LPs highlight continued relevance of French private equity market

Speaking to French daily Les Echos earlier this week, PAI partners boss Lionel Zinsou remained unfazed by the prospect of trying to attract commitments from international investors for a €3bn, France-based fund. "It is wrong to believe that France scares the rest of the world. I think it mainly scares French people themselves," he said.

But wind the clock back a few months and one would have struggled to find private equity professionals – bar the most stoic of local players – willing to stand in France's corner. The country was still reeling from a year that saw dealflow slump to post-crisis 2009 levels, as well as the fiscal zeal of a newly elected socialist government eager to tax capital gains in line with the highest income bands. Combined with a national economy slowing to a virtual standstill, these woes made France the punch bag of many a panel at industry conferences throughout Europe.

Attitudes are indeed changing, according to Christophe Bavière (pictured), CEO and managing partner at Idinvest Partners, which invests both directly and as a fund-of-funds manager throughout Europe: "Granted, LPs can be baffled by the more worrying political and economic issues. But LPs nowadays are incredibly sophisticated and well informed: they know that after the US, Europe is one of the largest industrial forces in the world, and that Europe is not limited to Germany. Even the most France-sceptic of LPs realises that part of the strength of Europe, and therefore some of the best investment opportunities, also lies in French companies and French entrepreneurs."

Difficulties remain, but savvy LPs haven't lost sight of the market's strengths

Ardian (formerly Axa Private Equity) closed its latest €2.4bn fund at the beginning of October, shortly after finalising its spinout from Axa. Ardian managing director Dominique Gaillard also believes that the worst might be behind when it comes to marketing France-based funds. "We have been seeing a lot of LPs over the past 24 months and it is true that selling products based in France was sometimes not the easiest thing to do. There are still some investors, particularly from the US, who we have to fight somewhat harder to convince that it is all about betting on good managers and strong businesses, not on the French macro environment," he says. "But more LPs, particularly from the Far East, now recognise that it is probably a good time to invest in France, as the best GPs will find opportunities to buy strong assets at reasonable prices."

Signs of respite
For many LPs, the manager case is indeed stronger than the country case and Neil Harper, managing director at Morgan Stanley Alternative Investment Partners' fund-of-funds division, states that the firm's view on France hasn't really been swayed by recent developments: "The first and single most important driver of our selection is the fund manager itself and the quality of its team - at the end of the day, the macroeconomic aspect is not that important. If the manager turns out to be focused on a sector where France is particularly strong, for instance, that would make it even more compelling. But the foremost criteria we will look at are a solid manager and a proven strategy."

And international LPs looking past the cover of The Economist might even find a few things to like in France. The first months of 2013 have seen welcome signs of respite for the industry, most notably a momentous U-turn on tax issues. Part of this was not the government's doing - Hollande's infamous 75% tax for higher incomes was scrapped by France's Conseil Constitutionel - but efforts were clearly made to appease an increasingly vocal business community. "The debate has been considerably pacified in the first few months of 2013, from both the industry and the government sides," notes a local mid-cap player. "The latter realised that we are responsible investors making a positive impact on the economy, and that a few misconceptions had to be scrapped."

As a result, instead of punitive capital gains tax (CGT) rates in excess of 60%, both entrepreneurs and private equity players stand to benefit from a regime ironically more favourable than under the reputedly business-friendly Sarkozy administration. Although still taxed at the same level as income - allowing the government to save face - CGT will benefit from hefty rebates depending on the nature of the shareholder and the length of the holding period. CGT could be cut by as much as 65% following an eight-year holding period, with the break tapering sharply after just two years. These changes would result in an effective tax rate of 32.75%. Investors in start-ups will be treated even more favourably, with steeper rebates resulting in an effective tax rate of 23.75%. The fact that there are no specific rules for carry means the rebates will also apply to private equity funds.

Dealflow is also (finally) on the up, particularly in the mid-market, where France saw investments worth €3.1bn completed in H1, against €2.3bn in the second half of 2012, according to unquote" data. The second quarter also saw France lead the European pack in the €500m-1bn segment, with four deals worth a total of €2.8bn, double the H2 2012 figures and exceeding the UK's €2.4bn across three deals. It would appear the country's assets still have drawing power even beyond the purely local GP base. Take Equistone for instance: three of the four investments scored by the GP in the first eight months of the year were done in France.

