Nordic Fundraising Report: dealflow, co-investments and the road ahead

Click here to read the rest of the 2017 Nordic Fundraising Report, published in association with Aztec Group

The 2017 Annual Buyout Review, published by unquote” in March, investigated the drop in deal value for 2016 buyouts in the region, despite an increase in volume year-on-year. It concluded that, because of a very strong IPO market, and also a trend among private equity houses to hold their top assets for longer, GPs were increasingly targeting smaller deals where more value was available. “It is increasingly difficult to find quality assets to buy at reasonable prices,” said Simon Wakefield, head of acquisition finance at SEB, in the March article. “This might hold back some larger investments from being sold. You can see this [increasing focus on the lower end of the market] made visible by the number of houses that are raising mid-cap or small-cap funds with separate teams.”

Says Torben Vangstrump, managing partner at ATP-PEP: “It’s a good thing for private equity to have more than one exit route available to them, but the challenge is in developing companies that are able to become public successfully.” On the emergence of dedicated small- and mid-cap funds raised by larger houses, Vangstrump is contemplative as to the benefit for their limited partners. “You can look at this trend in two ways; firstly, the GPs feel that they are able to identify dealflow that offers potential investment opportunities. Secondly, and slightly more negatively, this represents a dilution of focus on the part of the GP, and I wonder if it is in their LPs’ interest?”

Data reported in the Annual Buyout Review supports the perceived shift towards the lower end of the market, as there was a dramatic increase in €5-25m EV deals, from 19 in 2015 to 28 in 2016.

From an LP perspective, this increase in competition makes the due diligence process behind investment decisions more important. “Competition for deals has increased, making hands-on value creation in portfolio companies important,” says Karl Falk, head of fund investments at AP6.

Co-investments and directs
The strategy of co-investments is one that is increasingly prevalent in the industry, says Norvestor’s Schau: “Most LPs we have spoken to recently mention their interest for co-investments.” Although there is a desire among LPs to participate in these transactions, there are strict requirements placed on potential participants, particularly around timings. In addition to adhering to the schedule of a co-investment deal, it is important that everyone involved in the process is clear in their communications of any obstacles and bottlenecks. Writing in AP6’s 2015 annual report, Christian Sinding, partner and deputy managing partner at EQT Partners AB, said: “It is important that promises are kept. We have a network of investors who are quick and reliable. Of course, investors must be given time to make a decision, but we prefer if questions are specific and put as early as possible.”

When offering co-investment opportunities, it’s important that the LP have the capability to execute on a sometimes very short timetable.” - Ulf Lundqvist, AP6

GPs know from experience which LPs are interested in which companies, and how much capital each is willing to commit to individual deals, and there are a number of LPs in the Nordic region who have been active co-investors for a long period of time. This track record is important to GPs when looking for partners in deals. Says Sinding: “The longer our history together, the better. This is a case of mutual knowledge, which is a prerequisite of good cooperation.”

“When forming new relationships for co-investments, GPs ask two questions,” says AP6’s Ulf Lundqvist. “When forming new relationships with LPs, we believe GPs put a lot of emphasis on the quality of money, which means having a good team, and also long-term capital. When offering co-investment opportunities, it’s important that the LP have the capability to execute on a sometimes very short timetable.”

AP6 have a team of 10 investment professionals working on direct and co-investments, and have become a preferred partner for co-investments with a number of managers. According to Lundqvist: “AP6’s experience with direct investments and the fact that we have a dedicated direct team means we have the ability to execute in line with GPs’ timetables.” Looking at AP6’s annual report for 2016, the pension fund made 10 co-investments over the course of the year in partnership with seven different managers. The importance of partnerships for carrying out co-investments is emphasised by the fact that four of these deals were executed in partnership with EQT.

In Denmark, ATP-PEP has developed strong co-investment capabilities, executing 51 transactions since inception. The fund-of-funds manager opened its New York office in 2007 to facilitate access to co-investment opportunities in the US, and Vangstrump notes the importance of adhering to a deals timetable: “It was important to have a presence in the same timezone to avoid becoming a bottleneck to the GP in the deal process.” The trend of LPs increasingly looking to partner with GPs on deals is something Vangstrump has noticed, and not just among larger institutional investors. There has been a notable increase in activity from family offices and foundations investing in private equity, and existing investors increasing their sophistication, including making direct investments.

