HIG Comes to Europe
When HIG Capital burst on to the European scene this summer – with a 600m fund targeting the lower mid-market and a new team made up of some of the industry's biggest rainmakers – it took many of the region's incumbent players by surprise.
"I thought the paper I was reading must have made a mistake," says the head of one private equity firm, which now finds itself going head to head with HIG. "I thought they meant HgCapital. I had never heard of these guys and was taken aback by how aggressive their arrival in this market has been."
But while little known on this side of the Atlantic, HIG is a pre-eminent brand in the US. Created 14 years ago by former Blackstone executive Sami Mnaymneh and Tony Tamer of Bain & Co, the firm has upwards of $4bn (2.9bn) under management.
HIG has resisted the temptation to climb the food chain, however, retaining its historical focus on deals valued at less than $250m, with a $10m to $40m equity sweet spot.
Instead it has expanded horizontally and now has separate pools of capital available for small buyouts, later-stage venture capital, distressed debt and a hedge fund-style product targeting public securities.
"We have a flat and flexible model. Whatever the funding requirements of a small-cap business, we can meet them," says Mnaymneh, who relocated to London last month to mastermind the firm's European strategy. "Our next step in this segment is to take our model to Europe and to replicate there what we have done so successfully in the US."
According to HIG, the firm has been active in Europe for years, regularly acquiring businesses with European subsidiaries and executing multi-jurisdictional deals.
But this is still very much a new territory; of HIG's 60 investments from its US LBO fund, just a handful, including French cosmetics business Diam Europe, acquired in March, have headquarters outside North America.
In fact, there has been nothing gradual about the firm's entry into Europe.
When HIG closed its maiden fund in July, it already had 13 professionals on its books in London, Paris and Hamburg. Another nine are poised to join by the end of the summer, and the firm plans to have built a 30-strong team by the start of 2008.
The UK office, which will consist of 13 investors when fully staffed, is co-led by Paul Canning, formerly one of Gresham Private Equity's most prolific originators, together with Matthias Allgaier, who joined from small cap investor Favonius Ventures, having previously worked at Apax Partners and General Atlantic. The German office is led by Wolfgang Biedermann, previously of Pricap Ventures and one of the founding members of Schroders' German team, while Patrick Caron, previously of BA Capital Partners Europe, heads the office in France.
The firm's primary ethos with the launch of the new business has been to hire locally.
"I know it seems obvious to recruit from the market you are going to be operating in," says Canning. "But you would be amazed how many others have got it wrong."
Scale is also imperative to HIG. The size of its new European team already dwarfs many of its peers in the lower mid-market, but mirrors the firm's US model exactly.
"There are close to 100 investment professionals at HIG in the US," says Biedermann. "They have a $750m LBO fund over there, so relatively speaking we are actually a fair bit smaller at the moment."
He adds that the firm is set apart from its peers because it is prepared to provide commitment and resource to deal-doing. Given this resource-intensive approach, hiring the right people is a big task. The process has already taken 18 months and the rest of 2007 has been dedicated to building critical mass.
While the head of each regional team is an investment professional – several of whom have experience of launching new private equity operations – the broader team dynamic is diverse with regards to operational, consultancy and financial backgrounds – something which enables the firm to conduct its due diligence in house. All staff, even the most junior, also have foreign language skills and extensive experience operating in foreign business cultures.
"The skill sets are a mirror image of the US HIG business," says Allgaier. "It is a deliberate attempt to create a team with a cross section of expertise, both operational and financial, to fit the firm's hands on approach."
Mnaymneh's relocation from the US to London has proved critical to attracting several of the new recruits.
"I had never heard of HIG before," says Canning. "Sami's relocation was very important for the dynamics of the team. It certainly got me over the line coming from Gresham. If the co-founder risks everything, professionally and personally, it helps make the dots add up."
While each of the senior recruits spent a great deal of time in Miami, working with the US team to get a feel for its approach to origination, deal structuring and portfolio management, Mnaymneh's arrival in Europe has also provided much-needed continuity with the US strategy and a sense of coherence in a group with no historical connection.
