, and regulatory compliance to tax and audit in more than 160 countries around the world.

Accountants and Advisors www.bdo.com

SMA 002071 Pub. PFM Magazine Size 8.07 x 10.63 Issue SEP Art Director: sd Copywriter: ac Account Executive: wt Date 07/30/18 COMMENTARY • CONFLICTS OF INTEREST

The guidance is also likely to recom- Five things to expect from mend that fairness opinions be sought on valuations and prospective deals, ILPA’s restructuring guidance though their importance may depend The guidance will be thorough, nuanced and focused on the circumstances of each deal. “How often does a fairness opinion on conflicts of interest diverge from whatever has been rec- ommended on the deal?” Choi said. “It may be that the value of a fairness opinion really depends on the circum- By ADAM LE Guidance will be limited to stances.” restructurings… for now he Institutional Limited 2ILPA won’t issue guidance on Expect to get it into the Partners Association is a force to other processes, such as stapled deals weeds be reckoned with. The industry or broader end-of-life fund issues, the 4 ILPA’s 2017 guidance on sub- Tbody issues guidance on various topics, latter of which Choi describes as “fairly scription credit lines is a five-page including its private equity principles, specific” to each case. Still, ILPA views document covering GP clawback, fees to around 450 member institutions restructurings within the context of a and expenses, tax considerations and representing more than $2 trillion in fund coming to the end of its term in legal risks, among other issues. It pro- private equity assets. most cases, and it wants to help remove vides LPs with nine recommendations ILPA’s upcoming guidance on gen- ambiguity over fund extensions or fees (including limited partner advisory eral partner-led restructurings couldn’t charged at the end of a vehicle’s term. committee-specific guidance) on the have come at a better time: such deals topic and lists 15 example questions account for as much as 26 percent of so LPs can grill their GPs on issues secondaries deal volume. Here are five ranging from terms to costs, how the things we can expect from ILPA’s guide- fund facility will affect the fund’s per- lines, to be published as early as the end $27bn formance, as well as regulatory and tax of the year. Secondaries deal volume concerns. It’s likely that ILPA will issue sim- ILPA wants to get it right ilarly thorough guidance when it While the body is keen to issue 26% comes to restructurings. GPs, and 1guidance on an increasingly com- Proportion of secondaries more importantly their advisors, mon and important issue, it doesn’t deals that are GP-led should be prepared to answer highly want to rush into providing guidelines specific questions from their LPs, all in that don’t make sense to industry practi- Source: Greenhill the name of greater transparency and tioners. “With the GP-led transactions, reducing potential conflicts of interest. every deal’s a snowflake,” ILPA’s managing director of industry affairs Jennifer Reducing conflicts of interest Nothing is set in stone Choi told sister publication Secondaries will be key ILPA understands the secondar- Investor. The association is aware that 3If there’s one issue secondaries-fo- 5 ies market evolves quickly, so it different nuances in each transaction cused lawyers constantly highlight as the is open to updating its guidance where can make issuing boilerplate guidance biggest concern when it comes to GP-led necessary. Its recommendations on tricky. restructurings, it is reducing conflicts of subscription credit lines call for con- “The true north for us is: would a interest. Expect ILPA’s guidance to out- tinuous member feedback so it can re- reasonable rational market participant line how LPs can push for better market flect “new market conditions.” Expect feel like this sounds right in the context testing for pricing on assets, the involve- the LP body to be receptive to ongoing of alignment in the partnership?” Choi ment of an intermediary, as well as ‘full suggestions from all segments of the said. and frank’ disclosure from GPs. industry. n

6 private funds management • Issue 166 • November 2018 07009_PFM_full_page.indd 1 08/10/2018 17:31 COMMENTARY • TERMS AND CONDITIONS

revenue generation from initiatives not yet launched. These might uncharitably be described as ‘pie in the sky’ assumptions. The trend toward covenant-lite structures has been well documented, but certain provisions that have crept under the radar could be more damaging than those which have received more publicity. Cambridge highlights, as an example, agreements which allow the borrower to remove assets from a lender’s collateral pool to generate more liquidity – leaving the lender with less collateral in the event of a default.

A route to renegotiation Some market sources accuse lenders of having sleepwalked into the current situ- Tightening: lenders should ratchet up pressure on borrowers to get better terms ation. There was no ‘sea change’ event as such, but incremental steps have created arguably the most borrower-friendly environment in the leveraged loan market Why lawyers are urging in recent memory. And that is why legal advisors are now urging lenders to wake lenders to get aggressive up and smell the coffee. Documentation is strongly in favor of borrowers, so financiers are What we hear is that lenders are being urged to find any route possible to being told to look for reasons to redress the balance of power renegotiate the documentation. Tech- nical breaches by borrowers – such as late delivery of documents, tardy re- By ANDY THOMSON The significance of this is that -ju porting and questionable capex items nior debt helps to cushion senior debt – are being used to hold borrowers’ he erosion of junior debt, holders from losses in the event of a de- feet to the fire. Lenders are being told looser covenants and less fault. The less junior debt, the quicker to focus on these breaches with alacrity reliable cashflow projections senior debt will start absorbing losses. and aggressiveness to try and claw back Tare combining, in the view of some Cambridge estimates that, as a conse- some of the creditor rights they have market sources, to produce an unholy quence, recovery rates on defaults on too readily tossed away. brew of toxic ingredients confronting leveraged loans may decrease from an Of the imbalance of power, one the leveraged loan market. average of 60-80 percent to between source told sister publication Private Research unveiled in August by 46-70 percent. Debt Investor: “These types of situa- Cambridge Associates revealed that, This is against a background of var- tions tend to find their own solutions, since the end of the credit crunch, ious pressures which could make de- and the shortcomings can be addressed far less junior debt is being included faults more likely. One is the tenden- in unconventional ways.” in deals – largely as a result of being cy for deal agreements to incorporate Lenders may be gradually acknowl- usurped by the unitranche product, questionable assumptions of future edging this. Whether they can at least which is often seen as a more us- cashflow – perhaps based around an- partially repair the damage will be in- er-friendly option by borrowers. ticipated synergies, new contracts or triguing to observe. n

8 private funds management • Issue 166 • November 2018 Irish Funds 6th Annual UK Symposium

ETC Venues, 155 Bishopsgate, London EC2M 3YD, UK, Register for free at Thursday, 15 November 2018 | 8:30am – 5.00pm, www.irishfunds.ie/events followed by a drinks reception

• Brexit - how Ireland can help • Diversity in Finance • The Practical Impact of GDPR • Board Governance & Shareholder Protection • ESG and Green Finance • Money Market Reform • Cryptocurrency and Digital Assets • Update on Regulation COMMENTARY • HUMAN CAPITAL

described a diverse and inclusive cul- Diversity is the new ESG ture as “a competitive advantage.” GPs may be reluctant to think about diversity in their own A deficit in workplace diversity contributed to heavyweight manag- teams; at some point they will not have a choice ers Blackstone Group and Brookfield Asset Management being passed up for a $50 million infrastructure allo- By TOBY MITCHENALL And so it is set to play out with cation by the $10.8 billion Chicago the issue of diversity and inclusion Teachers’ Pension Fund in June, sis- hat starts as a talking among private equity firms. ter publication Infrastructure Inves- point can become a The discussion stage is well and tor reported. fundraising deal-breaker. truly underway. It is a topic that will One blue-chip GP told me that at WWe saw it with ESG (environmen- be front-and-center at our upcoming a recent meeting of its biggest LPs, tal, social and governance issues). The Women In Private Equity Forum in diversity and inclusion was one of idea that non-financial impact should London. only two agenda items LPs insisted be a considered and documented part on. Unsurprisingly, that same GP of investment decision-making has is currently working on a number taken a long time to take root. of steps – including training for the “In the early days […] investors firm’s leadership, as this represents wanted the highest rate of return 21% a cultural step change – to create a and didn’t put any pressure on the Increased likelihood of above more balanced and diverse team. firms in terms of environmental is- average profits if a company is Now the Institutional Limited TRANSPARENCY. sues [and] jobs offshoring,” Carlyle’s in the top quartile for gender Partners Association, the body that co-founder David Rubenstein told diversity rather than the represents more than $2 trillion in sister publication Private Equity In- bottom quartile investor capital, has the issue well CONFIDENCE. ternational in 2016. and truly in its sights and has ex- But taken root it now has. A large panded its due diligence question- cohort of private equity investors (33 naire to include general partner-level TRUST. percent, according to the PEI LP Per- 33% diversity issues. spectives survey last year) always in- Increased likelihood of Diversity and inclusion is becom- cludes ESG as part of their manager outperformance on EBIT ing a real issue for private equity Some things can’t be bought, sold or traded. due diligence processes. margin if a company is in the firms, whether they know it or not. Those who work in this area often top quartile for ethnic and As with other areas of financial ser- refer to the private equity industry as cultural diversity vices, women are under-represented Clients have relied on Duff & Phelps to help protect these fundamental ideals for being on a “journey” in terms of ESG. at senior levels. Only 17 percent of Source: McKinsey more than 80 years. We deliver objective advice in the areas of valuation, disputes and The first steps involve thought-lead- Carlyle’s managing directors and ing institutional investors (asset own- partners are women. In Blackstone’s investigations, M&A, restructuring, and compliance and regulatory consulting. Balancing ers) discussing it. Some prescient GPs UK operations, men earn 30 percent proven technical skills with deep industry expertise, we help our clients address their join the conversation. Formalized fo- As Cambridge Associates head of more than women on an hourly ba- rums and events are convened, lobby- private markets Andrea Auerbach re- sis. Are other firms likely to be any most complex business needs. Learn more at www.duffandphelps.com ing groups and associations join the inforced to us recently, asset owners different? dialogue. Specialists are hired at both are thinking about how to bake it Undoubtedly there are GPs that – GPs and LPs. Guidelines are drawn into their investment decision pro- behind closed doors – question the up and boxes added to due diligence cess. value of monitoring and reporting questionnaires. Carlyle has taken the notable step ESG issues, yet investor demand has Or to put it another way: the con- of hiring a chief diversity officer pushed them to do so. Expect the versation moves from “Why should from BlackRock. Carlyle co-chiefs same to happen with diversity and we do this?” to “How can we do this?” Kewsong Lee and Glenn Youngkin inclusion. n

M&A advisory, capital raising and secondary market advisory services in the United States are provided by Duff & Phelps Securities, LLC. Member FINRA/SIPC. Pagemill Partners is a Division of Duff & Phelps Securities, LLC. M&A advisory and capital raising services in Canada are provided by Duff & Phelps Securities Canada Ltd., a registered Exempt Market Dealer. M&A advisory, capital raising and secondary 10 private funds management • Issue 166 • November 2016 market advisory services in the United Kingdom and across Europe are provided by Duff & Phelps Securities Ltd. (DPSL), which is authorized and regulated by the Financial Conduct Authority. In Germany M&A advisory and capital raising services are also provided by Duff & Phelps GmbH, which is a Tied Agent of DPSL. Valuation Advisory Services in India are provided by Duff & Phelps India Private Limited under a category 1 merchant banker license issued by the Securities and Exchange Board of India.

