Deal-by-deal fundraising: Incremental approach

Sanjay Chakrabarty was a man in demand. A couple of months earlier he had worked with Partners Group on the buyout of India-based business process outsourcing (BPO) firm CSS Corp. Now he had another BPO deal lined up - Aditya Birla Group was willing to offload its Minacs subsidiary - and various parties were interested in getting a piece of it.

There was no fund behind these transactions, or at least not at first. Chakrabarty departed US-based Columbia Capital at the end of 2013 and the deals he has participated in over the past two years were channeled through Capital Square Partners, an investment holding company. AVCJ understands that the firm has applied for a fund management license in Singapore and a vehicle will be launched in 2015.

Around the turn of 2014, when Minacs was in play, Capital Square was working on a deal-by-deal basis; it sourced interesting investments and was able to contribute some capital, but required partners to put in the rest.

CX Partners ended up leading the Minacs transaction. According to a source familiar with the situation, this was because at least one group would only consider the deal as a co-investment alongside a portfolio GP. A number of other LPs came in as well, including Hermes GPE, which participated directly. It was familiar with Capital Square from having been shown other deals.

"Our focus and ability is on evaluating transactions and if it happens that a good deal comes through a fund-less sponsor then we consider it," says Sunny Chu, investment managers at Hermes. "The key issue with investing deal by deal is to ensure that the GP is well funded, stable and well aligned. We evaluate many such opportunities every year but very few go far in our process."

No standardization

The Minacs situation captures a number of the dynamics often found at work in deal-by-deal fundraising: a GP that has no active blind pool vehicle and is reaching out to LPs not only for support on an investment, but also with a view to a future fundraise; and LPs looking for ways to participate, in part driven by concerns about minimizing the fee burden.

In this particular field of private equity, however, attempts to discern any kind of standardized model quickly falter. Data supplied by Preqin indicate there are currently 13 GPs in Asia operating on a deal-by-deal basis, compared to 59 in Europe and 97 in North America. While this approach is more established in the Western markets than in Asia, the number is almost certainly an under-projection.

A deal-by-deal strategy could sit anywhere along a sliding scale with shopping around investments in an opportunistic fashion at one end and something resembling traditional blind pools at the other. Where a particular manager lies on this scale depends on a combination of factors, and some managers argue they don't belong on it at all.

What everyone might agree on is that deal-by-deal is attractive in theory but difficult in practice, with challenges ranging from execution to managing LP expectations.

"In an ideal world you would have an existing revenue-generating platform and the deal-by-deal model is incremental to it," says Nirav Kachalia, managing director at The Yaro Group, who has experience working with groups that pursue such strategies. "But if you don't have a strong track record and a robust stable of investors, it's difficult. For the stability of one's team, one's mindset, and an ability to execute, one needs a level of commitment at some point."

On the one hand the strategy can offer huge flexibility and immediate carried interest on exit from a particular asset - catnip to a pure dealmaker who does not want the heavier fiduciary responsibility that comes with fund management. On the other, it is unpredictable in nature. If a GP that identifies a strong deal but cannot get support from investors it could suffer serious reputational damage.

Choice or necessity?

Opinion is divided as to whether deal-by-deal fundraising is on the rise in Asia and the strength of the various forces behind it. There is more money coming into private equity, particularly from family offices that are eschewing blind pool funds in favor of direct exposure to deals. Equally, GPs in Asia outside of the big name firms are finding it harder to raise capital.

"I often get people come in with an interesting strategy, but it's a challenging fundraising environment so we try to give pragmatic advice," says Dean Collins, a partner at Dechert. "It is a case of, ‘You tell me you have great contacts and great deals, so go and get a deal done and you will find it easier to raise a fund on the back of that.'"

Deal-by-deal therefore comes into play when fundraising has been aborted or not even reached the PPM stage.

When private equity fervor gripped Indonesia circa 2011, a number of local groups either looked into raising funds, but few got traction. For example, Fairways Capital, which did not launch a vehicle in 2011, now describes itself as an investment holding company, making investments on behalf of clients and offering corporate advisory services.

