AVCJ Awards 2020: Firm of the Year - Mid Cap: Advantage Partners

Q: Advantage took some significant steps in terms of succession planning last year – a first for an independent Japanese GP. What was the thinking behind it?

A: These weren’t our first steps. This process has been underway for five years and it will probably continue for another five years. We brought an outside strategic investor – Tokyo Century Corporation [a large Japanese non-bank financial services company and a longstanding LP in Advantage’s funds] – into our fund management entity and we transferred a 20% ownership stake in the firm to the non-founder partners and employees. We also announced Shinichiro Kita as head of the Japan buyout team, but that was really formalizing a structure that has been in place for several years. These changes are part of a bigger transition in terms of how the firm is owned and governed, and how investment decisions are made. By involving a broader group of partners and professionals, the idea is that the firm will long outlive its founders.

Q: How did LPs respond, especially given the impending Japan fundraise?

A: We were transparent and consulted with LPs, made the announcement, and did follow-ups. The reaction has been positive. There were questions about potential outside influence on governance and investment decisions, but there is no change in that aspect. There were also questions as to the implications of bringing in an outside investor in terms of economics going away from the team and how we would keep it to a manageable level. We were able to show that the economic value going away is not material enough to detract from the motivation of the team. Most of that has been absorbed by the founders. We were already allocating more and more of the economics to the non-founder investment team, rewarding those who are adding value.

Q: Wasn’t carried interest reasonably widely dispersed at Advantage from the outset?

A: Yes. We started out building a large team with a small fund, such that we couldn’t cover all the team costs with management fees. The founders invested in building the team. Our team has always been as large as or larger than our management fee. In that context, we weren’t going to be the highest in terms of base salary, so we put the focus on carry participation from the outset to make up the difference if the funds were successful, especially for those we brought in at senior level. This also ensured that our team was tightly aligned with LP interests. In the very early days, we had what we called the 70% theory – people came in at 70% of previous salary level and we more than made up for that with participation in carry; this also served as an effective affirmation of their commitment to building a successful practice with us. This has made the more recent transition easier.  We also have a team with a lot of experience. The average tenure of our partner and principal group in Japan is over 14 years. Even in the ex-Japan Asia team, the principals and partners have been with us 12 or more years.

Q: You raised JPY85 billion ($790 million) for your sixth Japan fund, one of several closes that took Japan buyout fundraising to a record high in 2020. What does this say about the market opportunity?

A: It was one of our best experiences fundraising, a very short and efficient process. We had a high re-up rate among existing investors – almost everyone who could come in did come in. As for the wider market, it’s the same story that has just continued, steadily, for quite some time. We are seeing people recognize there are deal opportunities in Japan with stable and attractive returns. There is some cyclicality as well – leading to an expectation that in addition to an underlying secular set of deal opportunities with founder-owners, another wave of carve-outs from large corporations is beginning. Many of these deals will be more accessible to private equity than in the past. A lot of that has to do with the business community appreciating that private equity has generally been a good steward of businesses. That’s positive for PE penetration of a substantial M&A market in Japan, but one in which we are still a very small piece, with plus or minus 10% each given year.

Q: What is the PE angle on corporate carve-outs?

A: Private equity can facilitate consolidation in industries where there is excess capacity and different corporate parents have different subsidiaries and divisions. On the governance front, we have proven to be good in terms of bridging the gap from shareholder to management to employees and really shrinking it so there is better understanding of what is important to stakeholders and shareholders and better communication of how to implement change within an organization. Perhaps that has been a bit lost over a long period of time in certain Japanese corporate settings. There have also been a lot of government initiatives in the past 5-6 years in terms of requiring more outside directors and focusing on ROE [return on equity]. Companies that are sincere and serious about it are taking measures. They recognize private equity can be helpful in situations where they have subsidiaries that they would be better off letting go and focusing the resources on areas where they want to remain competitive.

Q: Is this already playing out in your deals?

A: Things really picked up in the fourth quarter – three new deals were announced in December, taking us to five for the year – and I expect that to continue into 2021. Of the five, three were carve-outs and two were succession deals. Some of these are situations we have been working on for some time that slowed down over the spring and summer due to COVID-19. We are now seeing COVID-19 itself become a driver of deal flow as companies find themselves challenged and in need of financing.

Pictured: Richard Folsom of Advantage Partners receives the Firm of the Year - Mid Cap award from Baker McKenzie's Dorothea Koo

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• Topics
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