DP170301_AD_PFM.indd 1 11/2/17 10:13 AM TRANSPARENCY. CONFIDENCE. TRUST.

Some things can’t be bought, sold or traded.

Clients have relied on Duff & Phelps to help protect these fundamental ideals for more than 80 years. We deliver objective advice in the areas of valuation, disputes and investigations, M&A, restructuring, and compliance and regulatory consulting. Balancing proven technical skills with deep industry expertise, we help our clients address their most complex business needs. Learn more at www.duffandphelps.com

M&A advisory, capital raising and secondary market advisory services in the United States are provided by Duff & Phelps Securities, LLC. Member FINRA/SIPC. Pagemill Partners is a Division of Duff & Phelps Securities, LLC. M&A advisory and capital raising services in Canada are provided by Duff & Phelps Securities Canada Ltd., a registered Exempt Market Dealer. M&A advisory, capital raising and secondary market advisory services in the United Kingdom and across Europe are provided by Duff & Phelps Securities Ltd. (DPSL), which is authorized and regulated by the Financial Conduct Authority. In Germany M&A advisory and capital raising services are also provided by Duff & Phelps GmbH, which is a Tied Agent of DPSL. Valuation Advisory Services in India are provided by Duff & Phelps India Private Limited under a category 1 merchant banker license issued by the Securities and Exchange Board of India.

DP170301_AD_PFM.indd 1 11/2/17 10:13 AM FEATURES • FOR THE RECORD

12 private funds management • Issue 166 • November 2018 FEATURES • FOR THE RECORD

April Evans is on a mission to get more women into private equity The CFO of Monitor Clipper Partners is doing her bit to redress the industry’s problem with diversity, writes Dominic Diongson

n a set-up that may sound familiar “I think that, just because of the way to many in the industry, April Ev- I operate, I see women in the industry ans is the only woman among eight at all levels. The data says the numbers Ipartners at mid-market firm Monitor haven't moved very much,” Evans says. Clipper Partners. Aside from one Ko- Evans sits on the board of the Wom- rean-American, the remainder of the en's Association of Venture and Equity, firm’s partners are white men. which has chapters across the country Speaking to pfm from her office in and brings women from private equity Boston, she points to statistics that show and venture capital to network with women holding a tiny fraction of the one another. The non-profit group, top positions in private equity. There founded in 2003, also helps women is no comprehensive data set, but in learn from one another and encourag- the UK, for example, the numbers are es dialogue among members on how dire. A May report by lobby group Brit- to develop professionally, she says. ish Private Equity and Venture Capital WAVE’s members range from junior Association and Level 20, a non-profit new hires, analysts, associates – all the advocating for women in private eq- way up to women who have been in the uity, found 6 percent of senior invest- industry for many years and hold senior ment team roles are held by women and positions, she says. women comprise just 29 percent of the The association will hold its second private equity workforce. In the US, the annual career forum in New York City Carlyle Group, which recently created on November 6, and firms will be the role of a chief diversity officer, says reaching out to students at colleges and that women make up 23 percent of its universities who are considering a ca- senior positions in the US, compared reer in private equity and venture capi- with what it says is 9 percent for the in- tal. The forum’s sponsors include some dustry average. of the biggest names in private equity.

[The Kauffman Fellows Program] really succeeded in providing a stream of really good, talented people who were different than most venture capital or private equity folks you were seeing and dealing with. It was an absolutely terrific foundation for that

November 2018 • Issue 166 • private funds management.net 13 FEATURES • FOR THE RECORD

“Most cultural change requires buy-in gram, which helped provide on-the- at the top, because it’s the top that drives ground experience to people who were the cultural values of the organization,” interested in learning about or potential- Evans says. 7:1 ly working in venture capital and private Evans’s start in private equity was Ratio of male to female equity. Half of the participants placed serendipitous. In 1993, she founded her partners at Monitor Clipper for one- or two-year stints in firms were accounting firm, which did the financial Partners, where Evans is CFO women and/or minorities, she says. statements for almost 70 funds every “It really succeeded in providing a quarter. But as her partner fell ill, the stream of really good talented people firm was dissolved and she found herself who were different than most venture hired by venture capital firm Advanced $2bn capital or private equity folks you were Invested by the firm since Technology Ventures, which was seeking seeing and dealing with. It was an abso- inception a chief financial officer. After nine years, lutely terrific foundation for that, and I because of a cultural change at ATV she thoroughly loved being a part of it.” sought a new challenge in 2005. That Evans epitomizes two key attributes of was her move to private equity, at Mon- 45 the modern CFO: being plugged into a itor Clipper Partners, where the deals Companies invested in network of peers, and making smart use were more complicated, she says. since inception of outsourced expertise. While Evans was at ATV, she became On the networking side, Evans says involved in the Kauffman Fellows Pro- she gets support from members of the

14 private funds management • Issue 166 • November 2018 FEATURES • FOR THE RECORD

Association for Corporate Growth's the service provider and Evans work Private Equity Regulatory Task Force Resumé together to evaluate the firm’s IT infra- (ACG PERT), where she sits on the steer- structure. ing committee. PERT brings together Title: Partner, CFO “Where do we have weaknesses, where CFOs, chief compliance officers and in- Joined: 2005 do we need to shore up our cybersecurity house legal counsel of mid-market pri- Previous Posts: Partner & measures, which is obviously a big issue vate equity firms across the country. CFO, Advanced Technology for all of us? Where are we vulnerable, “April Evans is a great organizer in Ventures and what do we need to do to address our industry because she not only has Founding Partner, Squillace that vulnerability? How do we stay cur- deep knowledge of the business value of & Evans rent with the latest trends and vulnera- finance and operations, but also a keen Falcon Partners Management bilities? Outsourcing IT from my per- care for and deep understanding of her BBK spective is the smart thing for all of us colleagues, co-workers and the stake- to do when we are not large enough to Harvard Student Agencies holders in Monitor Clippers’ portfolio command the expertise of the chief tech- companies and funds. That combination PricewaterhouseCoopers nology officer,” she says. makes her a sought-after addition to ev- Education: Simmons University, That focus on outsourcing expertise ery campaign and a friend and mentor MBA extends to legal work, where Monitor has to many in our industry, including me,” Boston University, MTS no need for an in-house general counsel. says Joshua Cherry-Seto, a fellow PERT and MSW A chief legal officer in a mid-sized firm member and CFO at Blue Wolf Capital. Duke University, BA would need to be a great generalist, tack- Evans also serves on the board of the Board Roles: Women’s ling everything from negotiating credit Business Advisory Council at Simmons Association of Venture and agreements, purchase and sale docu- School of Business She was a director Equity ments for transactions to fund formation in the Boston chapter of Private Equity Financial Executives Alliance matters to real estate to human resources CFO Association, a networking group. Certifications:CPA and employee issues. On outsourcing, Evans says: “We live “We prefer to go to law firms in spe- in a world where probably the greatest cific areas where they are best in class challenge is doing more with the same because, again, we wouldn't have enough resources, doing more with the same work to support a full time in-house gen- number of people. What that means is eral counsel,” she says. finding efficiencies wherever you can in Aside from the in-house IT co-ordina- what you currently do, in order to be able tor, six people in finance, accounting and to deploy people in a slightly different di- tax work directly under Evans . Two staff rection.” in Luxembourg take care of Monitor’s non-US investments. Outsourcing to fit your size In understanding the complexities Information technology is the most sub- of the new US tax law, Evans turned stantially outsourced function, as a firm to outside accountants for their inter- Monitor’s size can’t justify a chief tech- pretation on the reforms rather than to nology officer, Evans says. Monitor ob- legal counsel. “My experience is the ac- tains the technological expertise it needs counting firms were quicker and better by hiring an in-house IT co-ordinator to think about the impact of tax reform who ensures that the computers, the tele- on our structuring than some of the law phone system and so on are operating firms were,” says Evans, who has a back- properly. That co-ordinator then works ground in accounting. “Accountants go with the outsourced IT service provider into building models right away. They’ll which, Evans says, really provides the build a model to get to the answer and do function of CTO. The IT co-ordinator, the evaluation.” n

November 2018 • Issue 166 • private funds management.net 15 FEATURES • TERMS AND CONDITIONS

eroded. We’re seeing key-man clauses Texas fights to claw being eroded – for instance, if you have two partners, your last fund could say back terms ‘if either partner leaves, the key-man In a heady fundraising environment, GPs are pushing fund clause is triggered’; the next fund might say ‘both have to leave for the clause terms in their favor, and it’s up to LPs to walk them back, to be triggered,’ which then essentially Texas Municipal Retirement System’s director of private means you don’t have a key-man clause. equity Christopher Schelling tells Isobel Markham We’re seeing that a lot. That’s the big trend we’ve seen; more things are really pushing their way and Are you seeing much creativity Right on target we’ve got to fight to claw it back. on fund terms? Q TMRS’s private equity returns since Christopher Schelling: There are some inception have met the pension Are you still seeing portfolio new structures being proposed. There plan’s benchmark Qmonitoring fees? are longer-dated funds, 15-20 years, CS: The practice is declining – it’s less there are some permanent capital vehi- Total portfolio prevalent than we think it used to be. If cles where they’re trying to structure an they’re used, we need to have an under- Core fixed evergreen fund that has the optionality income standing around when and where they to hold a private equity portfolio com- may be used. It’s definitely declining, Non-core fixed pany forever but can sell if and when income^ and our preference is to never pay them. it’s the right time to do so, like a private But like most other things in private holding company. Those are the rarities, US equities equity, you don’t ever get 100 percent but there are a few firms out there try- Non-US equities of what you want. We’re aware of when ing to think a little differently, and in they’re used, we don’t have a lot of them; those cases trying to reduce fees, trying Real return it would be nice to see it completely go to reduce transaction costs. But by and away. large, it’s still a standard two-and-20, Real estate* I think [accelerated monitoring fees] five [years] and five-plus-one-plus-one- Absolute have pretty much gone away. The Se- plus-one model. return+^ curities and Exchange Commission has really taken a hard look at that. Cer- Private equity*^ Has the ‘pendulum of power’ tainly, for the big, publicly traded funds swung fully toward GPs? Q 5-Year net performance (%) out there, they’ve all stopped. CS: Everything is pushing the GP’s TMRS Benchmark way. Every re-up comes with stuff the * Real estate and private equity return as of prior quarter end How willing are you to back a (returns are available on a quarterly basis only) fund without the traditional 8 GP has pushed their way. You can walk + Absolute returns are as of prior month end Q ^ Non-core fixed income, absolute return and private equity some of those back, and in some cases, performance are the annualized return since inception, given percent preferred return hurdle? we’re not interested in investing in those their performance history are less than 5 years CS: There’s very different reasons why funds anymore. Not only are we seeing Source: TMRS Investment Staff Report Q2 2018 there might not be a hurdle; one we can discounts going away but premium do, one we would be very, very hesitant economics in some cases, carry’s going The $28 billion Texas Municipal Retirement to do. up, we’re seeing hurdles going away – 8 System has a 5 percent target allocation If you’re a small fund and you’ve his- percent pref to zero, or sometimes the to private equity that currently stands at 1 torically generated really high rates of pref is dropped to 4 percent. We’re see- percent. Recent commitments made by the return that have exceeded what would ing a lot of governance stuff that’s mov- program include €45 million to CapVest be a hurdle in every period, you’ve never Equity Partners IV and $50 million to TPG ing their way, what the limited partner had a hurdle, and you’re coming back to Opportunities Partners IV, according to PEI advisory committee gets to actually do data. market with the same terms, your fund being eroded, fiduciary standards being size is not growing, that’s one where we