Similarly, just in the past week, AVCJ has been made aware of two Indonesia-focused executives that have left their respective firms and are now reaching out to fund-of-funds with a view to completing personally-developed transactions on a deal-by-deal basis.

In this context, Crescent Point stands out as a GP that through choice rather than necessity declined to raise a blind pool for the best part of a decade. The firm in part owes this distinction to its flying start.

Founded in 2002 on the back of opportunities created by foreign investors exiting Asia and connections with family offices in the Middle East, Crescent Point's first deal was Air Asia, which delivered a very strong return. An equally successful second investment gave the firm sufficient balance sheet firepower to pay overheads and participate in deals, and willing partners in these families.

A fund followed but the firm found that it could get more strategic value out of its family office network - most groups have their own operating businesses - so it stuck with the deal-by-deal approach. Having started with approximately 15 families, Crescent Point now works with around 40 from Asia, North America, Europe and the Middle East.

The firm has always been wary of large pools of capital because there is often pressure to invest for the sake of investing, according to one source. It wants to be patient and opportunistic.

A hybrid strategy

Nevertheless, Crescent Point has recently shifted to a hybrid model, with a dedicated pool of third-party capital on top of the balance sheet contribution and whatever is syndicated among the families. There are two reasons for this. First, it allows the firm to move quickly on deals and have the capacity to pursue larger transactions or several investments at once. Second, a handful of investors said they would rather make a single, larger allocation with the option to top up on particular deals.

Such attitudes among LPs have a broader impact on how deal-by-deal investors structure their businesses. Notably, there is muted enthusiasm for pledge funds in Asia. These feature around the mid-point of the sliding scale, offering GPs a degree of certainty because there are some pre-negotiated terms with LPs as to how much capital will be committed by LPs. In certain cases, a management fee is also agreed before any deal is done and, while LPs have discretion, there may be a limit to the number of times they can turn down investments.

Much as the Crescent Point investors wanted to make single commitments to a string of deals, the trade-off between manager quality and resources can be a stumbling block for pledge funds. If an LP isn't confident enough in a GP to support a blind pool - perhaps because the team doesn't have a lot of experience - then is it really worth the effort to assess each deal individually?

"The majority of LPs don't like pledge funds," says Javad Movsoumov, executive director with UBS' private funds group. "They would rather do due diligence on a fund and then commit to a blind pool. If there is a pledge fund, every time a GP comes to them with a deal they have to evaluate it. A large number of LPs wouldn't have the capacity to process these direct deals."

Fees can also be an issue. Chu says that Hermes prefers GPs to seek alignment by focusing more on carried interest than management fees, but the quality of the transaction is the primary consideration and if that is validated the firm will listen to proposals from managers that reflect a small team trying to fund appropriate deal and team expenses. Others take a harder line.

"Unless the circumstances are extraordinary, we want to do co-investments on a no fee, no carry basis and it's hard to see how that works for somebody doing deal-by-deal," says Doug Coulter, a partner at LGT Capital Partners. "We might be able to live with some carry or carry above a hurdle, but the fees would be very hard for us."

According to Lorna Chen, a partner at Shearman & Sterling, some GPs in China are offering deals to LPs in return for a flat "finder's fee" intended to cover costs during the course of the investment and zero carried interest. This is done to build goodwill ahead of a blind pool fundraise. Several industry participants claim to have seen management fees as high as 2%, but only on drawn down capital, and then 20% carried interest; others put the typical rate at a 1% and 10%.

Between the lines

A number of GPs have managed to carve niches in the space between those that are able to raise blind pools and those who turn up with a blank term sheet. They tend to be relatively young, often seeing deal-by-deal as a stepping stone to a traditional fund structure. And then the vehicles they are raising are distinct in the high level of transparency.
Southeast Asia-focused Hera Capital, for example, is said to raise funds on more or less an annual basis, with LPs given a clear idea of which transactions will be targeted.

Heath Zarin, formerly head of principal investments in Asia for HSBC, spun-out in 2013 to form EmergeVest and has since raised capital from a mixture of investors for two specific themes: Asia special situations (which formed Zarin's remit at HSBC) and UK control deals. It has completed five deals with around $100 million committed and has a further $100 million available.

