Know your limits

Rather, it focused on restrictions within fund terms on private investments into public equities (PIPEs). And of the 90 GPs polled, the survey found that 43% had no restrictions whatsoever on the proportion of their funds that could be used for PIPE deals.

This has long been a bone of contention in the Asia Pacific private equity industry – though evidently not enough of one to force a stricter PIPE limitation protocol until now. LPs argue, legitimately, that the practice confuses their allocations to public and private asset classes, such that they could in theory end up exposed to the same company twice over. Also, PIPEs go against the much-vaunted investment thesis of private equity – that it allows long-term counter-cyclical bets on businesses where the investor actually gains a measure of, or complete control over the asset, to improve its value by directly boosting or re-engineering its business.

On the GP side, the arguments in favor of PIPEs in the region have long been rehearsed. There are fewer large targets in Asia Pacific, and any fund aspiring to do deals of reasonable size is almost inevitably driven to play in the public markets. Also, the cachet in Asia of listed-company status drives most business founders to list early in their company’s life cycle. In the same vein, these entrepreneurs are frequently reluctant to give up too great a share of the family jewels; above all this means loss of control. And the personal, dynastic nature of many Asian businesses, with compliant boards and limited shareholder control, reduce still more a financial investor’s chances of getting a controlling stake in a business. Plus, a GP with unique access and advantages in Asia’s opaque markets might be able to gain access and deliver value in PIPE situations that normal public investors cannot rival.

Following this logic, to play in Asia and to gain access to a share of the dynamic region’s action inevitably means accepting a greater proportion of PIPE deals. But do these arguments hold water? (And to be clear, we are not talking about privatizations, where a fund invests in the public stock of a company to take it private and delist it.)  For some firms – Hopu Investment Management springs to mind – with a deliberately broad mandate, closer to a special situations/opportunistic vehicle than a pure private equity play, this is probably not an issue. LPs in those funds presumably know full well how wide their GP’s investment focus is likely to be.

But in other funds, the grey area that bleeds into minority investing and growth capital, let alone full-blown PIPEs, is a legitimate concern. Some LPs have suggested to AVCJ that funds doing too many PIPEs should be systematically discouraged and criticized for not adhering to pure private equity. For funds with clear terms, this is not an issue: most adhere to a common standard of 20% or less of the total fund, and transgressing those terms is an actionable offense. However, the grey area for those without such terms appears to extend very far.

Surprisingly, AVCJ sources suggested that LPs had hitherto accepted the loose constraints on PIPE investing simply on the basis of an implicit understanding that the GPs would focus on private investing, or they were tacitly accepted as the price of admission to Asia. If so, such attitudes sound like a relic of an earlier phase in the evolution of the region’s fast-developing private equity sector. Whether LPs really have been so trusting of their GPs in the past, few expect them to be so after the 2008-09 crash, which threw the tensions in the GP/LP relationship into sharp relief. So expect stricter limits on PIPE investing in future. And, some would say, about time.

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• Topics
• Performance
• PIPEs
• Regulation
• Funds