16 private funds management • Issue 166 • November 2018 FEATURES • TERMS AND CONDITIONS

ting the valuation and buying from the other one, but there still are conflicts of interest in the model. You essentially have liquidity going from one fund to the next. We’ve voted against it in a couple of instances and we’ve approved it in a couple of instances.

What’s the main area of con- Qcern? CS: Carry. In the prior fund the general partner could be realizing carry, so in those situations we’ve said, ‘You’ve got to roll that carry or escrow it or re- invest it’ or something, otherwise it’s kind of a free option. We have voted against it and that doesn’t make us a Restraint: LPs must be prepared to pull back GPs popular member of the LPAC to have to do that, but I think that’s our duty, to really challenge and question some would consider that. A lot of venture marketed as ‘business as usual,’ and in of these things. Hopefully they all work funds don’t have and have never had a some cases I can understand why it is out great because we’re still invested in hurdle, but they make 20 percent net the case, but there are still potential them, but I think there are some issues every year, so the hurdle doesn’t really conflicts and risks around it that I don’t that can occur. come into play. We would consider that. love. A large fund removing the hurdle The general thesis is: ‘We have in- Do you have the freedom to in- that has been there in the past, that is bound interest in the company from a Qvest in funds with non-tradi- raising a bigger fund that is going to be number of other entities, we don’t really tional terms? oversubscribed, to me the justification want to sell all of it yet; the company CS: We would consider them. There for removing that hurdle is not LP-fa- could use some additional capital’ – so would be an educational process in- vorable. It’s something that is signaling it’s quite common in a growth situation ternally and it would still have to go either what your expected returns are – ‘We have very strong visibility into through our formal recommendation going to be going forward or you just revenue for the next year or maybe even process which, as a government entity, want more economics if returns aren’t longer, and so as the biggest private eq- is very robust. If we think it’s the correct as good as you expect them to be. Both uity fund in this company to date and structure and the correct manager for are a concern. having been in it for five or five years those assets, we would certainly consid- You’re seeing some public pensions now, we know it really well.’ There may er a perpetual vehicle, and we have, be- just in principle refuse to commit to be a third party who is putting a bigger cause I think it actually removes some those types of funds. For us, that would chunk in, the prior fund is taking their issues. There’s no transaction fees com- be very, very low probability to get position out and then the subsequent ing or going, there’s no issue around there. fund is buying in at the new mark. That valuation or who’s getting liquidity or seems to be happening quite a bit. who’s not. It’s just good assets that you What is the biggest source of I understand the reasons why – you can hold a long time. Warren Buffett Qfrustration for you at the mo- have a lot of capital being put to work says ‘My favorite holding period is for- ment? and so private equity’s increasingly ever,’ and he’s done a pretty good job, so CS: Fund to fund sales. GPs are using buying from private equity, there is the maybe we should take cues from what current funds to buy a stake in a com- third-party fund setting the valuation he has done and see if we can replicate pany held by a prior fund. It is being so there’s not one fund technically set- something similar in PE. n

November 2018 • Issue 166 • private funds management.net 17 ROUNDTABLE

How to manage cyber-risk Protecting data and information is a key focus for private equity firms, but how do they stay ahead of the hackers? by DOMINIC DIONGSON photography by LEA RUBIN

18 private funds management • Issue 166 • November 2018 ROUNDTABLE

From left: Anurag Sharma, Mike Stiglianese, Noah Becker, Prom Vatanapradit, Eric Feldman, Brian Ferrara

rivate equity firms, like any other business, are often targets of thieves and criminals who seek Pto steal information through phishing, malware and other means. For Mike Stiglianese, a managing director at BDO who is also the consulting firm’s national lead on technology and cybersecurity for the financial services industry, protecting a firm’s management data system is critical. It’s a responsibility that should be shared top- down – from managers to lower-level employees, he adds. “I try very hard not to use the words ‘cyber security.’ In my mind this is all about cyber-risk management and putting it in perspective as a risk management discipline, especially when I'm dealing with private equity firms,” he says during a recent roundtable discussion with executives at private equity firms and service providers in New York. Cyber-risk management, Stiglianese says, is a discipline similar to financial risk or credit risk management in that resources are put in place to minimize the likelihood of an incident and to protect against it. Should a security breach occur, a firm should be able to detect it and implement the proper response, he adds. “Management and board directors understand how to manage risk. When Sponsored by: BDO, EisnerAmper and WithumSmith+Brown people use the word ‘cybersecurity’ they think technology, yet we don't know

November 2018 • Issue 166 • private funds management.net 19 ROUNDTABLE • CYBERSECURITY

We don’t coin it ‘incident response.’ We think of this as ‘incident preparedness,’ because it’s something that is constantly changing Eric Feldman

what they’re talking about. The reality is complement its general risk program, is that data going back and forth? And it’s managing risk in the same way that Feldman says. ultimately, how will you protect that you do anywhere else,” Stiglianese says. “We don’t coin it ‘incident response.’ data?” A collaborative effort by key members We think of this as ‘incident prepared- Sharing data should be a firm’s big of a firm is also vital. Eric Feldman, the ness’ because it’s something that is con- concern in terms of vetting the individu- chief information officer at mid-market stantly changing,” Feldman says. als who have access to that information, firm The Riverside Company, says their he says. cybersecurity team comprises staff from Staying frosty “If you don’t have folks who are prop- the technology department, the compli- Preparation is important so that each erly trained, who understand the risk, ance group and human resources who member in a response team can react understand what the requirements are meet on a quarterly basis. properly to an incident and protect the and how it could affect downstream, Feldman chairs the team and gets firm’s data. you’ll never really have a successful cy- feedback from colleagues. They then “What’s important is really under- ber-program,” Ferrara says. “It reinforces work with outside counsel, which meet standing your data. What data don’t training, tabletop exercises and that pre- with the firm twice a year and offer the you want? What data do you want to paredness versus the response. We may global regulatory perspective on recent protect?” asks Brian Ferrara, a senior have a great set of policy documentation rules – among them, the EU’s Gener- manager specializing in process, risk procedures. ‘OK, an incident happened. al Data Protection Regulation enacted and technology solutions at EisnerAmp- Which way do we go? Who’s doing in May. This affects Riverside as it has er. “You have massive amounts of data what?’” investments in Europe. From those dis- throughout your organization, so you And it’s not simply a case of hackers cussions with legal counsel, Riverside need to figure out what’s relevant, what’s who are targeting firms through ran- develops its own internal policies that important and where it is located. How somware or phishing, Feldman says. The

20 private funds management • Issue 166 • November 2018 ROUNDTABLE • CYBERSECURITY

inadvertent loss of data could come from an unencrypted laptop that was stolen or has gone missing or someone emailing a AROUND THE TABLE document with no password protection.

Beyond checking boxes Noah Becker is the chief financial officer for lower mid-mar- Firms should do more than just simply ket firm LLR Partners, which he joined in 2012. Based in Phil- go through a list of procedures and check adelphia, LLR invests in technology and services businesses the box when going through an incident and has raised more than $3 billion across five funds. response plan, says Anurag Sharma, a principal at WithumSmith+Brown’s cybersecurity practice. Eric Feldman is the chief information officer at The Riverside “If you’re sitting there in a crisis with- Company, which he joined in 2011. Founded in 1988, River- out a planned approach not knowing side has more than $8 billion in assets under management, who’s going to do what and trying to with an international portfolio of more than 80 companies. figure things out on the fly, that is the worst situation to be in,” he says. Prom Vatanapradit is a vice-president and head of technol- Firms also need to record every inci- ogy at CCMP Capital. Since it was founded in 1984, CCMP dent, whether it be big or small, because has invested more than $16 billion in buyout and growth eq- each case is something to learn from. uity transactions. Prior to joining CCMP in 2016, Vatanapradit “Your response plan is not a static plan; was a managing director and chief technology officer/head it is not a static document. It needs to of infrastructure at Och-Ziff Capital Management. evolve. As the threats evolve, the plan needs to evolve. And as you go through the feedback, besides seeing what went Brian Ferrara is a senior manager at EisnerAmper, specializ- wrong during your response, it’s also ing in process, risk and technology solutions. He has more important to focus on what went right,” than 15 years of experience in the Sarbanes-Oxley Act, in- Sharma says. ternal auditing, process re-engineering, risk management, At the same time, if an incident were compliance and IT controls. to happen, there might be conflicting objectives in the resolution, he says. Anurag Sharma is a principal of WithumSmith+Brown’s cy- “Do you want to recover as soon bersecurity practice and system and organization controls as possible, or do you want to retain practice based out of their Princeton, New Jersey office. He enough forensic evidence to support any has more than 19 years of experience on cybersecurity and subsequent breach notification process?” has written of many articles dealing with cybersecurity chal- Sharma says. “Either of those approach- lenges faced by small and medium businesses. es would take you in a different direction. You can’t have both objectives met together, and that is why it is very criti- Mike Stiglianese is the lead on national technology and cy- cal that with whatever incident response bersecurity for the financial services industry at BDO. Based team you have in place, you have rep- in New York City, he has more than 30 years of experience in resentation from the legal side and the IT financial and risk management, compliance and controls, technical side so that they can take that shared services and expense management. Stiglianese pre- decision to say whether this is allowed viously worked at Citigroup, where he managed an imple- and this is not allowed, and to deter- mentation program that included driving ‘check-list’ compli- mine the way to achieve it.” ance to a ‘risk-based’ compliance program. Not all firms will have the expertise to deal with security incidents. A firm’s