"His presence is also vital because it means we will not be distracted by the little things," says Biedermann. "He is ultimately in charge, so the possibility of decision-making fractures in the group is limited. Importantly for me, he is also a cosmopolitan American who speaks French – not one of these Americans without a passport."
Mnaymneh's migration was also a linchpin to HIG Europe's success on the road. First-time fundraisings, however impressive the individuals involved, are notoriously difficult to complete. But by all accounts, the strength of the HIG brand meant this debut raced to its 600m target, almost entirely funded by the firm's existing investor base in the US.
"LPs love them to death," says Canning. "Institutional investors have been convinced by the firm's ability to replicate its US track record and Sami's relocation was a big part of that."
"I can see it is an utterly compelling proposition," adds one fund of funds investor. "The scale of resource being thrown at this team, coupled with an attractive market – I am not surprised they didn't run into trouble. The investors may not have worked together before but the infrastructure and ethos seems eminently credible and transferable."
Among the advantages that the firm brings is an ability to draw on US resources to enable it to underwrite both the equity and debt on a deal, as well as a transatlantic capability.
HIG's first fully fledged European deal is also a showcase for its strengths. The acquisition of Diam Europe, which has subsidiaries in the US, the UK, Belgium, Germany and Spain, was completed through Bayside Capital, HIG's distressed debt fund. From its US headquarters, the firm negotiated the purchase of senior debt from the company's American lenders at a big discount, according to Thibaud Caulier, the founding member of HIG's Paris team, who joined from an HIG portfolio company, where he oversaw the turnaround of the European operations. But from its fledgling French office it was then able to work with the business's French management team to arrange the equity package.
"We were the only private equity firm that could make it work because we were the only firm interested in this size of deal with that cross-border capability," says Caulier.
HIG underwrote both the debt and equity for the transaction, enabling it to complete within 45 days. It syndicated the financing five months later.
"With the current turmoil in the credit markets, it's great not to have to rely on the banks," Caulier says.
But there is a flip side to running such a large operation in the smaller deal market. Several in the industry have speculated as to whether adequate incentivisation will be possible for a lower mid-market firm of this size.
"It's a complicated team dynamic," says one lower mid-market investor. "I think there could be a case of too many mouths to feed. The question is, are they going to be effectively incentivised?"
This is something the HIG team vehemently denies. "What the size of our team proves is that HIG spends the management fee on resources, not simply as a bonus," says Biedermann. "That means we are very carry driven. It is true that we will have to generate better returns than our peers to earn the same money, but we believe that our deeper level of resource will allow that to happen. What better incentivisation than that?"
Deal or no deal
For now, at least, the focus at HIG Europe is on creating the infrastructure that will enable it to replicate its success in the US. The firm is putting no pressure on itself to complete any deals at all this year.
As for the future, a template for aggressive expansion is already in place. A Swedish national is soon to join HIG in London, and Scandinavia is a likely next destination – although Mnaymneh insists that if deal flow takes off more quickly in Spain or Italy, for example, the firm's plans remain flexible.
It is also on the look out for distressed debt professionals, initially to assist with complex LBO targets, but with a view to launching related investment products in the future.
Wherever HIG arrives next, there is no doubt it will make its presence felt. The firm's migration has already created a stir in the European market not seen since the arrival of the US mega buyout houses a decade ago. But while its model is unique, its team is, as yet, collectively unproven.
In the words of one lower mid-market investor: "I don't know what's going to happen. But one way or another the impact of this firm is going to be huge."
The ease wIth whIch HIG Capital's maiden European fund raced to its €600m target was unusual, to say the least, in the world of new emerging manager fundraising.
The fact that the firm is in the top five per cent of performers in the US clearly helped its cause. But such spin-outs and strategy migrations are normally a very tough sell to the conservative population of global limited partners.
