Post-economic crisis the industry standard terms for private equity are being re-evaluated by all parties and many are looking to new geographic horizons to seek out the best returns.
Change is certainly afoot and, as Cayman Islands counsel to the offshore funds promoted by many of the world's leading private equity fund managers and as fund formation activity continues to steadily increase year-on-year in the Cayman Islands, we are in a unique position to identify the trends occurring in the offshore private equity funds space and in the wider private equity market. 2015 is shaping up to be an interesting year and here we give our thoughts on two of the most interesting trends coming out of this year's vintage of funds.
IT IS ALL ABOUT THE LONGER-TERM HORIZONS...
Whereas traditionally investors in private equity expected to see their money locked-up for 10 years, subject to extensions (at the discretion of the general partner, by a vote of limited partners or the advisory committee), rarely for more than three one year periods, with a fairly standardised fee-structure, it looks like the horizon might just be changing.
THE TERM OF SOME NEW FUNDS JUST GOT LONGER...
With a number of key players, from the middle-market to the biggest buy-out firms, coming to market with new funds with longer-term investment horizons, with some proposing fund terms even as long as 20 years, investing in slower-growing, less risky assets, with less leverage and a more investor-friendly fee structure.
So, why is longer better? In the current macroeconomic climate of less leverage and more competition, players on both sides have had to reassess their expectations of returns and fund managers are now looking to diversify their offerings accordingly. By increasing the terms of these new funds, fund managers are able to make investments that don't fit within their existing buy-out fund mandates, for example, long-term infrastructure projects or assets which are better suited to more permanent capital, for example, insurance companies. In fact, in recent years many of the biggest names in private equity have turned their attentions to the insurance sector and have spent billions of dollars on insurance assets and, in some cases, have even raised funds specifically focussed on financial institutions and insurance companies. By investing in these types of assets over the longer-term, fund managers are able to collect a steady, more predictable stream of income, significantly increasing their AUM (as they in turn manage the investment of the capital of the portfolio insurance company as well), enhancing their values in such a way that is particularly attractive for the publicly traded fund managers out there.
How long is too long? Longer fund terms are attractive to investors looking for a reliable yield in this period of historically low interest rates with less frequent deployment of capital and to those that would prefer to hold on to high growth assets over the longer-term rather than divesting prematurely simply because the term of the fund is coming to an end at the typical 10 year point. But, for some investors it may be difficult to commit to a longer term strategy. Ultimately whether this trend continues will be determined by whether the lower but more predictable returns and lower fees make this a more attractive prospect for investors versus investing in the public markets. Only time will tell.
WHILE THE SUN IS SETTING ON OTHER FUNDS...
Given the huge volume of private equity funds raised in the 2005-2008 period and, assuming that a significant chunk of those funds were established with the traditional 10 year (plus extensions) model in mind, it is clear that we are entering a period where a huge number of funds are reaching the wind-up stage of their life-cycle.
But, are these funds ready for the sun to set? You would expect that these funds would be in the final stages of liquidating their assets but some commentators are suggesting that due to decreased levels of capital deployment during the economic crisis many of these funds still in fact have sizeable unrealized value, requiring the fund manager's time and resources to continue to manage and eventually realize. What does this mean for investors? This will somewhat depend on the specific circumstances, for example, are term extensions permitted in the fund documents and if so, for how long and whose consent is required? If the consent of investors is required, it is paramount that the fund manager is able to convey a clear strategy for liquidation within a time frame that is acceptable to investors. However, there may be diverging objectives among the investors with some open to an extension of the fund's term in order to maximise long-term value versus other investors in need of immediate liquidity.
Money talks...In recent years we have seen a steady increase in the number of funds going out to market with significantly more flexible and potentially longer periods of extension to their terms, even up to 15 years in some cases and an uptick in the ability of GPs to unilaterally extend the term. It would appear that fund managers have learnt the lessons of the past and are now looking to make their documents as flexible as possible to avoid headaches in the future. But if you are an investor focused on immediate liquidity, you could find yourself trapped in a fund for longer than you would like. This could be from the GP having a right to unilaterally extend the term, the fund's larger investors wanting to extend the term to maximise value, or because you are a minority investor in a fund that requires a limited partner vote to extend the term.
WHILE SOME ARE LOOKING OUT AT THE STUNNING AFRICAN HORIZON...
So, while some fund managers are turning the traditional norms of private equity fund terms on their head, other fund managers are changing their geographic focus to make their mark, putting aside concerns over the short-term challenges for the stunning longer-term horizons that investment in Africa, and in particular Sub-Saharan Africa, can offer.
MORE, MORE, MORE...
With stagnant European economic growth, the current Chinese uncertainty contagion and a congested U.S. domestic market, the private equity industry is putting aside concerns over falling commodity prices, political uncertainties and fears over the scale of the Ebola crisis to focus on the stunning promise of Sub-Saharan Africa with almost US$4 billion raised by private equity in 2014 for this region alone, according to the Emerging Markets Private Equity Association. Such is the interest in the region that we are now seeing key U.S. players raising funds specifically focussed on the region and all indications are that this is a trend that will continue judging by the significant uptick in the number of 2015 vintage offshore funds that we have seen coming to market with this geographic focus. According to the African Private Equity and Venture Capital Association, 2014 saw record levels of investment with private equity funds investing US$8.1 billion in African companies. Traditionally, the focus for private equity investment in Africa was the region's abundance of natural resources but increasingly, investors and fund managers alike have changed their focus and are looking at the African consumer market for returns, for example, infrastructure, healthcare, education, telecoms and financial services, brought about by demographic shifts in the region's increasingly urbanised population with more disposable income.
AGAIN IT IS ALL ABOUT THE LONG-TERM HORIZONS...
This is certainly a region not without its challenges but it has good long-term fundamentals and provided that all players focus on the longer-term potential rather than the short-term challenges, we believe that Africa will continue to emerge as an exciting opportunity for private equity.
In recent years the macro economy has thrown a few curve-balls at the private equity industry, forcing all players to reassess expectations, re-evaluate industry norms and focus on new horizons. Whether the trends we are seeing turn out to be anything more than ephemeral, only time will tell, but so far the private equity industry has proved itself to be a pretty adaptable beast.
Previously published in The American Lawyer | October 2015
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