November 2018 • Issue 166 • private funds management.net 21 FEATURES • COMPLIANCE

Your response plan is not a static document… As the threats evolve, the plan needs to evolve. And as you go through the feedback, besides seeing what went wrong during your response, it’s also important to focus on what went right Anurag Sharma

general counsel, compliance officer or technology officer won’t be an expert in Internally, you’re cyber-risk, so hiring outside consultants assessing portfolio to do the work makes sense. It may also companies in terms of mean taking out cyber liability insur- what industries they are ance and having an advisory service to ensure that handling forensic evidence in and what types of is done properly, according to Feldman. information they have One method to acquire sensitive in- Noah Becker formation is phishing. Sharma says that the most common phishing campaign is someone impersonating a colleague to send an email asking for information. A At LLR Partners, a lower mid-market simple solution is flagging external email firm which has investments in technol- on the server. Continuing education on ogy businesses, it’s an area that is slowly phishing is important because new tac- evolving. Noah Becker, the firm’s chief tics are being used. financial officer, says that three to four Feldman says that, like other private years ago there would have been less equity firms, Riverside tests its employ- consideration about cyber-risk at the ees by phishing them, and it has been portfolio level. But with each year it’s extremely effective in raising awareness. becoming more of a focus for managers “It’s just sort of baked into the overall as the firm’s roster becomes bigger and education in keeping people on their more data-intensive. toes, being good corporate citizens.” “Internally, you're assessing portfolio Lessons learned at the management companies in terms of what industries level can also trickle down to portfolio they are in and what types of informa- companies. tion they have,” Becker says. “That leads

22 private funds management • Issue 166 • November 2018 ROUNDTABLE • CYBERSECURITY

to risk profiling and then really focusing Examples of these categories are security combined assets under management of on particularly the higher-risk portfo- organization, security strategy and doc- more than $4.2 trillion. lio companies if they’ve got personally umented policies and procedures. River- There was concern that portfolio identifiable information [PII], payment side follows up with the company twice companies might give some pushback card information and HIPAA [health a year to evaluate changes within their to management because they might data] and other types of data. You’re risk posture. feel an intrusion into their operations. also assessing what people are involved “We really train our companies be- But Stiglianese says communicating at the portfolio – how are they focusing cause most of them don’t have an in- with the portfolio companies on their on it and how are they addressing issues? cident response plan,” Feldman says. cyber-risk management profiles is im- I think that’s going to continue to get “Having incident preparedness as part portant to ensure that best practices are deeper and deeper each year.” of the conversation gets our companies in place. Feldman established the Riverside In- thinking about how best to manage this “There are very simple things that you formation Security Office a little more risk.” can do that can give you a good idea of than four years ago, in partnership with what the cybersecurity profile of your a number of service providers. Its aim is Peer pressure organization is, and I’ll give you five to help educate their portfolio compa- Staying involved with peers within the simple things,” he says. “One is if you nies, which currently number more than industry through trade organizations just do nothing more than ask them to 80, about risks facing mid-market com- helps. For Feldman, he’s part of the Pri- see their policies and procedures in the panies. Typically, within the first 100 vate Equity CTO (PECTO) network cyberspace. The next one will be if they days of acquiring a company, Feldman and AITEC, a community of more had done a vulnerability test and if they says, Riverside is conducting a pure risk- than 300 members who work for buy- have seen it. The rest is understanding based analysis based on 19 categories. side alternative investment firms with what they do for patching, what they do

When people use the word ‘cybersecurity’ they think technology, yet we don’t know what they’re talking about. The reality is it’s managing risk in the same way that you do anywhere else Mike Stiglianese

November 2018 • Issue 166 • private funds management.net 23 ROUNDTABLE • CYBERSECURITY

for access control and what they do from data on the cloud in name providers, automatically receiving that benefit and employee training. which you feel is more secure because the tools that you’re using. The cloud “None of those things are that intru- Microsoft has a far better security team makes it very easy to do so compared sive. Just have a conversation,” Stigli- than we could ever imagine,” Becker to trying to budget your own on-prem- anese continues. “While that won’t tell says. “But we do not put certain data ise facility in terms of your systems and you how good they are, if you don’t get on the cloud. For that we have a very then trying to budget cybersecurity and the right answer you know how bad they restricted access on-site storage, which protection into that. That makes it much are. If they have policies and procedures, adds another layer of protection and easier for a smaller shop to get the best of that’s a good thing. If they’ve got the control.” breed,” he says. vulnerability test, that’s a good thing. Signing up with reputable provid- If they don’t, it’s bad. Right away you’ll ers, which have spent billions of dollars Everyone’s in play know – at least whether they’re ignoring on hiring the best in technology, also Keeping up on regulation has had some or they’re doing something.” provides some benefits. Expertise and surprise advantages. When CCMP had Storing data is also a concern for knowledge from brand-name companies to be in compliance with GDPR to se- mid-market private equity firms who trickle down to private equity clients, cure the privacy of data of its clients and may not have the infrastructure available and that can help reduce costs for firms employees, the firm used a file crawler to store vast amounts of information on who might otherwise have to spend to system that found PII data in an archive servers at their offices. In that case, they set up similar services, according to of Excel files. may turn to cloud computing services Prom Vatanapradit, the head of technol- “Once everyone’s involved in regu- like those provided by Amazon or Mi- ogy at buyout firm CCMP Capital. lation, which involves the chief legal crosoft. “In cloud services, the security is officer, that gets the eye of our CEO. “We’ve got the vast majority of our baked in. So once you’re on it, you’re Everyone’s in play – going from a siloed

In cloud services, the security is baked in. So once you’re on it, you’re automatically receiving that benefit and the tools that you’re using Prom Vatanapradit

24 private funds management • Issue 166 • November 2018 ROUNDTABLE • CYBERSECURITY

You have massive amounts of data throughout your organization, so you need to figure out what’s relevant, what’s important and where it is located Brian Ferrara

technology person to actually having like email filter providers using AI to than necessarily being on the leading meaningful conversation with others,” make sure that the emails purporting edge of these new technologies. Let Vatanapradit says. to be your CEO – and the next versions them play out a little bit longer. Let In terms of what’s the next step in the of that type of threat – are blocked.” it get to a point where the large banks evolution of cyber-risk management, Ferrara adds: “Building the technol- start making the investments and start blockchain and artificial intelligence ogy is on its way – not for the small- seeing how they start implementing come to mind. But panelists say their er players in the market but for larger these technologies and start making it contribution is likely to be a way off players in our space who have the time, worth something that’s more practical and agree that the bigger private equity the dollars and the resources to invest for other firms to use. So right now firms will have the scale and resources and try to make it work. From a secu- again it’s something to watch, some- to take the lead. rity standpoint, all of the blockchain thing promising, but you know my “I feel like blockchain will eventually technology as I understand it is a very feeling is it’s premature.” be impactful, but it’ll probably impact secure method of transacting data, but Ultimately, everyone from the higher-transaction industries first, and making it operational will take a little C-suite down has to be involved to then when it becomes widely adopted, time to get there.” maintain best practices on cyber-risk will move to the private equity firms Stiglianese says: “My general feeling management. themselves where there’s less volume,” is, right now these technologies have a “Cyber-risk is not just the respon- Becker says. “And I think on the ar- promise for the future. For a lot of the sibility of the technology team or tificial intelligence side, it will be the private equity firms, there’s much more your outsourced service provider. It’s vendors that are adopting it and in- value they could get out of implement- a shared responsibility of the organi- corporating it into their products and ing and utilizing some of the proven zation. It’s got to come from the top services. I think AI will impact in ways tools that are out there right now rather down,” Feldman says. n

November 2018 • Issue 166 • private funds management.net 25 EXPERT COMMENTARY • FUND DOMICILES

Selecting the right jurisdiction in The Brexit opportunity readiness for Brexit is going to be critical, not just for start-up managers but for Luxembourg and the established managers in the UK who will need to ensure continued distribu- Channel Islands tion to EU investors. The alternatives sector should see growth in trusted domiciles There are two likely options: as fund managers seek continuity, argue Graham Perry-Dew, 1. If a fund is completely outside the Julian Carey and Stuart Winter of Vistra EU then marketing to investors using the national private placement rexit will undoubtedly bring plemented for the UK. The optimum regime of each target member state considerable opportunities over outcome for the alternatives industry continues to be an effective solu- the next few years, though not would be retention of UK membership tion. A manager can establish its Bwithout risk. of the European Economic Area, al- own standalone operation in an EU The opportunities are found in lowing retention of passporting rights, jurisdiction. This option may be ex- questions of domicile. The expectation though this seems unlikely. The next pensive and operationally difficult is that the alternatives sector will con- best thing would be a UK-specific ar- in terms of recruitment and reten- tinue growing significantly in Luxem- rangement that achieves the same out- tion of resource. bourg and other trusted domiciles such come. Otherwise the UK would need as the Channel Islands. In preparation, to access passporting rights as a “third 2. A manager may re-domicile its many service providers are increasing country”. whole operation in the EU. This their levels of investment in key domi- option may be expensive, opera- ciles to accommodate the up-turn in tionally difficult and unsettling for activity. Managers need existing investors. A manager may Access to EU markets for non-EU choose to engage a third-party EU managers is a core problem faced by a to take action to based administrator. Changes to significant proportion of clients; how- ensure they can delegation rules may impact on the ever, they can be supported through continue with their acceptability of these situations to the third party Alternative Investment marketing strategies local regulators. In such instances, Fund Manager offering. In addition, managers will need to look to the the market is seeing an increase in for prospective EU support of global providers to ease UK-focused investment products be- investors the impact of Brexit on their busi- ing established in the UK, in a direct nesses. response to Brexit. Overall, Brexit is encouraging fur- It would be reasonable to expect a View from Luxembourg ther development of sector expertise pragmatic solution that gives AIFMD Given the uncertainty created by Brex- in appropriate jurisdictions as func- passporting rights to the UK, but there it, some fund promoters began consid- tions and operations are expanded in may be a period of disruption before ering Luxembourg as a more favorable these locations. The foreseeable risks this. Many people are worried about fund domicile in 2016. As the Brexit lie around the Alternative Investment the overall impact of Brexit on invest- scenario has unfolded they have also Fund Managers Directive regime and ment market performance in particu- begun to look at AIFM/Management passporting. The overriding complica- lar and on the economy more broadly. Company arrangements to future-proof tion for the sector is the impact Brexit With continued uncertainty around and ensure continuity of distribution will have on the AIFMD regime. Brexit, managers need to take action arrangements post March 2019. There is a significant risk of a period to ensure they can continue with their To this end, certain promoters have of disruption and adjustment for clients marketing strategies for prospective already decided to establish AIFMs in as a new model is developed and im- EU investors. Luxembourg, or, driven by economies