A handful of institutions, primarily the big US pension funds and some of the longest standing investors in the European private equity market, such as Morley, Scottish Widows and Pantheon, have active emerging managers programmes. And there are even a small number of fund of funds players – notably Parish Capital – that offer specialist emerging manager services.
But while the enthusiasm and entrepreneurial flare inherent in a group of individuals starting up by themselves can be appealing – as well as the opportunity to talent spot the next big thing before it becomes prohibitively popular – the majority of limited partners have strict no first-time fund rules.
Furthermore, the current trend is for LPs to rationalise their portfolios. Investors are looking to commit more money with fewer managers, meaning that the criteria for selecting new relationships are becoming more stringent.
"Fund rationalisation means that it is all about re-ups now," says Garry Tipper, managing partner of Zeus Private Equity, a firm launched by a trio of managers from Aberdeen Murray Johnstone at the end of last year, which is in the market raising its £100m (€147m) debut.
"It takes a lot more to convince an LP to part with £10m than £100m," adds Rod Selkirk, chief executive of Hermes Private Equity, which is considering taking its third buyout fund, sponsored by the BT pension fund, to third-party investors. "Raising a first-time fund is never going to be easy in that kind of environment."
Spinning: a good story
The success, or otherwise, of a first-time fund depends heavily on the circumstances of its creation. "I think it depends entirely how first-time first time is," says Mounir Guen, chief executive of placement agent MVision.
The concept that institutional investors are most comfortable with is the spin-out – the primary advantage being that the new firm can provide proof of past performance as a collective entity. But even for teams with a collaborative track record, there is no guarantee that a maiden fundraising will be plain sailing.
In addition to the usual concerns about team instability, lack of back-office support and the pressure on first-time funds to complete new investments – the need to make the first few deals count can cause new teams either to be over-cautious or trigger happy – the motivation behind a spin-out is also a key area of focus for potential investors.
There is a perception that many new firms are the result of problems rather than opportunities."It could be remuneration, personality tensions, or simply that the firm has been going through a bad patch and can't raise fresh capital," says one LP. "But when you see a bunch of guys leaving their existing firm, the first thing you wonder is, what went wrong?"
There have been a number of fractures from, for example, Aberdeen Murray Johnstone– a firm which has recently emerged from a rocky few years following the contentious collapse of an attempted management buyout led by Jonathan Diggines. In addition to Zeus, another UK small-cap firm, Modus, has also arrived on the scene, headed by former Murray Johnstone investment directors Paul Newton and Mike Rogan.
Elsewhere, firms experiencing a strategy shift also tend to give rise to spin-offs spawned by disillusioned employees. Apax Partners, for example, has been through a period of significant change over the past few years, focusing on mega buyouts at the expense of venture capital, and increasingly the lower mid-market, too.
Toby Wyles, the co-head of European leverage at Apax, joined forces with Apax venture specialist Michael Risman and David Nahama, an Apax technology investor, in addition to Ian Riley of BC Partners and Mark Hatford of Bridgepoint, to create European mid-cap investor Vitruvian Ventures last year. Vitruvian has been in the market looking to raise €1bn for more than 12 months.
Another Apax venture investor who found himself increasingly redundant was Peter Blumenwitz. He left the firm to become one-third of the management team – alongside General Atlantic's Frank Hankelmann and 3i's Herbert Seggwiss – behind German firm Buchanan Capital Partners' new fund, which was launched with a €150m target early in 2006. According to industry rumour, more Apax spin-outs are in the pipeline.
Investment bank babies
One instance where the rationale of the spin-out has proved compelling, however, is firms that have devolved from investment banks. A decade after an initial exodus in the late 1990s, when banks nervous about the fluctuation of returns let private equity operations slip through their fingers, a second wave is now in full flow. Regulatory issues and conflicts of interest with lucrative private equity clients have given rise to a spate of spin-outs, including Court Square Capital, which has recently closed a fund on $3.13bn (€2.3bn) – well above its $2.5bn target – with no backing from former parent Citi.
