Private Equity: Bridging the gap
Martin Steward meets the co-founders of OceanBridge Partners, whose flexible new model aims to maximise the potential of private equity investing
Most private equity activity involves a general partner hitting the road with its new fund, raising the euro-value of commitments from investors that it thinks it can put to work in the current cycle, then spending the next five to seven years drawing the capital down and buying and managing companies, before selling them and returning cash to investors in the hope that the profits will entice them to plough that cash back into the next fund.
Does that model really maximise the opportunities or the benefit of private equity? A number of constraints – notably around size and time horizon – suggest not.
Most private equity veterans can point to the €20m opportunity that promised a 50-times exit multiple that they had to let go because they’d raised a €1bn fund designed for €100m investments. Even more will remember building a company into a sector-dominating machine they could easily have held for another 15 or even 20 years, but which they had to sell to get cash back to LPs, many of whom would probably have preferred to have stayed invested, too.
But fund horizons can be too long as well as too short. A pre-IPO deal can turn a great profit in 6-12 months, entry to exit. But while an LP would love a 50% IRR on a six-month investment, it is not much help to a GP looking to craft a decent IRR over a fund’s full, five-year cycle.
And we could go on. A fund manager, domiciling his partnership vehicle in the Cayman Islands, Guernsey, or wherever, commits to that for the next five years for every portfolio company. Will it make sense to domicile a Chinese or French company in the Caymans, rather than Hong Kong or Luxembourg? Will regulatory tolerance for offshore domiciles look the same in three years’ time as it does now? And we haven’t even got to the management fees paid on cash waiting to be put to work, or the lack of transparency on fund transaction fees.
“Funds have to put 20% of their capital to work every year, and they all go to the same auctions at the same time,” says Philippe Robert, a co-founder of OceanBridge Partners. “So their LPs pay five times to watch their GPs push up the price of the companies they buy, and it all happens again when they all exit at the same time.”
OceanBridge was set up in 2011 to address these problems. Robert and his co-founders Martin Clarke, a colleague from Permira, and Michael Dugan, an ex-Blackstone partner whom he has known since their days at Donaldson, Lufkin & Jenrette, had long been picking up on the frustration some larger investors were feeling.
“But it started to become really obvious through the liquidity crisis of 2008, when many were stuck with commitments at a time when they were not keen to invest,” says Robert.
“With OceanBridge we had a blank sheet; we could design anything we wanted – a governance structure that could genuinely work for big investors looking for something different.”
What they came up with was a company in which a small group of ‘investing partners’ would each take part of a 25% equity stake (alongside the 75% held by the managing partners), which would provide working capital to finance the people and infrastructure necessary to source bespoke private equity dealflow. Those deals will be structured individually as holding companies and offered exclusively to the investing partners who can choose to partake or not in each deal presented, in whatever size suits them.
“We want to be a conduit for these asset owners to make direct investments, by providing experience and skills they would find it costly to replicate,” explains Clarke, whose early career involved building in-house private equity divisions for the UK Coal Board pension scheme and Prudential. “At the same time we didn’t want to have to cold call 10 people for every deal, so we want to establish formal relationships with a limited number of strategic asset owners – and we thought the best way to do that was to have them take equity directly in OceanBridge.”
That gives partners both alignment of interest (OceanBridge’s shareholders get a piece of the management, transaction and performance fees) and transparency (they get to see exactly how that revenue is split between management, transaction and performance fees).
Breaking free of the fund model should remove the size and time-horizon constraints that eat away at potential returns. The cash-on-demand model relieves the pressure to put committed cash to work, which means a more targeted approach to dealflow and less reliance on overcrowded auctions. “It’s quite likely that we’ll be looking at deals where private equity wouldn’t conventionally get involved because it’s the wrong type of profile or the wrong type of asset,” says Clarke.
That creates a virtuous circle regarding size and capacity: with no need to chase down every deal, resources can be kept modest, which relieves any pressure to generate a pile of deals to pay the way. OceanBridge is not expected to grow beyond 30-40 professionals.
The absence from the auctions probably answers one of the more obvious criticisms of the model, too: What credibility will OceanBridge bring to market without any committed capital? Rather than competing for dealflow, Clarke and Robert expect to be generating proprietary opportunities by working directly with vendors to find solutions for their own liquidity and time-horizon problems. It helps that they already have deals under their belt to show that the model works, and that one of them is involved in supporting the Mayhoola Group of Qatar on its €700m acquisition of Valentino from Permira.
“If we are working with prestigious sovereign wealth funds and pension funds, people are not going to turn us away,” as Clarke puts it. “At the moment Oceanbridge is still wholly owned by the managing partners, but we’ve done several transactions in our first 12 months and are about to begin seriously talking to potential partners who may want to take equity stakes.”
Sovereign wealth funds are the first port of call, but Clarke and Robert point to North American pension funds that have tentatively started building private equity direct-investment teams – often to participate in co-investments, where they need due diligence expertise but do not necessarily have the capability to take the leadership role in sourcing or selecting deals.
“In our model, we are taking the responsibility for sourcing the deals, but we offer greater flexibility than they can get within a fund-based co-investment,” says Robert. “We are not saying that these investors will not commit to funds anymore, or that this model should be the core of anyone’s private equity strategy – but we are saying that the industry is maturing, and that people are looking for alternatives to the basic fund paradigm.”