26 private funds management • Issue 166 • November 2018 EXPERT COMMENTARY • FUND DOMICILES

of scale, are negotiating with third-party AIFMs to provide these services for existing and newly raised funds under a delegation model. Even post Brexit, the fund promoter will still be able to provide portfolio management from the UK or elsewhere. From a Luxembourg perspective, when considering a soft Brexit, to a certain extent some of the impact is immediate. Promoters raising new funds Parry-Dew: Luxembourg Winter: future looks Carey: private placement already have to be sure they will be will see immediate impact bright for Channel Islands is a cost-effective solution able to market their funds and operate effectively whatever the outcome. So business should continue along current Guernsey and Jersey as well-regulated mains important are either setting up lines, with Luxembourg continuing to jurisdictions can provide these rapid- their own offices in the EU or using ser- attract new funds and grow AUM. ly growing markets with substance in vice providers to set up EU-domiciled In the event of a hard Brexit then which to domicile funds, and an attrac- feeder vehicles or parallel investment we envisage similar growth in fund tive alternative to other domiciles. vehicles with local AIFMD-compliant numbers and AUM, but expect more The mainland EU jurisdictions manager oversight, in conjunction with AIFMs to be set up, and a small in- have traditionally looked to Luxem- their Guernsey-domiciled funds. flux of personnel into Luxembourg, or bourg and Dublin for their UCITS It remains difficult to speculate about third-party AIFMs appointed. and AIFMD compliant funds. Global the impact of either a ‘hard’ or ‘soft’ third-party administrators can make Brexit on Guernsey and Jersey. Neither View from the Channel Islands the best of both worlds by providing have ever been EU member states but Guernsey and Jersey have always been AIFMD compliant management and the Channel Islands have historically, outside the EU and their relationship compliance services out of Luxem- and continue, to attract EU fund man- is one of affiliation, via the UK, re- bourg for non-EU managers who want agers and funds raising capital from the lating only to some specific trade. Fi- to market into the EU outside of the EU. The private placement regime con- nancial services have been outside this private placement regime. Other ju- tinues to be a cost-effective and practi- relationship and hopes of being in the risdictions, such as Guernsey or Jer- cal solution for which Channel Island first round of “third country” jurisdic- sey, can be used for less expensive and administrators have developed a credi- tions able to passport into the EU via less restrictive non-EU funds focused ble track record for delivery. The future equivalence in regulation were dashed on raising money from the rest of the therefore looks relatively promising for when the negotiations were abruptly world. both Guernsey and Jersey post-Brexit. n terminated by the EU in response to Culturally and linguistically, Luxem- the Brexit vote. bourg will always appeal as a tax-neu- The Channel Islands, therefore, have tral domicile for German and French Graham Parry-Dew is the director, continued to rely, and indeed thrive, on investment vehicles, but the dominance global depositary, Luxembourg. Ju- the private placement regimes of mem- of the City of London is likely to con- lian Carey is the associate director, ber states to market funds into these tinue post-Brexit. The stated intention client services, Guernsey, and Stuart jurisdictions. Guernsey and Jersey’s of not including financial services as Winter is the director, business devel- biggest relationship is, of course, with part of the Brexit settlement, whatever opment, funds, Jersey. the UK which remains by far the most the outcome of negotiations, can only important jurisdiction for the islands. serve to strengthen the long-established The Channel Islands, rather like the bonds between London and the Chan- SPONSORED BY UK, are looking much further afield nel Islands. UK alternative managers VISTRA to the Far East and the United States. for whom access to EU markets re-

November 2018 • Issue 166 • private funds management.net 27 SPECIAL REPORT • CYBERSECURITY

double-entry bookkeeping by real-time journal entries. Among the companies with finance text analytic solutions, SAP provides blockchain-as-a-service for easy and low-risk experimenting with cloud-based distributed ledger technology.

How does it work? Blockchain allows companies to write their transactions directly into a joint register (instead of keeping separate records), which creates an interlocking system of verifiable and enduring accounting records. These cryptograph- ically sealed transactions cannot be falsified or destroyed, and in many ways are more secure than a notary. Executives no longer have to wait for quarterly, semi-annual and annual re- Blockchain: allows real-time reporting porting. Blockchain fundamentally provides a source of trust, secures the integrity of accounting records with completely Using AI to make traceable audit trails and creates fully automated audits. The accuracy and portfolio decisions immediacy of the distributed ledger Advances in blockchain and artificial intelligence will drive reduces the need for time-consuming multiple audits of companies with mul- efficiency and business decisions in private equity, writes Vishal tiple ledgers. Shukla, a senior director at compute acceleration start-up NVXL In such a system with complete transparency and real-time reporting, there are no incentives to delay hiring, hief financial officers and Executives will be relying on block- advertising and implementing projects other executives at private chain and AI, machine learning and to the end of the quarter. The timing equity firms will be able to deep learning financial software pro- can be based on what’s best for the Cquickly assess the financial health of a grams to gather and analyze extensive company, not the financial reporting business in real-time using blockchain data. schedule. and artificial intelligence, executed They will be using machine learn- As far as potential hurdles, new through machine learning and deep ing and deep learning to weigh thou- governance will have to be determined learning. sands of known factors – from seasonal around who gets access to the infor- The technology is still in its infancy, shifts to industry timings – based on mation, since maintaining transparency but the capacity to review predictive historical data. The result will be more is part of the strengths of blockchain. results of companies is being devel- accurate assessments of individual com- There will also be “switching costs” to oped, which will help private equity panies. move financial statements into block- executives to make better long-term Most accounting and auditing work chain distributed ledgers in the cloud. decisions on their work and on their is still manual and time-consuming; Lastly, financial practices will have to portfolio companies. blockchain will work to enhance the move all transactions that previously

28 private funds management • Issue 166 • November 2018 SPECIAL REPORT • CYBERSECURITY

existed outside the ledger, into the ing. For example, a company may entire portfolio and gauging results blockchain ledger. show a loss of $100,000 a month in its over five to 10 years. Using semantic first quarter, indicating overspending. analysis (identifying what decisions Beyond distributed ledgers However, this statistical analysis may made by machine learning and deep After distributed ledgers are fully es- be wrong. learning) and comparing results over tablished on the blockchain and in A truer picture comes through time, AI can predict events that can the cloud, investors and private equity machine learning and deep learning tech- help private equity in business deci- firms can run this data via deep learn- nology, made possible by the increase in sions. In a global scenario, for exam- ing, referencing historical data and granular data as devices such as laptops, ple, there are millions of variables that inputting thousands of other variables can impact business – these variables into the neural network. This means come from macroeconomic factors, that over time, the accuracy of pre- A company that global political conditions, global dicting the accounting direction of the trade environment and so on. These company becomes more realistic. is projected to start data points are readily available on the Investors will be able to have an end- operating at a 10 percent internet today, but it is impossible for a to-end view, and can look over the entire loss in two years based human to factor in all the massive data portfolio, by reviewing the growth and on AI analysis [could] and make a pattern out of it. AI can expenditures that have been analyzed help solve such data problems. by machine learning and deep learn- inform the private equity AI can examine portfolios with ing. This end-to-end view will suggest executive that it may a more holistic view, can review any what kind of company should receive be advisable to sell number of companies at once and investments based on its future growth in one year identify patterns that can advise pri- potential. vate equity officers on their most criti- Some behavioral biases can cause cal decisions. For example, a company investors to make mistakes. Using cell phones and tablets became house- that is projected to start operating at machine learning and deep learning hold items. As a result, factors such as a 10 percent loss in two years (based will potentially safeguard from these location, weather, demographic trends, on AI analysis) will inform the private human errors, or at least call attention psychographics and common industry equity executive that it may be advis- to a reality based on a whole new type patterns can be used for machine learn- able to sell in one year. AI will also be of software that continuously learns ing and deep learning outcomes. able to alert an executive to fill in their and improves every time new data is These machines are being trained fund portfolio with a particular type of inputted (without being explicitly pro- and can predict more accurate results. company that is missing. gramed). So a statistically true result can now be Blockchain-distributed ledgers are set The analysis of investor portfolios refined, and in fact may show some- to become the next version of account- and predicting five years in the future, thing completely different. For the ing systems. Similar to how the internet recognizing trends in the market – all above example, the company that was became an integral part of every financial become more feasible and accurate with operating at a loss in the first quar- business, blockchain will have the same blockchains and AI, machine learning ter will have an enormous increase in type of impact in terms of how transac- and deep learning. Managers will be profits in the second quarter, since their tions are recorded, reconciling informa- able to more easily observe portfo- clients make their major purchases in tion across businesses and enabling new lio risks and data drifts, giving them the second quarter. AI will eventually infrastructure for financial products and greater insights. be able to fill in the information gaps services. As these tools get smarter and quickly, going far beyond the scope of faster, private equity companies will gain Predicting investments human capability. deeper and real-time insights in their Using blockchain real-time journal current evaluations of their portfolio, entries, private equity managers can Managing portfolios while enabling more accurate predic- statistically see the burn rate of a spe- The complexity of predicting invest- tive decision making for their long-term cific company and analyze its mean- ments increases when looking over an value estimates. n

November 2018 • Issue 166 • private funds management.net 29 FEATURES • COMPLIANCE

partners with the first quarter 2015 A wake-up call on GP-leds financial information, which, accord- The SEC will act on fund restructurings if it believes investors ing to VSS’s calculations, still showed an increase in Fund III’s NAV.” The haven’t been given full information. By Nathan Williams SEC says that the offer letter made it appear that the limited partners would receive the full value for their he Securities and Exchange and VSS used this as the basis for the interests. Commission has taken action offer to LPs. against a firm over a GP-led However, at the beginning of May Trestructuring, in what’s believed to be 2015, before the deal went through, With GP-led the first case of its kind. VSS failed to inform limited partners Veronis Suhler Stevenson agreed to that the firm had received informa- transactions, every deal pay $200,000 for allegedly mislead- tion indicating the NAV of the fund is a snowflake ing limited partners about the value had “increased significantly” on the Jennifer Choi of fund stakes it had offered to buy in amount previously stated, to the tune an effort to dissolve a $1 billion fund. of approximately $1.74 million, the The sanction relates to stakes in the SEC says. “VSS is pleased to have reached a New York firm’s Fund III, which was The regulator says the “omission of resolution with the US Securities and raised in 1999 and VSS was looking this information regarding the poten- Exchange Commission and to put to dissolve in late 2014. VSS offered tial increase in the value of Fund III’s this inquiry behind us,” the firm says LPs a cash distribution-in-kind pay- portfolio companies resulted in cer- in a statement provided to pfm. “VSS out at a price based on 100 percent of tain statements in VSS’s May letter is committed to upholding the high- the fund’s December 2014 net asset being misleading. In addition, after est standards in all that we do and we value. The SEC says the NAV of the the offer was made, VSS did not pro- remain dedicated to continually en- fund at the time was $33.9 million, vide the remaining Fund III limited hancing our practices.” A person with knowledge of the situation tells pfm the later valuation Failure to disclose at the center of the SEC action was The SEC alleges that VSS misled LPs to the tune of $1.74m incomplete, preliminary and turned out to be incorrect. The person says a third-party appraisal of the fund's value had previously been approved by the LPs.

