Japan succession planning: The generation game

Few PE firms in Asia can claim more than 20 years of history with no discernable changes in leadership or ownership structure. In fact, the origins of Advantage Partners can be traced back even further to 1992, five years before Japan introduced legislation allowing financial sponsors to pursue buyouts, thereby sowing the seeds for the industry as it exists today.

It should therefore come as little surprise that the firm is among the first of its domestic peers to address succession planning. Tokyo Century Corporation, a domestic financial leasing business, will take a 14.9% interest in the GP through the purchase of existing and new shares. The private equity firm says the capital will bring balance sheet strength that will be used to improve service quality, but it also facilitates internal transition.

“We have already passed 20% of the ownership of the firm to the non-founder partners and employees. We will do more of that in future,” says Richard Folsom, who co-founded Advantage with Taisuke Sasanuma and remains co-representative partner. “The issue is how do you achieve that. It’s not as simple as telling younger members of the firm to buy out older members – there have been cases in partnership structures where that really hasn’t worked. Leveraging outside sources of capital and shareholders to manage this process can make it easier.”

Advantage is not the only Japanese PE firm considering its transition options – though no other has opted to sell a stake in the GP. Unison Capital, which was founded in 1998, is expected to unveil leadership changes ahead of its next Japan fundraise. Tatsuo Kawasaki, a managing director at the firm, declined to comment on specifics, while noting: “We all age, the clock turns in the same direction at the same rate for everybody. Changing of the guard inevitably happens.”

The LP view

Advantage raised its first Japan-focused fund in 1997 and closed its fifth in 2017 with commitments of JPY60 billion ($535 million). This marked the completion of a decade-long return to form after a bloated fourth fund, raised at the height of the pre-global financial crisis bubble, was forced to write off its largest investment in Toyo Star Bank. A smaller bridge fund was raised in the interim. This vehicle has delivered strong returns and its full-scale successor is said to be tracking well, having secured a full exit from Iishi Sports and a partial exit from Net Protections.

There is also a $380 million Asia ex-Japan vehicle – born out of efforts to help Japanese portfolio companies expand overseas – and two funds that make minority investments in public companies that don’t want to be privatized but are interested in working with Advantage based on its value creation proposals. The firm has approximately 45 investment professionals in Tokyo, Shanghai, Hong Kong, and Singapore. 

LPs were informed of the Tokyo Century transaction ahead of the announcement two weeks ago. General feedback suggests it is viewed as a benign development. Some movement on ownership was expected, though little was known as to what form it would take. One LP notes that, while Folsom and Sasanuma have committed to stay with Advantage despite diluting their ownership and taking some money off the table, he has not been informed as to the minimum length of their tenure. However, he is not uncomfortable with the overall situation.

“With Fund VI to launch this year, two big things always came up: generational transition and whether they would be disciplined on fund size or make the same mistake as 2007 and take on too much capital,” the LP says. “At the AGM [annual general meeting] last week, they said all the right things about the target, and then the transition came to light. We knew something had to be done and I’m glad we have visibility on it ahead of the new fund launch.”

Another LP who attended the AGM expresses concerns about the longer-term implications of the deal, citing Advantage’s multi-strategy approach and suggesting it might result in an IPO at some point. “I think they have enough talent to manage these different parts of the business, but I don’t like this trend [of PE firms going public],” he says. Advantage asserts this is nothing more than a theoretical prospect.

Asked whether he would prefer Dyal Capital Partners or The Blackstone Group’s Strategic Capital Holdings Fund – where buying GP stakes is a core part of the strategy – as a shareholder over Tokyo Century, the general LP view is no. The presence of an investor that is also a longstanding LP and brings specific value-add is more palatable than a group taking a purely economic interest, which might need to be transferred or exited at some point in the future.

Tokyo Century was formed in 2009 through the merger or Tokyo Leasing and Century Leasing. It is Japan’s second-largest leasing business and trades in Tokyo with a market capitalization of JPY525 billion. In addition to serving as an LP in Advantage’s funds, the company provides mezzanine finance to portfolio companies. Indeed, CEO Shunichi Asada previously established Mizuho Financial Group’s leveraged lending group, which supported some of Advantage’s early buyouts.

As a shareholder in the GP, Tokyo Century will introduce proprietary investment opportunities to Advantage and share information on sectors in which it operates, while the private equity firm will contribute management support expertise to Tokyo Century and introduce investment opportunities that fall outside the scope of its funds. While Tokyo Century will have board representation, it will not sit on the investment committee and investment decision-making processes will be unchanged.

“It’s a lot more than just a capital transaction,” says Folsom. “Tokyo Century has a large client base of Japanese companies and they recognize the need to provide things beyond traditional lending and lease financing – they see a lot of things in their pipeline that are carve-out or succession situations. So, there is deal sourcing support, financing support, and they are motivated to be an ongoing LP in our funds. It also brings balance sheet money to the firm and helps us with longer-term transitions and business development.”

Advantage claims to have begun its transition well before the 20% ownership stake transfer. Carried interest has always been reasonably widely distributed, with half going to non-founders in Fund I; that share is now above 60%. In recent years, the firm has also broadened the number of people involved in internal decision making on issues such as personnel and compensation. 

Gradual evolution

By bringing Tokyo Century into the fund management entity, Advantage has essentially committed to making it a permanent pool of capital rather than a vehicle through which economics flowed to those adding value to the firm. While this could be used for GP commitments, the primary motivation is to create an additional layer of stability. The team has always been relatively large for its fund sizes and there have been times – for example, while rebuilding after the challenges in Fund IV – when the founders have made up shortfalls in management fees to cover fixed costs.

It is part of a concerted effort to establish a sustainable institutional platform that can outlast the founders. Moreover, the presence of an external shareholder gives impetus to ongoing, industry-wide moves to improve reporting and transparency. Asked about Unison’s adoption of institutional processes, Kawasaki cites greater emphasis on compliance as a key contributing factor.

“In the early days it was simple: raise money, invest, and return, and do the same again,” he observes. “Now, longevity aside, institutionalization has become a must even for firms that are not so big. Inch by inch, everyone has to institutionalize, or there is no way to operate.”

The early impact of the changes being made at Advantage will be assessed by LPs during the Fund VI due diligence process. Asked to list his main concerns, one investor offers the following: the amount of capital being raised for Japan, the impact this is having on valuations in and outside the Advanatge portfolio; the firm’s future as a multi-strategy player; and whether the revised economics represent fair distribution.

“From a titling perspective, we’ll get the carry table from the previous fund and part of diligence is making sure it is equitable and going to right people. We’ll look at attribution and who has participated in which transactions,” the LP adds. “It sounds like they are being sincere, but until you really look into the tent, it’s tough to say whether change is happening on economics or not.”

Ordered succession – continuation rather than spin-outs and wind-downs – has yet to become a prevailing trend in Asian PE. However, an increasing number of firms will have to confront the issue over the next five years if there is a desire for franchises to outlive founders. Scattered across Australia, China, India and now tentatively Japan, stories of success and failure are roughly equal in number. In the absence of historical precedent in Japan, Advantage looked to the global GPs.

“We have tried to model ourselves after global firms, looking at how they organize themselves, how they structured their economics when bringing in outside shareholders and in IPOs,” Folsom says. “We’ve followed Bain Capital since our founding. From an early stage, they had a large group of partners who governed the firm. That’s a great model. We have always wanted a broader level of partners participating in governance.”   

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• Topics
• North Asia
• GPs
• LPs
• Fundraising
• Japan
• Advantage Partners