PRINT THIS PAGE Structural solutions for a longer life20/07/2005. Source: SJ Berwin. Jonathan Blake
Just as support for a unified European fund vehicle seems to be building some momentum in Brussels, a debate is also developing about whether a "one-size fits all" model can be the right answer for an evolving - and increasingly diversified - private equity industry, says SJ Berwin.
The cover story of a recent issue of the industry publication Real Deals featured SJ Berwin's head of private equity, Jonathan Blake, in an article evaluating the merits of the limited partnership - the dominant structure in Europe for funds. And as the range of available vehicles continues to expand - with countries like Luxembourg specifically creating new legal structures to persuade funds to locate there - that debate about optimum fund structures is sure to continue.
Of course, the starting point for this discussion should not be an analysis of the legal vehicles available, but the commercial objectives of the promoters, and those of the investors they want to attract.
When private equity began to develop in Europe more than two decades ago, the commercial need was for a vehicle that provided a tax efficient wrapper for a series of managed investments intended to deliver capital gains within a relatively short period of time. Investors were happy to commit for a period, but because of the illiquidity inherent in the underlying assets most wanted their money back when assets were realised, there being no other obvious way to get out. The limited partnership provided a good way to achieve that.
But not all funds have the same commercial objectives. Even in the early days there were other models, with some large funds opting for an evergreen (not a limited life) structure, where liquidity was offered by the secondary market for shares in a corporate structure. Although nowhere near as prevalent as the LP, that structure is also well established, with a number of European houses operating (at least in part) through an investment trust or other corporate entity.
But there are also problems with that model - in particular, driven by the inherent nature of the underlying assets, discounts are often applied by investors. That makes further fundraising harder and the management focus more short term (as the quoted price of the fund becomes a pre-occupation in itself).
The debate is now being fuelled by some industry observers who are starting to argue that the industry has shifted. With private equity now well established as an alternative ownership model for many types of company, there is a thought that the traditional 3-5 year time horizon for an investment no longer makes sense. Some point to the rise in secondary buy-outs as evidence that there are many companies that simply do better in private equity hands in the longer term, rather than for a transitional period before they go back to a trade buyer or float on the public markets.
And, in the venture world, longer holding periods (seeing companies through multiple financing rounds) are seen as inevitable, particularly while public markets have less appetite for high growth stocks. That would point towards funds having a longer lifespan. One can also argue that the increased liquidity provided by the secondaries industry - offering LPs a way out of a fund before it is wound up - could get some investors out more quickly if they need a faster path to liquidity (although secondary sales are also at a discount).
The emergence of infrastructure and renewable energy funds - that typically invest in income producing assets with a much longer holding period - is also pushing the same way. These funds often try to offer investors a range of exit options, including an ultimate intention to float the fund itself, but the primary motivation for investors is usually the income that the asset generates during its working life, not the profit on its ultimate sale.
So these developments are stretching the limited partnership model, but for most GPs and institutional investors a limited life structure that simply makes investments, realises them and distributes the proceeds is still seen as the most robust approach: the underlying assets do not lend themselves to many other options. What does seem more likely is that investors will sanction a longer tail fund and, increasingly, limited re-investment.
One size will not fit all. But for the time being, the limited life structure looks to have a strong future, and the limited partnership fund (and its variants) still does that particular job rather well.
Jonathan Blake
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on our services to the private equity industry please contact Simon Witney in our London office 020 7533 2222 or visit our website at www.sjberwin.com
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