Conflicts of interest VSS “lowballed its purchase offer to $35.6m LPs,” regulatory compliance advisor Q1 2015 NAV, Cipperman Compliance Services said according to the SEC in a note on the SEC action. The com- $33.9m pliance consultant said that it “general- ly advises against principal transactions 2014 NAV $0.2m with clients/investors/LPs. Purchasing private interests directly from a client is Settlement so rife with conflicts that no amount of paid by VSS disclosure may be sufficient.”

Source: SEC “What is interesting about the subject proceeding is that the new finan-

30 private funds management • Issue 166 • November 2018 FEATURES • COMPLIANCE

formation was incorrect. Would the Better late than never investors who did not sell, and would the SEC, then claim that it was not The VSS case is a welcome intervention from the regulator, proper to have released the informa- writes Secondaries Investor editor Adam Le tion? These questions demonstrate the significant risks associated with a Legal practitioners have long on the amount of NAV that trades principal buying investors’ interests.” warned the US regulator was likely – was involved in the process on to act on GP-led restructurings – Fund III (the SEC letter does not Clear as day and at last it has. This appears to mention one). Limited partners have been pushing be the first time the watchdog has At the heart of the matter is for greater transparency from general censured a firm over an apparent the principle of “full and frank” partners, including secondaries deals conflict of interest related to a disclosure. But rather than dismiss such as that involving VSS. general partner-led deal. GPs VSS as simply a case of alleged Wall The Institutional Limited Partners have a fiduciary duty to act in Street skulduggery, the industry Association, which has around 450 the best interest of their limited should take this as welcome member institutions globally repre- partners, including providing guidance from an enforcement senting at least $2 trillion in private them with information relevant to body that has been unnervingly equity assets under management, has their interests, as outlined in most silent over best practice in GP- been raising issues with the SEC for limited partnership agreements. led deals. With no standardized changes in rules that call for more dis- In the VSS case, the conflict is approach as to how to treat conflicts closures from private equity firms. particularly acute because the of interest in such transactions, In a proactive step, the trade body buyer of the fund stakes was some parts of the industry have says it will issue an update to its pri- managing partner and owner of been left to their own devices. vate equity principles that includes the GP itself and a member of Secondaries has come a long guidance on GP-led restructurings as the fund’s investment committee. way in a short time, but remains a early as this year. It has been discuss- Such roles give access to portfolio relatively small corner of private ing the issues surrounding these deals valuation “inside information,” as markets. Better that kinks are ironed at its events, Jennifer Choi, ILPA’s one legal expert familiar with the out now and lessons learned early managing director of industry affairs, matter put it, that a third-party than when annual deal volume tells sister publication Secondaries In- purchaser would not have. is measured in the hundreds of vestor. One unanswered question billions and GP-led restructurings “Our sense is that [GP-led restruc- is whether an advisor – whose become a regular exercise for the turings are] becoming more com- compensation is typically based brand-name global GPs. monplace because LPs are seeking to restructure portfolios, they’re seeking liquidity solutions, GPs want to offer optionality and secondaries dry pow- cial information which the SEC felt der is tremendous,” Choi says. should have been disclosed appeared Purchasing private “Guidance now feels like something to be preliminary,” says Ralph Sicilia- interests directly we need to do in the context of the no, a partner at law firm Tannenbaum from a client is so rife third iteration of the principles, but Helpern Syracuse & Hirschtritt. also on a standalone basis with some "One might wonder what would with conflicts that no education wrapped around it for the have happened if the preliminary amount of disclosure industry.” information was disclosed, and some may be sufficient ILPA will engage with GPs about investors decided not to sell their restructurings, she adds. interests based upon it, and it later Cipperman Compliance “With GP-led transactions, every turned out that the preliminary in- Services deal is a snowflake.” n

November 2018 • Issue 166 • private funds management.net 31 FEATURES • TERMS AND CONDITIONS

lion. The impact of the increase in size is The holy trinity of terms that the GP can enjoy a larger quantum Long-time limited partner turned consultant Ray Maxwell carried interest even if the multiple generated is lower. Scenario C below shows reflects on the three key economic terms at the heart of the a £500 million fund that generates a 1.5x relationship between manager and investor multiple and the GP contributes 1 percent of the capital. In this instance, the GP will enjoy a profit of £45 million and ithin private equity there overall, the investors enjoy a 1.8x multiple a 10x multiple. is a holy trinity of terms and the GP a 20x multiple. Carried interest is the share of gains – carried interest at 20 Of course, as in Scenario B, if the GP given up by investors to GPs as an in- percent,W management fees at 1.5 percent commitment rises to 3 percent, the inves- centive to produce superior returns and to 2 percent and a preferred return of tors enjoy a marginally higher multiple it should not be available for indifferent 8 percent. These terms have become a and the GP’s multiple declines but still performance. Standardizing carried in- standard and are applied to virtually all remains substantial. terest made sense when funds were ap- private equity funds no matter their size proximately the same size, but now the or purpose, and this creates anomalies. range is immense and at the top end, relatively modest performance still allows Carried interest GPs to participate in substantial carried The accepted view is that carried inter- interest pools. est should be 20 percent of capital gains, An alternative model, which has some but there is little explanation as to why considerable merit, would be to drop the this should be so. The earliest reference notion of a fixed rate of 20 percent and is in the Bible referring to Joseph’s plan create a progressive carried interest step to encourage grain production in ancient function that delivers higher rates of car- Egypt: “Here is seed for you, sow the ried interest as additional proceeds are land. And it will be at the in-gatherings delivered. Scenarios D and E illustrate that you will give a fifth to Pharaoh and the concept based on a £500 million the four parts shall be yours.” (Genesis fund with increments set at £100 million. 47:23-24). In the 12th century, ship cap- D shows that if the fund produces £500 tains received a fifth of the profits on the million of gains, the GP would receive cargo they “carried,” and closer to today, £75 million of carried interest, which is it was the rate adopted by the oil and gas Maxwell: look again at the sacred cows equivalent to a rate of 15 percent. E shows industry as appropriate compensation for that if the GP was able to deliver £1 bil- “sweat and labor.” Private equity had no lion of gains, the quantum of carried hesitation in adopting the term. Inves- The question is the balance between interest would have increased to £212.5 tors, who may not have read all the small risk and reward and there is an immediate million – equivalent to a carried interest print, didn't protest, since the general contradiction in that the investors require of 21.25 percent. partners of funds only have to contribute greater risk to achieve their targeted rates This model aligns the interests of both a small percentage of committed capital of return while it is not in the best interest GPs and investors with the incentive to to be enabled to participate in the carried of the GP to assume too much risk and deliver high cash-on-cash returns. To interest. In essence, the investors assume thereby jeopardize carried interest. make sure there is not a tilt in favor of the risk and the GP enjoys the return as A further wrinkle is the impact of fund the GP, the maximum marginal carried demonstrated. sizes. Over the past 25 years fund sizes interest rate should be 50 percent, and if Scenario A assumes a fund size of £100 have grown substantially and a typical the GP has reached that point then the million ($132 million; €112 million) and mid-market buyout fund, which histor- investors should be in a state of delirium. the GP contributes 1 percent of the cap- ically would have been in the order of There is an argument that this model ital. If the fund generates a 2x multiple £250 million in size, is now over £1 bil- ignores the impact of time and that GPs

32 private funds management • Issue 166 • November 2018 FEATURES • TERMS AND CONDITIONS

Enjoying the return will hold on to investments for as long as possible to maximize the cash-on-cash Scenarios A shows a GP commitment of 1% to a £100m fund which earns a multiple of 2x multiples. This is unlikely because the opportunity to sell investments is infre- quent and moreover, general partners are constantly in the market to raise new Committed funds and they will need to demonstrate performance to their investor base. Proceeds

Gain Management fees In its infancy, private equity adopted the Multiple fee structure found in oil and gas funds, and the general rate was set at 2 percent 0 20 40 60 80 100 120 140 160 180 200 of funds raised. Most funds were in the (£m) range of $50 million to $200 million Investors GPs and therefore the fees generated were just sufficient to hire decent staff and make, manage and exit investments. Scenarios B shows a GP commitment of 3% to a £100m fund which earns a multiple of 2x Over the past 25 years there has been a transformation in the private equity industry. Fund sizes have grown, new Committed funds are being raised every three to four years and there has been the emergence Proceeds of the multi-asset manager encompass- ing the whole gamut of alternatives from Gain private equity through to private debt, infrastructure and real estate, with each Multiple segment generating substantial fees. The

0 20 40 60 80 100 120 140 160 180 200 result is that management fees have be- (£m) come a significant component of private equity managers’ earning, diminishing Investors GPs the exclusive focus on maximizing carried interest. Scenario C shows a £500m fund with a GP commitment of 1% and Most private equity funds have a life of a multiple of 1.5x 10 years with a further two or three years added to allow for an orderly disposal of Committed residual assets. The management fee is usually charged on committed capital Proceeds less the cost of investments realized or written off. This creates a long tail of fees Gain and every three to four years a new fund is raised (usually the same size or larger Multiple than the previous fund) resulting in the 0 100 200 300 400 500 600 700 stacking of fees. It is unlikely that the increase in marginal revenue is matched (£m) by an increase in marginal costs, as a new Investors GPs fund does not require the recruitment of Source: Ray Maxwell an additional team.