"We are not a blind pool in the conventional sense," Zarin says. "One would normally put together a PPM to raise a large vehicle to invest over multiple years. At the time, we had several deals we wanted to do over a period of six months, so we raised capital on the back of that. We have a shorter investment horizon than a traditional fund and a narrower investment mandate."

Knowing exactly what the first few deals would be and identifying the specific nature of others to follow removes or substantially reduces blind pool risk. In this sense it is a good fit with the needs of family offices that are increasingly seen as the natural partners for deal-by-deal shops in Asia.

This is in some respects a global phenomenon. One version of events is that family offices became uncomfortable with blind pools in the wake of the global financial crisis and now prioritize direct transactions or fund structures with a clear pipeline of assets. Another is that such groups are entrepreneurial by nature and therefore prefer to direct exposure and hands-on involvement.

"There are large family offices that have done fund investments in private equity but over time they have accumulated enough knowledge to say, ‘We could do it ourselves.' They can cut out the middle man and the blind pool, so instead of paying 2/20 they will pay a budgeted management fee for their internal team and the deal team will get less than 20% carry. They get to look at every deal and say yes or no," says David Kirby, founder and managing director of Kirby Capital Advisors.

Kirby works with about 30 family offices in the US, each of which has at least $1 billion in investible assets and a sweet spot of $10-30 million per investment. He is currently sourcing investors to participate in deals alongside GTI Capital, an India-based fund-less sponsor. The firm's managing partners include Gaurav Dalmia, a member of the family behind local conglomerate Dalmia Group.

Family offices are also emerging as a powerful force within Southeast Asia. Former 3i Group executive Mark Thornton was working on a deal-by-deal basis in Indonesia until last year when he was retained by Metdist - a trading company owned by the Bagri family, which previously held a stake in the London Metals Exchange - to advise on public and private equity investments across the region. Medtist has no interest in blind pools; it is looking for direct deals of $2-5 million.

"When I came to Asia in 2000 private equity was in its infancy. Fast forward 15 years and it feels like the new wave of capital in the market is the family office money," Thornton says. "There is a lot of family office money but it's difficult to access because you need to have a relationship with someone within the family office to have that trust factor."

Relationships matter

The private banking units of international banks will consider deals for syndication among their high net worth clients, but these transactions tend to fall into one of two categories: global private equity firms that have no problem raising blind pool money but allocate a portion of a deal to a private bank as a marketing exercise to attract more fund investors; and pre-IPO rounds for technology companies, which tend to come via investment banks rather than GPs.

Austin Mok, who works in private banking for a large financial institution in Hong Kong, says that many smaller sponsors approach him with deals but it is difficult for them to get through the bank's due diligence process.

Penetrating the family office community directly, meanwhile, is in an exercise in patience and persistence, although opening one door can open others. Yaro Group's Kachalia admits that the most fruitful networking comes from within the community itself. A GP may have a geographically diversified LP base, but there are often concentrated pockets of investors in each continent - a result of referrals between families.

The reality is that few fund-less groups in Asia are able to syndicate a deal among a collection of willing family investors. The status quo may gradually shift and a number of industry participants say deal-by-deal is here to stay: With LPs wanting to have fewer, larger relationships, money is gravitating towards the established firms; family offices are becoming more comfortable with direct deals, so they will seek to interact with the smaller GPs - that are having trouble raising capital - on this basis.

The counterargument is that relatively few family groups have the experience to go direct and, if any kind of mass movement in the market is not accompanied by additions to internal capabilities, investments will go wrong. "The merit of having a blind pool is that you leave the investment decision to someone else," says Chen of Shearman & Sterling. "This is an educational period for some LPs in Asia where they understand that there are professionals there that can do their job."

Winning family office clients on a deal-by-deal basis and then retaining them for the long-term ultimately hinges on offering something they can't get elsewhere. "In order to get started you need to have proprietary deal flow," says EmergeVest's Zarin. "If you don't have an edge on a deal or a series of investment opportunities, this is not the way to build a PE business."

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• Topics
• Fundraising
• Investments
• GPs
• LPs
• Fundraising
• Asia
• Hermes GPE
• LGT Capital Partners
• LPs
• GPs
• EmergeVest
• Capital Square Partners
• Crescent Point