Liquidity for the house: Preparing an alternative asset manager for sale

Written in conjunction with John Humphrey, Partner, Berkshire Global Advisors

Overview

While the vast majority of alternative asset managers remain owner-managed, in recent years a growing number of GPs have pursued IPOs, equity and debt solutions from external investors, and even outright sales. With such M&A activity in the private funds space initiated by a wide range of drivers – including generational shifts, liquidity requirements or the need for expansion capital – the complexities of executing deals to achieve optimal outcomes cannot be downplayed.

The increasing rise in the availability of liquidity for alternative asset managers is a marked shift from the position signalled by the High Court in 2014 in Re Charterhouse Capital Ltd. In this case the judge commented that private equity businesses are "among the most difficult types of businesses to sell", with IPOs "challenging" and sales to competitors "unlikely". He also said that, although not impossible, it was clear that it would be "extremely hard" to source third-party investment.

Fast forward eight years and we now see successful financial sponsors regularly able to attract investment at valuations that are highly attractive to their current owners, while last year also saw the completion of IPOs by alternative asset managers including Petershill Partners, Bridgepoint Group and Antin Infrastructure Partners.

Reasons for this change in the landscape are varied but reflect the fact that there is rapidly expanding investor appetite for GPs as an asset class; third party equity and / or debt financing is being sought to fund higher levels of GP commitments required by LPs; and those LPs are increasingly demanding multi-strategy, multi-jurisdictional investment managers that can offer a suite of products to increase their exposure to alternatives.

Engaging stakeholders

A primary consideration at the outset of any deal of this kind will be how to successfully manage the interests of all stakeholders: the leaders and/or founders of the business, the LP investors and the non-partner senior team in the business, and how to engage with them in a manner which allows the deal to be delivered and enhances the future growth prospects of the business.

Leaders/Founders

There will frequently be several founders with different motivations, objectives, and interests spread across several funds. Many deals collapse because the partnership cannot agree on the way forward. Seeking input from experienced third-party advisers and taking the time upfront to collectively agree on a strategy that everyone can get behind is an essential  part of the process. Furthermore, tackling head-on those dynamics between the partners in the business which may potentially give rise to issues down the line is fundamental to successfully delivering the deal.

Investors

It should also always be remembered that these are businesses that are dependent on raising capital from investors through building strong relationships with them over time, so the engagement with investors must be carried out thoughtfully and in the right way. Limited partners are live to the new market in GP-stakes and the possibility that GPs may seek to deal with their succession issues through a sale to a larger house and have consequently reacted by increasingly insisting on change of control provisions being included in limited partnership agreements. Furthermore, any corporate event in the GP is likely to result questions across the board from investors and so being ready to anticipate these up front, and demonstrate ongoing alignment, is key to the success of the transaction.

It is worth noting that it is not unusual for deals which result in a change of control to be contingent upon a consultation with the LP advisory committee, though even more likely is some kind of approval process from LPs that will require an investment of time and resource by the GP to secure buy-in.

The principal concerns of investors will typically focus around the stability of the business and continuity in the core team, as well as ongoing alignment of interests. Managers are always advised to be as transparent as possible with LPs, as they will understand the dynamics and the need for re-investment in future funds and positive structuring for the next generation.

The team

It is stating the obvious to say that alternative asset management businesses are dependent upon the people within them and a corporate event, like a sale or third party investment, can be unsettling and result in senior team members who are below the C-suite questioning what this means for their own future, and their place, within the organisation.

Utilising the ability to negotiate via video conferencing and work from home flexibility that the pandemic introduced across the office based sector, establishing separate email accounts, and holding all meetings outside the office are practical solutions to maintaining deal confidentiality until such time as it can be announced and enable the founders/leaders to control the messaging.

Equally, carefully constructing communications and doing it in a manner agreed with a buyer or equity finance provider may also help to settle team members who otherwise might be uncomfortable with the change.

Finding the right partner

These are not transactions that are usually suited to an auction processes, in part due to the importance of confidentiality but also because cultural and organisational fit – and meeting the different liquidity requirements and longer-term objectives of the founders, senior partners and next generation within the team – are both integral to a successful deal. Considering these factors is fundamental before the potential buyer universe is explored.

Limiting the parties approached about a transaction can help prevent a leak about the deal – something which, for the reasons identified above, is particularly important in the early stages of market exploration. After initial discussions, conversations can move into discovery to explore in more depth the potential around business fit and cultural alignment.

Once a potential buyer is identified, they will want to embark on an extensive and potentially intense (and intrusive) due diligence process for which managers are rarely well prepared. That process will focus on investigating the firm in great detail, diligencing the robustness of management, and exploring the robustness of IT systems, regulatory compliance processes and financials. If the founders are not all selling out, this will be alongside a go-forward process that includes a great deal of discussion on crafting the strategy and governance arrangements to engineer the best way forward.

Structuring the deal

The final challenge is around identifying the right structure for the transaction to fulfil the requirements of all the stakeholders and provide a secure platform for future growth.

Economics

Earn-out periods typically extend from three to ten years, depending on the liquidity requirements of founders and the projected fundraising horizon. Metrics are generally based on EBITDA thanks to its ability to capture both assets under management and revenue growth in the context of costs. That said, some firms will flip to a revenue-based multiple to avoid impeding the ability to synergise.

Entitlements to carried interest in existing funds, for both partners and other senior members in the firm, can also potentially be monetised on a platform deal. Although achieving a satisfactory valuation for this can be complicated and buyers will typically expect that any clawback due to investors will be treated as a price adjustment, it can be a meaningful way to give liquidity to employees below partner level and help sell the deal as a "good news story".

Governance

The degree of control retained by the senior leaders in the business post-transaction is fundamental to how the deal is sold to the relevant stakeholders. Founders have been known to hold onto entrenched rights to sit on the investment and management committees (or other key decision-making bodies) for at least the period of any earn-out, which mitigates the immediate impact – for the firm and its investors – and helps to reassure the selling shareholders that their economics will be protected. Whilst surmountable, a buyer who seeks to exert absolute control over such a business post-completion should bear in mind that this may make the deal slightly more difficult to sell to limited partners.

The end result

The end result should be a new partnership with a third-party stakeholder where there is a good fit for all stakeholders involved with a new, longer term trajectory for the business secured to deliver continued growth into the future. Despite the current macroeconomic uncertainties, sponsors can still expect their businesses to be an attractive investment and acquisition targets for now, and the trend towards consolidation is unlikely to slow as compliance costs and the levels of regulatory scrutiny continue to increase.

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