The picture has improved considerably on the venture side as well. The second quarter was particularly buoyant, with activity reaching an 18-month high, according to unquote" data. France notably proved that - contrary to some other European countries - its venture ecosystem is fit for nurturing innovative businesses past early funding stages: the country featured the strongest in unquote's top 20 largest VC deals of 2013 (see our Venture Capital Report, available in the unquote" app).

Furthermore, EVCA released a study in March likely to boost the morale of local mid-cap buyout houses - and catch the attention of LPs looking for hands-on value creation. The productivity and employment CAGR figures measured in portfolio companies between 2005 and 2011, at 10.5% and 5.8% respectively, put France ahead of its European neighbours in EVCA's Delivering the Goods report.

Finally, it would appear that the country delivers on the returns front as well. The latest Afic data reveals French buyout funds outperform their UK counterparts, with an average net IRR of 14.1% since inception, versus the UK's 13.4%. "There is undeniably a real, deep and solid track record in France," says Bavière. "While [Afic's data] proves that the entire GP base performs well overall, these headline statistics also hide a great disparity between teams - with some managers delivering excellent performance."

Room for improvement
While things are improving, there undeniably remain points of contention. The local private equity industry is struggling to shake off the image that, although mature and deep, the GP landscape is in dire need of a shake-up - starting with the sheer number of players on the market. "The French mid-market buyout fund scene got slightly overcrowded around 10 years ago, with supply possibly exceeding demand in later years. This happened everywhere else in Europe, to be fair, but was perhaps more keenly felt in France, paving the way for a wave of consolidation in the sector," says Bavière.

Harper agrees that too many "me-too" funds have historically plagued the country's upper-mid and large-cap markets, but offers words of solace: "For a start, a number of GPs won't be able to raise new capital in the future. Furthermore, most of the bank-sponsored teams, which have historically been a significant component of the French private equity market, won't be in existence going forward. Overall, I have a reasonably positive outlook on the French market for the next five-plus years from that point of view."

The words might be comforting, but Harper also warns that local GPs will also have to try harder at differentiating themselves if they are to remain relevant in an increasingly competitive fundraising environment: "France is home to a lot of experienced, good-quality generalist managers. This is both a strength and a weakness: there are benefits in being able to rely on a mature GP base able to deliver, but France should have more space for more specialist strategies and these haven't really materialised yet."

Beyond consolidation and strategies, some observers argue that the generational change looming for many managers should urge them to tackle team dynamics issues head on. "Unfortunately, some of the GPs are a bit stale when it comes to succession, which can result in awkward situations. Second, there is a perception among LPs that some teams are a collection of bright individuals as opposed to a well-glued collective," says Armando D'Amico, managing partner at placement agent Acanthus, which counts French GPs Azulis, Perceva and Nextstage among its client base.

Finally, the progress made in the first half of 2013 cannot fully make up for the fact that French GPs are still at the mercy of an unstable, potentially constricting fiscal and political framework. "The French private equity and venture industry does fairly well already, despite a sometimes stifling amount of red tape," says Benoist Grossmann, a managing partner in charge of direct venture funds at Idinvest. "If that administrative burden could be lifted, even slightly, we could be able to rival US players. Think of it as two equally skilled swimmers, but with one having weights tied to its feet, while the other wears flippers."

"Unfortunately, the efforts to explain all the country's strengths to international investors are made all the more difficult by bouts of incredibly ill-thought-out political posturing," Grossman bemoans, before recalling Yahoo's failed attempt at buying VC-backed online video platform Dailymotion, thwarted by a government keen on keeping the business in French hands. "US venture players will think long and hard before investing in a French start-up following the Dailymotion debacle: if the business turns out well, the French state could block a potential sale."

These long-standing obstacles might remain a major thorn in France's side, and will still be driving away those LPs less keen on making the effort to find diamonds in the rough, but even this lack of universal appeal can have its own advantages for contrarians. Says Bavière: "On the flip side, these 12 months of uncertainty and ‘French-bashing' have created opportunities for investors with a longer-term vision and a good understanding of the intricacies of investing in Europe, and more specifically in France. One of our secondaries funds has clearly benefited from some investors offloading, perhaps too quickly, part of their European commitments in reaction to this perceived complexity and risk."

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• IDInvest Partners (AGF Private Equity)
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