Banks and deal-sourcing: Information arbitrage

Banks were once the mainspring of Japan's nascent private equity industry. They knew the lay of the land and could connect inexperienced GPs to companies that they would otherwise overlook.

Yasushi Ando, CEO and COO of New Horizon Capital, says that those days are long past. Now companies have become more comfortable dealing with GPs on their own. "Awareness of private equity is prevalent among local banks, that's true. But now, rather than local banks, the companies themselves come to us, pop into our office to consult what they should do," he says.

While banks may not enjoy their previous dominance, their influence hasn't disappeared entirely. Several PE players observe that financial institutions are always looking for ways to involve themselves in the deal process, and though views on their effectiveness vary, most feel that banks have significant staying power.

One significant advantage that banks still hold is that of information. While many of Japan's better-known companies are now confident seeking financing themselves, others - due to size or to location - are still unfamiliar with private equity. There is a lack of trust when presented with proposals by GPs, and banks can serve as intermediaries in these situations.

"It's the big banks that have long-term business relationships with these good companies in rural areas," says Gregory Hara, director and president at J-Star. "They may listen to the pitch if it is presented by these trustful big banks."

Lacking heirs

Succession issues most commonly convince an otherwise uncertain company to consider a private equity investment. In cases where the aging founder of a family-owned business has not found a suitable successor, he may rely on the advice of a bank with which he has a longstanding relationship when assessing prospective third-party buyers.

Bank-sourced deals are not specifically tracked, but according to data collected by PE advisory firm Brightrust Partners, succession situations, which are often sourced by banks, comprise about 10% of the historical buyout deal flows in Japan. Size can vary hugely. Brightrust records acquisitions of this type as high as $300 million, though they are likely to fall between $10 million and $80 million.

In addition to succession, small-cap companies are increasingly turning to GPs for support in growth initiatives. Hideaki Fukazawa, president and managing partner of Tokio Marine Capital, says that banks have proven useful in these situations as well, since his firm cannot maintain contacts with every company that might present such an opportunity.

"If this is a big company or traditional company, we have other ways of getting access," says Fukazawa. "But as far as family businesses are concerned, they are not well accustomed to dealing with PE. Access to regional banks is a much more efficient way to make appointments."

Though banks have their uses when it comes to finding deals, GPs tend not to consider them as a first source. There are several reasons for this, and all have to do with their perceived lack of objectivity. For one thing, many banks have their own affiliated PE funds and these groups may get first option on deals that come in.

"Because they are somewhat related, there is a better fee arrangement between bank-related GPs and the banks. Therefore the bank has an incentive to bring the deals to their related GPs first," says J-Star's Hara. "I'm not saying it's a bad deal or good deal, but sometimes the leftovers are brought to independent funds like J-Star."

At the same time, bank-related GPs may not be under the same kind of pressure to produce returns as independent firms. If they are willing to accept lower rates of return then deals that reach them through bank channels may not be of interest to independent players anyway.

Potential conflicts

Another common issue with bank-sourced deals is transparency. When a bank finds a deal, it has a large amount of control over the subsequent process. There may be a temptation to overstate the case for a particular deal, even seeking investments to prop up a company that has become insolvent.

"The banks can pull the plug, but they are reluctant to do so," says New Horizon's Ando. "They ask us to put in some money to save them, and finally they agree to make some provision for the loans. So it happens at the very last minute. That's a problem, because this sort of thing actually makes things quite difficult. They should approach us much earlier."

However, Joji Takeuchi, CEO and co-founder of Brightrust, argues that these transactions are not necessarily more prone than other types to generate conflicts of interest, since PE deals by their nature involve multiple parties trying to promote their own concerns. In his view, conflict is more likely to occur between a reluctant company and a bank pressing for a PE investment; but even in these cases the outcome is better with a deal than without it.

"The lender bank may press the company owner to accept PE capital and professional management brought by the GP," Takeuchi says. "The owner may not be too happy. But this should not be seen as a conflict of interest issue."

Though GPs have their issues with banks as a deal source, they agree that the institutions can provide an essential service. Banks realize this too, and far from reducing their influence, some forward-looking institutions are attempting to build up their role in the PE ecosystem by investing in their in-house capabilities.

"Some advanced regional banks have realized that if they don't have a good M&A advisory business, or don't have a good understanding of business succession from an equity point of view, they will be pushed out by other banks," says Tokio Marine's Fukazawa. "Most of the leading Japanese regional banks now have in-house M&A advisory staff."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• North Asia
• Buyouts
• Financials
• Financial Services
• buyout
• Japan
• New Horizon Capital
• Tokio Marine Capital
• J-Star