November 2018 • Issue 166 • private funds management.net 33 FEATURES • TERMS AND CONDITIONS

To add insult to injury, the manage- Step by step ment fee is charged on capital committed Scenario D shows a progressive carried interest step function if the fund and not invested capital. As an illustra- produces £500m of gains tion, a £100 million fund with a management fee of 2 percent draws down 10 80 20 percent of its capital in year one, which means that it will invest £10 million and 70 charge a management fee of £2 million – equivalent to an actual rate of 20 percent. 60 15

This creates “fee drag,” meaning that the 50 management fees in the early years of a fund’s life have a highly corrosive effect 40 10

on investors’ net returns. Carry (%) But management fees are hardly the 30 only source of fees for private equity carryCumulative (£m) 20 5 groups. There are other corporate -fi nance fees, such as transactions fees, that 10 can be levied, albeit they are now shared with the investor as an offset against the 0 0 management fee and to pay for any abort 500 600 700 800 900 1000 costs. However, the question is whether Gain (£m) the private equity group should enjoy Cumulative carry (£m) Carry (%) Source: Ray Maxwell any of these fees at all because, without the investors’ capital, they would not be in a position to make any investments. to provide investors with some relative- relatively early liquidity and the rate cho- The problem is that fees are charged ly early liquidity and create a modest sen was the “risk-free” rate pertaining at per fund without any recognition of the benchmark against which private equity the time. The rate was deemed to be the overall size of the group and its fee gen- performance could be measured. yield on a gilt with similar maturity to erating capabilities. While it was accept- Unlike conventional equities, private the weighted average life of a private eq- able in the past – when private equity equity is illiquid and that creates signifi- uity partnership, which was estimated to AUM were low – to charge per fund, it cant issues when measuring private equi- be around six to seven years, and in the is less acceptable now as AUMs are now ty performance on a time-weighted rate late 1980s, that rate was around 8 per- running into the billions. Private equity of return basis. It takes time for alloca- cent. This figure has become a standard groups need to become more transparent tions to be converted into commitments feature even though the yield on a 10- about their revenues and profitability as to private equity funds and usually up- year gilt today is only 1.42 percent and businesses and fees should be more reward of three to four years before those equity returns today would struggle to flective of marginal costs. commitments are fully invested. More- exceed 8 percent. Private equity cannot have it both over, investments may take six to seven A consequence of the introduction of ways – either significant carried interest years before they are realized, and in the the preferred return was that it made or high fees – but not both. As in most intervening time those investments are general partners aware that time is an corporate finance situations it is accept- valued on a prudent basis. The result is exacting mistress and that any delay in able to pay a modest retainer and a huge that private equity appears to be under- achieving exits would make it more diffi- success fee. performing relative to quoted bench- cult to reach the promised land – break- marks due to a combination of duration ing into the carried interest. Of course, Preferred return and a money rate of return being applied having returned capital and the preferred The third part of the trinity is the pre- to unspent allocations. return to investors, the quid pro quo has ferred return, which first saw the light The introduction of a preferred return been that general partners have been of day in the late 1980s as a mechanism was aimed to provide investors with some granted a “catch-up” and can claim fur-

34 private funds management • Issue 166 • November 2018 FEATURES • TERMS AND CONDITIONS

Smooth progression priority claim to distributions, but the trade-off is the unknown amount of time Scenario E shows a progressive carried interest step function if the fund produces £1bn of gains it takes the general partner to catch up – it could be six months or six years, and as 220 35 mentioned, during this period investors 200 30 are literally “out of the money.” 180 An argument has been put forward

160 25 that there should not be a catch-up at all, since the preferred return compensates 140 20 investors for the loss in the time value of 120 their commitment over a fund’s life. Cer- 100 tainly this would be sensible if the pre- 15 Carry (%) 80 ferred return was set at the current low

Cumulative carryCumulative (£m) long-term risk-free rate. 60 10 The carried interest structure pro- 40 5 posed in part one ignores the internal 20 rate of return as the principle measure of

0 0 performance, but focuses on the money multiples primarily because private equi-

500 600 700 800 900 1000 1100 1200 1300 1400 1500 ty is an absolute return class where its ob- Gain (£m) jective is to maximize the multiple. And Cumulative carry (£m) Carry (%) Source: Ray Maxwell therein lies a paradox in that the point of maximum IRR is reached well before the point where the money multiple can be ther proceeds until 25 percent of the pre- for younger members of the team, with maximized due to the laws of diminish- ferred return is recovered equivalent to a the immediate expense of growing fam- ing marginal returns. The objective is to carried interest of 20 percent. This means ilies, the thought of enjoying carried in- take time out of the equation since gen- that investors are in an “out of the mon- terest in the distant future is not a great eral partners have limited control over ey” position for an indeterminate period incentive. the timing of an exit, particularly if the of time until the catch-up is achieved. What happens if the hurdle rate can- market moves against them. There are, however, a number of other not be achieved? In essence, the general When private equity was in its infancy issues with the preferred return. partners are running the investments for 30 years ago, more attention was paid to The rate that has been adopted as fee and not capital gain. It could be ar- the structure of funds and there was an standard bears no relationship to current gued that they have to do their best to be appreciation that terms and conditions risk-free rates, or indeed, equity rates. in a position to raise another fund, but should vary depending on fund size. To- Should general partners be subject to since so many investors rely on track re- day the range of fund sizes is enormous such time pressure? General partners cord, the general partners may feel that but terms and conditions have become cannot predict with any certainty when there is little merit in trying to “bust a standardized, which favors the behe- exits will be achieved, and indeed, hold- gut.” moths since they do not have to perform ing periods have increased from four A preferred return works well for “one well to enjoy substantial carried interest years in the 1990s to over six years now. stop” investment, but makes little sense as well as enormous fee income. It leads to sub-optimal investment for venture capital where there are several The holy trinity has to be revisited to decisions at the beginning of the life of rounds of funding which may be drawn determine the terms and conditions that a fund because the objective (stated or down in tranches depending on hitting are appropriate for a maturing industry not) is to eliminate the preferred return milestones. rather than religiously sticking to the accrual as quickly as possible because of The question has to be whether the terms that were relevant when private eq- the burden of compounding. preferred return has served any useful uity first saw the light of day in the late It back-end loads carried interest and purpose. Certainly it gives investors a 20th century. n

November 2018 • Issue 166 • private funds management.net 35 FEATURES • TAX

Coining it: the Swedish exchequer stands to benefit from a Supreme Administrative Court ruling

The chill around Sweden’s tax decision Funds are considering their future in the country after the nation's top court ruled carry should be taxed as income, not capital. By Nathan Williams

n the decade-long battle between That person says it is “a fact” that the court system. This loss of faith will Nordic private equity firms and funds based onshore are now consider- affect future decisions about whether to Sweden's tax authority over how ing whether to go offshore. While there go on or offshore.” Icarried interest should be treated, the is no direct link between Sweden’s de- The tax move is roughly in line with tax authority finally came out on top. In cision to change how carry is taxed and the country’s overall push to reduce June, Sweden’s top court – the Supreme a decision on where to domicile, the economic disparities. The government’s Administrative Court – passed its final person adds there is an indirect link redistribution reform policies give in- judgment. “insofar that the general feeling among vesting in programs such as employ- The judgment against firms such as practitioners and tax advisors is that the ment and education precedence over Altor, EQT and Nordic Capital in de- tax authority has not pursued things in tax cuts. termining a significant portion of car- a balanced manner.” Individuals who take on carry, in- ried interest paid to general partners stead of paying 25 percent, will now be should be taxed as income, not capital. Loss of faith subject to a tax rate closer to 60 percent, While this was the most highly pub- The aggressiveness of the tax authorities plus social security contributions. Tax- licized case of Sweden’s tax authority and the administrative court’s views on es collected from income, profits and acting against private equity, it was not the laws “has made its mark,” the per- capital gains contributed 36 percent of the only one. The result, according to son says. the SKr1.93 trillion ($212 billion; €182 a person with knowledge of the situa- “People have completely lost confidence billion) in total tax revenue collected in tion, is “a complete loss of confidence” in the tax authorities, and more impor- 2016, according to data compiled by in Sweden’s tax and court system. tantly, have lost faith in the courts and OECD.

36 private funds management • Issue 166 • November 2018 FEATURES • TAX

“It is correct that the Swedish Su- Gaining on the capital preme Administrative Court has ruled Capital gains make up 4% of Swedish tax receipts in favor of the tax agency in a number of cases on carried interest,” a spokes- man for the Finance Ministry told pfm. 4 96 “However, the main issues have not been where these funds have been lo- Revenue 0 10 20 30 40 50 60 70 80 90 100 cated, but rather how the carried inter- % est has been declared.” Capital gains Other

He pointed to other rules, such as Source: OECD the recently revised controlled foreign corporation rules, as a signal of the government’s combative stance, saying that a fund offshore, where the GP isn’t, is anything above that is taxed as capital “step by step this government is mak- provocative. But, well…” gains at 30 percent, he says. ing sure it’s more difficult to run away This is the same rate, Stefansson from your tax obligations.” On shore, on side? adds, as the local law firm, grocery shop But rather than chasing Swedish One fund that decided to base itself on- owner or small business. firms away, one leading tax lawyer shore from inception was Adelis Equi- Others, however, question whether says the more aggressive posture taken ty, the mid-market investor co-founded there is any goodwill resulting from a by the tax authorities has influenced by Gustav Bard, the former chief exec- Sweden base, with one observer point- funds’ decision to base onshore. “If utive of 3i Nordic. ing to Valedo Partners, which was you’re onshore you don’t have the echo “When we set up in 2012, there was founded by former employees of EQT. system of people in a tax haven advising a lot of uncertainty about where the tax “There might be this idea that ‘Let’s real humans at the general partner. If interpretation by the authorities would go onshore and alleviate some of that you bring everything onshore it means end up for Jersey and Guernsey struc- pressure and get more favorable treat- there is no ‘advisor to the fund’ situa- tures,” says Adalbjörn Stefansson, head ment,'” says one advisor. “It doesn’t tion and it does make you less vulner- of investor relations at Adelis. work. Look at Valedo. They have al- able to tax authorities. It’s less provoc- “As we were starting fresh with no ways been onshore and the tax author- ative. I don’t want to say structuring legacy structures, we decided to give ity went after them to get them to pay [Sweden] a try. Obviously as a mid-mar- corporate income taxes on management ket investor in Swedish companies, we fees.” He adds it was unprecedented for Sweden: the deal also saw there might be some market the authorities to try to tax a fund enti- Dividends for private equity are taxed goodwill for having a Swedish struc- ty in this way. at the same rates as local grocery ture.” The decision by the authorities to stores or other small businesses Stefansson believes Adelis was the sue Valedo may have had a ripple ef- first firm explicitly targeting non-Swed- fect. At the time of the announce- ish investors to be onshore. He says “it ment, Nordic Capital was considering took some time for the tax people to whether to base its ninth fund in Swe- get around it” but after Altor decided den or Jersey. to base its fourth fund – a €2 billion “They were putting serious resourc- <€500,000 >€500,000 vehicle – there in 2014, it “solved the es into the case for going onshore [to issue.” The model was proven. Sweden],” says one Scandinavian GP. Dividend taxDividend rate Regarding the taxation of carry, “They’d spent hundreds of thousands. Stefansson says the rules are complex Midway through mapping out how it 0 and there are some exceptions. The might work if they went onshore, the first €500,000 or so in dividends in Valedo verdict came in. And this was 50-55% 30% any given year is taxed as income, at a one of the reasons they decided against Source: Swedish tax authority marginal tax rate of 50-55 percent, and it.” n

November 2018 • Issue 166 • private funds management.net 37 IN CASE YOU MISSED IT • NEWS

‘NO-DEAL’ PREPARATION notifications. The only way of market- EMPLOYEES ARE A TOP REQUIRED: PROSKAUER ing in this jurisdiction would be via CONCERN FOR CFOS the AIFMD marketing passport, which would not be available. Private equity firms that are domiciled in the UK and seek to do business in Eu- rope would need to set up jurisdictions before March 29, when the UK plans to secede from the EU.