Two DLJ Merchant Banking Partners spin-outs, Diamond Castle and Avista, have also done well, raising $1.825bn and $2bn respectively. Meanwhile, Argan Capital – run by Bank of America's former European buyout team – has raised €425m for its maiden limited partnership fund.
"It was a mutually beneficial split," says Argan founder Lloyd Perry. "We were already operating independently, sharing no carry and getting no real input in terms of deal origination or infrastructure. And we no longer fit with Bank of America's core strategy. They have also spun out their US VC business as Scale Venture Partners and their third-party fund business as Conversus Capital.
"We had the opportunity to build a great track record as part of this institution, but this was a logical time to start doing things by ourselves."
The degree of amicability in a separation is important in helping to determine the nature and success of a spin-out. The ability to avoid any bad mouthing, on either side, inevitably benefits both parties.
There are also legalistic implications. Take Argan, for example. The departing team was able to negotiate time to raise its new fund while still working for Bank of America, enabling it to be up and running as soon as it spun out.
Restrictions on soliciting commitments from the parent company's investor base can also be relaxed, although these are circumnavigable anyway; if an LP calls you, then there is no case to answer. It is also possible, in some instances, for those leaving the firm to retain carry rights.
One big advantage of a friendly divorce is the ability to negotiate attribution – one of the most controversial elements of marketing a spin-out. It is notoriously difficult to prove just what an individual contributed to a deal, and prospective limited partners have become acutely sensitive to manipulation practices, be it exaggerated involvement on stellar investments, or the more common cherry-picking, whereby less than impressive transactions are omitted from the literature of a new fund.
As Alexander Apponyi, a partner at BerchWood Partners, says: "LPs expect a cobbled together track record on a first-time fund. What they don't want is to be lied to."
A negotiated letter of attribution with a former employee can help avoid any unpleasant scenes. But there are alternatives. Exponent, a spin-out led by four former 3i investors – Tom Sweet-Escott, Richard Campin, Chris Graham and Hugh Richards – in 2003, provided a template for attribution analysis.
Together with placement agent Helix Associates, the team spent days poring over 6,000 pages of annual accounts in a coffee shop close to Companies House. They managed to reconstruct a record of 60 buyouts that had taken place between 1995 and 2003, proving – almost conclusively – that these four investors had been responsible for generating more than £1bn for 3i.
The diligence paid off, and top name LPs, including Pantheon, Allianz Private Equity, HarbourVest and Hermes, fought for the chance to back this fi rst-time fund, which closed above target at £400m in just five months.
Exponent's real attraction was not only that it was able to prove that each of its founders had a consistent track record of successful investment, but rather that many of these deals had been completed as a team.
Despite sometimes fairly weak attempts at establishing professional or personal links between team members at other new ventures, raising a first-time fund becomes dramatically more difficult if the individuals involved have not demonstrably worked side by side in the past.
"Non-spin-outs are a lot harder," says Guen. "When we work with these groups we tell them from the outset to expect to be out on the road for at least two years."
There are exceptions. HIG got around the issue by invoking the concept of brand. If an individual is of suffi cient prominence in the market, that can also go some way to carrying a fundraising. "Visibility is everything," Guen says. "Unsung heroes are no good. You have to be well known and well liked, particularly among the LP community."
When Graham Keniston Cooper left Cinven to head Lazard's new private equity division, he had an exemplary track record, but he was not a high-profile figure. Lazard failed to raise its debut fund and has since wound up its activities without completing a deal. Keniston Cooper has since been hired to raise Morgan Stanley's new European buyout fund.
Conversely, Atlas Venture co-founder Michel Dahan has already passed the €100m mark for his new life sciences venture, Aescap, and is heading towards a €150m hard cap. And when Harold Mix left Industri Kapital to launch Altor Equity Partners, assembling a disparate team of lawyers, investment bankers and debt providers around him, he completed one of the most successful first-time fundraisings of all time.
