Putting all the pieces together
In an environment that is becoming increasingly challenging for private equity funds to raise cash, placement agents have become a growth industry.
The role of the placement agent is to act as a broker between the general partner of a private equity fund, and the limited partners, ie institutions which invest in that fund.
The agent is hired by the general partner specifically to look for investors, and is paid a fee. This is usually around 2% of the fund size, although payment can also be in the form of a share of the manager’s profit.
Although many general partners still raise capital successfully without using a placement agent, these brokers are now used for a substantial number of private placings.
But as their prominence has grown, so have rumblings about the potential conflict of interest in their position. The argument runs: how can the agents give potential investors an objective assessment of a fund, when they are being paid by the general partner?
Conflict of interest is not exactly new in financial services, and there will always be placement agents who accept too many client mandates, running the risk that some of those funds will not be of a particularly high quality.
However, the increasing sophistication of pension fund investors means that if they are looking at the private equity sector, they are likely to get advice from consultant actuaries, most of whom have sizeable private equity departments.
Armed with the ability to ask the right questions, they are likely to find that the wealth of information from the placement agent can help them make their own choices from the funds available. Crucial information – such as whether a manager has lost key staff – can be difficult to get hold of, and placement agents can help in obtaining it.
Furthermore, it is not in the interests of the placement agents themselves to take on funds which subsequently perform poorly. Such a blot on their track record would make it more difficult for them to pull in investors for future launches.
In other words, it pays for the placement agent to be picky too.
For instance, London-based placement agent Helix Associates accepts only four or five deals from the 100-plus approaches it receives per year.
“Investors are committed to providing capital over several years, unless the managers go wildly off course in terms of strategy,” says John Barber, director, Helix Associates. “They don’t see what they’re investing in, for anything up to five years, so the fund manager’s integrity and track record is something we care a lot about.”
The firm uses its in-house research resources to vet a fund before taking it on as a client. Much of this due diligence is then used in marketing the fund to investors. The whole process, from first approach to closing, can take 18 months.
“It’s not a business for the impatient,” says Barber.
Different placement agents have their own vetting strategies, but
the basic elements are likely to be
Primary desk research on a potential client will include standard procedures such as reviewing cash flow statements and past investment performance, comparing them with appropriate benchmarks.
Besides this, Helix sends prospective clients a questionnaire with over 100 questions. As well as the obvious points on finance and management, it contains more searching enquiries. For instance, a smaller - say 10-person - general partner may be asked how it will cope if a key member of staff leaves, or dies.
“We take a lot of references,” says Barber. “We speak to people who’ve done business with the potential client – lawyers, advisers, and chief executives of companies they have funded. We ask about their strengths and weaknesses, what they contributed to the company, and what their character was like when the going got tough. We also ask whether the person in charge of the deal has since left.”
For each prospective client, Helix can take up to 60 individual references, involving half-hour phone calls or meetings.
“Personal chemistry is also a factor – we get to know our clients well, and sometimes we say ‘no’ simply because we can’t imagine being with them for such a long time,” says Barber.
When Helix is dealing with former clients, the vetting process is somewhat lighter, as long as the manager’s funds are performing.
“But because there is normally a gap of three or four years between fundraising, a great deal can happen,” says Barber. “On the plus side, people can get older and more experienced, but on the minus side, an investment can go sour.”
Besides a track record and character, clients also have to be offering a fund which Helix think can be successfully marketed.
“They may have an interesting proposition, but no demand,” says Barber. “For instance, although we specialise in Europe, we’ve looked at a number of Greater China funds, but said ‘no’ because there’s not enough demand yet.”
Once a client is taken on, the vetting process becomes more intensive.
Two to three months are spent on preparing the offering, which means more research, plus refining the presentation.
The marketing strategy also has to be ironed out – for instance, if the managers are Swiss-based, Helix must decide whether to offer the fund to Swiss investors first, in
case it looks more credible to other investors if it is backed by local
Once the presentation and private placement memorandum (effectively the prospectus) is complete, Helix contacts potential investors. The agent possesses a list of investors on its database, and this is enhanced by in-depth knowledge of likely candidates in specific countries, each member of staff being assigned to cover individual countries.
Potential investors are then sent a letter enclosing the private placing memorandum. If they agree to a meeting, they receive supporting information, while the client receives a briefing note.
Dozens of one-to-one meetings are then held between the client, Helix, and investors.
However, with each investor independently vetting the fund, the process of getting them on board can be long-drawn-out. Barber once received around 40 follow-up
e-mails after meeting one potential investor – who in the end, did not commit.
Agents give investors confidential evidence about the funds, often presented in a so-called data room. These can include records of the reference calls, but may also cover more general information about the specific market and sector that the fund is investing in, as well as competitor funds.
The end objective is the signing of the limited partnership contract and deed of commitment, which obliges the investor to put in tranches of money at the manager’s discretion. For the placement agent this is not easy, however.
“We try to set a fixed date for closing, but getting people to come in is like herding cats, and it often slips out of our control,” says Barber.
Agents collect their fees when the investor makes a commitment into the fund, although some agents may be paid a retainer upfront.
Helix charges a small fee to cover research overheads, but virtually all its fee is a percentage of the capital raised. In general, the agent’s fee may also depend on the size of the client or how well-established they are.