JERSEY FAST TRACKS FUND APPROVAL Fault line: managers should prepare for Revolving door: CFOs in Europe are worried no-deal Brexit Recent changes to the Jersey private about retaining talent funds regime could usher in instant on- Funds should be acting now and making line approval of funds on the island. The Hiring and retaining employees is at the contingency plans to cover all potential regime for authorizing funds has been top of concerns for chief financial officers Brexit outcomes, including a worst-case adapted to make it possible to submit ap- in the US, according to a survey by Duke no-deal Brexit scenario, says law firm plications online and the Jersey Financial University. Of the CFOs from 241 pub- Proskauer Rose. Services Commission has launched an lic and private companies surveyed in The firm said in a recent note that the online application tool for funds to fast- the latest Duke CFO Global Outlook, 53 proposed transitional arrangement be- track their products. The JFSC antici- percent expressed “difficulty attracting/ tween the EU and UK, which would see pates all applications and notifications retaining qualified employees” as a con- EU laws – including the Alternative In- will be paper-free by early 2019. cern in the three months to mid-Septem- vestment Fund Managers Directive re- The Jersey Funds Association says the ber. That response was the highest since gime – stay in place until the end of 2020 changes and new technology will signifi- the second quarter of 2008, when the cannot be relied upon: “There is no cer- cantly speed up the authorization process survey first released results on that topic. tainty at this time that the transitional and have the potential to “revolutionize” Compared with other regions, CFOs arrangement will come into effect.” the sector. in Europe also put hiring and retaining As a result, Proskauer says fund man- Jersey recently moved to allay fears employees at the top of their concerns, agers utilizing the cross-border passport that funds based in the UK crown de- with 36 percent responding. That num- should put contingency plans in place pendency wouldn’t be able to do business ber was lower in Asia, at 34 percent; in now and should also consider their lon- with the rest of Europe following state- Latin America, at 16 percent; and in Af- ger-term plans “on the basis that the pass- ments by ministers that a ‘no-deal’ Brexit rica, at 13 percent. Respondents in the port would not be available after 2020.” was the likely outcome of UK-EU sepa- survey said that they have used higher With the UK expected to become a ration talks. salaries and bonuses as incentives to at- third country (a non-European Econom- tract and retain employees. ic Area country), the firm says that alter- The survey is comparable to views held native fund managers would not have by CFOs at private equity firms, who say access to the various passport regimes that retaining talent remains a challenge. for private funds and could only market At an Invest Europe forum in Lisbon in their funds in the EU under national pri- June, CFOs said good pay and engage- vate placement regimes. ment were among the ways they retained However, Proskauer warns that it is members of their finance team. A recent “not always feasible to obtain NPPR ap- EY survey showed that while 18 percent proval for marketing in certain mem- said it was difficult to retain talent, but ber states” and cited Italy, where do- Point and click: Jersey has streamlined fund a higher proportion, at 35 percent, said mestic law does not allow for NPPR approvals it was more difficult to attract talent.n

38 private funds management • Issue 166 • November 2018 IN CASE YOU MISSED IT • PEOPLE MOVES

GENERAL PARTNERS borrowers and lenders on leveraged fi- Clayton, but he will continue in his nance deals, event-driven corporate fi- role until a replacement is found. Antoine Rouland joined Agilitas nancings, infrastructure/secured debt Hetner was important in the agen- Private Equity in September as in- platform financings, and emerging cy’s effort to better co-ordinate cy- vestment director. Prior to Agilitas, markets project financings. Dunn has bersecurity policies by working with Rouland worked for Ciclad, a French also advised the Loan Market Associ- other federal financial regulators and private equity fund, as an investment ation. helping the agency manage cyber-re- professional for seven years. Before lated market risks. He also focused on working at Ciclad, Rouland was a Dan Shribman has joined B Riley working across the SEC’s divisions project manager for global manage- Financial, a diversified financial ser- and offices to strengthen cyber in- ment consulting firm Booz. Prior to vices company, as president of the cident response planning and threat joining the private sector, he spent investments division. In this newly intelligence capabilities. He also four years in the French army. established role based in New York, worked as a senior advisor for cyber- Shribman will help manage and security policy to former chair Mary Anne-Claire de Pompignan oversee B Riley Principal Jo White and former acting chairman also joined Agilitas, in Investments’ portfolio Michael Piwowar. August, as the new of companies. The Hetner previously served as the cy- head of investor re- firm’s Principal In- bersecurity leader for the technolo- lations. De Pom- vestments subsid- gy control program in the Office of pignan previously iary invests in or Compliance Inspections and Exam- worked at Lyceum acquires underval- inations. Capital where she ued businesses and focused on investor assets, and typically Pamela Dyson stepped down as the relations and capital acts on investment SEC’s chief information officer after markets. ideas that are sourced eight years to join the Federal Re- Before her time at Lyce- and originated from with- serve Bank of New York as executive um Capital she was an invest- in the B Riley platform. vice president, head of the technology ment director at European Capital, Shribman joins from An- group and CIO. where her focus was on investing pri- chorage Capital Group, During her time with vate debt in pan-European mid-mar- where he worked in the SEC, she helped ket buyouts. De Pompignan is taking close collaboration deliver the agency’s over for Charles Lemon, who left last with management 2018-20 IT Strate- year. teams and corpo- gic Plan and created rate boards to max- the IT Strategy and SERVICE PROVIDERS imize shareholder Innovation program value in the form to lead the SEC’s Matt Dunn was hired by Arthur Cox, of both operational digital transforma- an Irish law firm based in Dublin, as turnarounds, capital tion efforts. Dyson be- a partner and head of the project and markets financings and gan her SEC career as as- infrastructure group. He will focus on communication and capital sistant director for enterprise working closely with the firm’s infra- deployment initiatives. operations, where she managed day- structure, construction and utilities to-day operations including IT infra- group on financings in the infrastruc- REGULATORS structure and all enterprise operations ture and utilities sectors, including for the SEC’s headquarters and its 11 PFI and PPP financings. Christopher Hetner will step down regional offices. Charles Riddle, the Dunn was previously a partner in from his position as senior advisor for SEC’s chief technology officer, took Clifford Chance’s finance depart- cybersecurity policy to Securities and over for Dyson as acting chief infor- ment. He has experience in advising Exchange Commission chairman Jay mation offer.n

November 2018 • Issue 166 • private funds management.net 39 INDEX

Firms in this issue Jersey Financial Services Commission 38 Chavez, Martin 4 Jersey Funds Association 38 Choi, Jennifer 6, 31 3i Nordic 37 Level 20 13 Clayton, Jay 39 ACG PERT 15 LLR Partners 21, 22 Dunn, Matt 39 Adelis Equity 37 Loan Market Association 39 Dyson, Pamela 39 Advanced Technology Ventures 14, 15 Lyceum Capital 39 Evans, April 13, 14, 15 Agilitas Private Equity 39 Monitor Clipper Partners 13, 14, 15 Feldman, Eric 9, 20, 21, 22, 23, 25 AITEC 23 Nordic Capital 36, 37 Ferrara, Brian 19, 21, 25 Altor 36, 37 NVXL 28 Hetner, Christopher 39 Anchorage Capital Group 39 Office of Compliance Inspections and Lee, Kewsong 10 Examinations 39 Arthur Cox 39 Lemon, Charles 39 PricewaterhouseCoopers 15 B Riley Financial 39 Maxwell, Ray 32 Private Equity CFO Association 15 BBK 15 Perry-Dew, Graham 26, 27 Private Equity CTO 23 BDO 19, 21 Piwowar, Michael 39 Proskauer Rose 38 BlackRock 10 de Pompignan, Anne-Claire 39 SAP 28 Blackstone Group 10 Riddle, Charles 39 Securities and Exchange Commission Booz 39 4, 16, 30, 39 Rouland, Antoine 39 British Private Equity and Venture Capital Setter Capital 4 Rubenstein, David 10 Association 13 Simmons University 15 Schelling, Christopher 16, 17 Brookfield Asset Management 10 Squillace & Evans 15 Schribman, Dan 39 Cambridge Associates 8, 10 Tannenbaum Helpern Syracuse & Sharma, Anurag 19, 21, 22 CapVest Equity Partners 16 Hirschtritt 31 Shukla, Vishal 28 CCMP Capital 21, 24 Texas Municipal Retirement System 16 Siciliano, Ralph 31 Ciclad 39 The Carlyle Group 10, 13 Stefansson, Adalbjörn 37 Cipperman Compliance Services 30, 31 The Riverside Company 20, 21, 22, 23 Stiglianese, Mike 19, 20, 21, 23, 24, 25 Clifford Chance 39 TPG Opportunities Partners 16 Vatanapradit, Prom 19, 21, 24 Debevoise & Plimpton 4 Valedo Partners 37 White, Mary Jo 39 Duke University 38 Veronis Suhler Stevenson 30, 31 Winter, Stuart 26, 27 EisnerAmper 19, 20, 21 Vistra 26, 27 Youngkin, Glenn 10 EQT 36, 37 WithumSmith+Brown 19, 21 European Capital 39 Women’s Association of Venture and EY 38 Equity 13 Falcon Partners Management 15 Federal Reserve Bank of New York 39 People in this issue Financial Executives Alliance 15 Goldman Sachs 4 Bard, Gustav 37 Harvard Student Agencies 15 Becker, Noah 19, 21, 22, 23, 24, 25 Institutional Limited Partners Association 6, 10, 31 Carey, Julian 26, 27

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