Q&A French Fundraising

01 April 2008

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The French market has experienced limited liquidity when it has come to large leverage transactions in 2008. In the past two months there have only been a couple of large buyouts in France. Limited partners have had to consider alternative means of investment in order to generate same rates of returns formerly offered by LBOs. In contrast, Q1 2008 has seen a number of funds holding their final close, all of which have reached their targets, some indeed exceeding them. In an attempt to gather an insight into the current intrinsics of fundraising in the French private equity market Francois Rowell speaks to Charles Lemon of Matrix Group, the placement agent for the Pechel Industries III fund which held its second closed this month; Jean-Pierre Cerange, president of Pragma Capital and manager of newly-closed fund Pragma II; as well as Herve Schricke of XAnge Private Equity, which recently closed Xpansion, its first capital development fund.

What is the current fundraising climate in France?

CL: Fundraising is never an easy process. However, I would not say that the recent market troubles have not particularly affected the fundraising process at the lower end of the market. Investors remain very interested in managers that have a proven ability to generate returns.

As an example, we are currently raising Pechel Industries III; the fund has been very well supported by the existing investors and is generating increased interest from international investors. European LPs are still confident of the long-term performance of the asset class and have significant pools of capital to invest.

It is perhaps too early to say how much the real mid-market has been impacted by the current economic conditions; however, we are probably seeing a much needed slow down or market rationalisation, rather than any fundamental shift.

JPC: The current financial trends will not bear a huge burden on fundraising in the French private equity market. Private equity is cyclical. Yes, we can currently see a number of constrictions which have come into play, but these are only temporary. It must be emphasised that private equity is a long term asset class. We must remember that funds do not have a lifespan of a single year. Therefore it is important that investments are made with a long term scale in mind. Traditional investment of three, four, five, even 10 years in which case the current market troubles may look like a minor blip. Private equity is not directly linked to the markets therefore LPs will still look to invest capital in a reliable long-term vehicle. In the end LPs will invest only when they can and when they feel the conditions are favourable. Current fundraising patterns such as the closure of Pragma II show that fundraising in France is healthy and LPs are still willing to invest, albeit maybe with a greater degree of caution. In the goal of seeking out a good IRR, LPs will continue to seek out a good track record from GPs' management teams in order to subscribe to the most secure fund with the most potential.

HS: The current fundraising climate could be less positive than previous years; this does not mean, however, that it is in any difficulty. Private equity is currently adapting to the market conditions. For example, XAnge has just raised a capital development fund with a view to take a different approach to benefit from the current market conditions in the long term. LP investors had initial reservations on capital development, often not identified as an asset class due to uncertainties about investing in minority stakes, which can be perceived as not having control on an investment. However, LPs will see that future exits are far easier than in the past because they are better construed in the initial deal. For large funds currently highly invested there may be more difficulties to exit or secure secondary buyouts. Investors may take a little while to adjust to certain GPs' moves as they adapt funds to the current market. Investors will still always seek quality investments and will vigorously research investment teams.

What are your thoughts for the future?

CL: For the immediate future, it is going to be interesting to see how some of these funds are going to spend the money. We have seen a lot of fundraising over the past 18 months, and a lot of funds significantly increasing in size.

The mid-market is a very competitive environment for finding and winning deals, and with a less favourable economic outlook, managers may find it increasingly difficult to emulate recent performance. True proprietary deal flow or a true differentiator is the only way to guarantee a reasonable entry price, which itself is a pre-requisite to generating real returns.

JPC: If we have one or maybe two years where there is a comparative underperformance in the French private equity market it will not cause a crisis. It would be inaccurate to judge the private equity market on such a short scale since private equity is a long-term investment. It is fairer to adopt a scale of maybe 10 years at which point the current uncertain times will be put into perspective. Limited partners understand this, which is why funds that were launched last year are still hitting their target closures. Both the GPs and the LPs acknowledge that the financial troubles we are seeing will eventually turn for the better and that is the point when we want to have funds ready to make investments. This does not mean, however, that GPs are going to simply wait for the financial climate to turn; they too will still endeavour to seek out interesting and high-yielding investments which we believe will be situated in the French small- to mid-market.

HS: Private equity is flexible and will adapt; it has done so before and the signs show it will do so again until the markets are favourable again. We have just our first capital development fund which we feel is adaptable to the current climate. With many GPs downsizing, we believe we will be in a comfortable position investing early-stage and expansion deals. Over the next year expect to see a drop in prices since they have been highly inflated over the last few years.

What sectors are currently generating more interest from LPs?

CL: European distressed and turnaround funds are very hot at the moment, although not that many are available and they become very quickly oversubscribed. We think growth capital is gaining a lot of attention, even later-stage venture and tech buyout funds.

The established managers in the mid-market remain very popular and despite some concern that larger LBO firms would start competing for investment opportunities in the mid-market, we don't believe that this will last or have a significant impact since it constitutes a different strategy and a different approach to investing.

JPC: We believe that this year there will be a particular interest in the French services sector as well as the energy sector.

HS: For 2008 there should be a focus on technology and software, especially companies in early-stage or companies looking to expand. Also in the small- to mid-market funds focusing on anything relating to mobile telecom companies, or related to the internet, the internet is likely to get particular attention from LPs.