"Mix had handled the fundraising for Industri Kapital's two most recent funds. His was the face that investors knew," says Guen.
"He had an aura of magic around him," adds Selkirk, explaining that Altor's prospects had been helped by Mix's timing. "He was starting something new just when Industri Kapital was going out of fashion."
One of a kind
A single extraordinary deal can also be enough to create an institutional fan base. Phil Cuneo, who was responsible for Investitori Associati's involvement in the Seat Pagine Gialle investment, gained enough notoriety from a single transaction to generate huge interest in his next project, Synergo.
New Italian seed capital investor Innogest also managed to avoid the pitfalls of fi rst-time fundraising. Founders Marco Pincirolli of BC Partners and Claudio Guiliano of the Carlyle Group were able to exploit their relationships with Italian financial institutions – and the novelty of big-name big-buyout investors taking the plunge into early-stage venture – to complete an unusually seamless debut in an unfashionable area of the market.
For other firms, the lack of a collective history can seem too big an obstacle to climb and many first-timers decide against a traditional limited partnership fundraising. "It is what I call a bubble gum and bandages approach," says Guen. "Get money however you can to start building a track record and then think about a more formal fundraising in the future."
For example, Key Capital Partners – a lower mid-market UK investor launched by Mike Fell and Owen Trotter of Granville Baird, Peter Armitage of Apax and Mark Buttler of KPMG – has opted for an annual fundraising model.
It is less of an onerous commitment for institutional investors, giving the firm the opportunity to prove itself early on and increase the capital it has to work with in a relatively short period of time. "It gives us the flexibility to ramp up more quickly," says Fell.
Another alternative for a first-time team is to find a sponsor. Darwin Private Equity – launched earlier this year by Permira investors Derek Elliott and Kevin Street, and CVC's Jonathan Kaye – received a £50m cornerstone commitment from Lord Jacob Rothschild's RIT Capital Partners, for example.
But sponsorship can prove a doubleedged sword. Concerns about a sponsor's most favoured nation status, carry splits and conflicts of interest prevent many LPs investing in such a fund. It is understood that despite Darwin's founders having a raft of great exits between them, including Homebase, Kwik-Fit, Travelodge, Inmarsat and Formula One, the firm is not finding its debut fundraising as easy as many in the industry expected.
"I thought it was going to be another Exponent," says one investor. "They are really well-regarded individuals. But a combination of them coming together as a team and the question marks surrounding their sponsor are taking their toll. It's great to have someone paying the bills, but a lot of LPs are just too uncomfortable with that type of situation."
Some investors allay limited partners' fears by investing substantial amounts of personal money in their owns funds: Argan, for example, which has also had the advantage of buying a sizeable portfolio from its old Bank of America fund in a secondaries deal. Others begin by exclusively investing from their own pocket, while Modus is raising capital from private individuals on a deal-by-deal basis.
Infinity Asset Management, launched by former BDO Stoy Hayward corporate financiers in Manchester last month, has taken a similar route, raising its £50m from a small group of wealthy clients.
"At BDO I spent most of my day with entrepreneurial families and their businesses, buying and selling companies, doing due diligence, raising finance and dealing with tax issues – all of the skills required of a private equity investor," says Daniel Finestein, one of Infinity's three founders. "These clients were our logical first point of call."
One final solution to the perennial problem of raising a first-time fund is simply to take things slowly. If a firm can manage to reach a first close and begin investing, it has the opportunity to demonstrate its ability while on the road – a strategy most favoured by spinouts from investment banks. Avista, for example, had already invested €1.1bn in 14 deals by the time it finally wrapped up its debut fundraising.
Whatever the situation, a new name at the top of the headed paper will always make raising capital a challenging experience. Astute LPs do of course exercise some judgement in their investment decisions, as well as merely looking at historical performance. But for the most part, raising a maiden fund will continue to require subtlety, creativity, and a good dollop of spin.
Amy Carroll is deputy editor of Real Deals.