“Over the last two decades, the market has developed at breakneck speed,” says Vangstrump. “It is more professional and internationalised than ever, and increasingly so. A stable pension system and supply of capital has contributed to the speed of growth of the industry in the region.”

Internationalisation
A topic that is becoming central to the private equity industry is internationalisation, with managers broadening their investment horizons and LPs looking to gain exposure to an increasing range of markets. For the Nordic countries, a region that has previously been dominated by local players, this growing internationalisation has the potential to significantly impact the dynamics of the industry on both the sponsor and LP side.

For local LPs, there has been an increasing allocation of capital outside of the region, as private equity programmes become more mature. As allocations are increased to the asset class, an increasing level of diversification is required. This scenario is common to LPs across the world, and, given the attractive economic picture for the region and track record of GPs operating there, overseas LPs are increasingly looking to gain exposure in the other direction.

As an example, Norvestor has broadened its LP base over the years, from 97% Norwegian LPs for its 2004-vintage Norvestor IV fund to 34% Nordic LPs and 66% global LPs in its latest vehicle. Says Norvestor’s Schau: “We started marketing to European LPs in 2003/2004, but, as it takes time building relationships, it took some time getting them on board. The size of Fund IV meant that it was backed by mostly Norwegian investors. Increasing our fund size over time, the track record generated by funds IV and V, and LP desire for exposure to the Nordic region meant that by Fund VI the LP base was much broader, and for VII even more so.

“There was a balance between Norvestor looking at overseas LPs due to the size of funds, and LPs wanting exposure to the region.” This balance is reflected across the industry, with any potential fundraising implications of local LPs looking elsewhere with part of their allocation offset by the increasing inflow of capital from outside the Nordic region, meaning GPs raising funds face a relatively straightforward process.

Lending
The growth of alternative lending funds, including buyout houses raising debt funds in parallel to their equity offerings, is a trend yet to reach the Nordic countries. “Local banks have very large balance sheets, and are happy to use them,” says Juha Peltola of Vaaka Partners. “There are very liquid debt and credit markets in the region, and therefore no shortage of credit to fund deals.” Looking at the top lenders by number of deals tracked by unquote” data, the dominance of traditional lenders is clear. Nordea, the region’s largest bank, tops the list, providing leverage in 29 deals, while other large Nordic financial institutions complete the top five. As ATP-PEP’s Vangstrump says: “A functional, robust banking system created a good climate for private equity.”

There are very liquid debt and credit markets in the region, and therefore no shortage of credit to fund deals” - Juha Peltola, Vaaka Partners

Relationships driving dealflow and fundraising
Despite the Nordic market being a particularly mature one, the level of intermediation across countries varies, and is also concentrated towards the top of the market. Where this intermediation exists, access to deals for overseas GPs is dramatically increased. However, for local GPs that have operated in the region for a number of years, the value of a local network for deal-sourcing lies in the opportunities that it provides over competitors from elsewhere that do not have these relationships.

CapMan originated in Finland in 1989, and raised and invested seven equity funds, as well as venture and mezzanine offerings, before expanding its operations into Sweden in 2004. Managing partner Markus Sjoholm points out there is a large difference between the markets: “Sweden is the most intermediated market in the region, and much larger than Finland, so we have to spend more time on deal sourcing there. Personal relationships with entrepreneurs are our primary route for deal sourcing, in Finland especially, although we do participate in structured auctions. We’ve not seen a significant increase in international competition in auctions, at least not in our size range.”

A similar observation is made by Vaaka’s Peltola; the Finnish mid-market GP operates almost exclusively in its home country, with one investment made in a Swedish business from Vaaka Buyout II. Moving up the AUM scale, GPs paint a similar picture. For Norvestor, whose average deal size since 2011 is almost double that of Vaaka’s, according to unquote” data, overseas competition is overwhelmingly around open deals. “Proprietary sourcing in the region remains a strong driver of deal flow for local GPs, which generally have a very strong network,” says Schau.

The importance of established relationships extends to GPs looking to raise funds, says Vaaka’s Peltola: “For new relationships, it can be tricky to get into funds later on. GPs and LPs will have a lot of long-term trust-based relationships. Where GPs have provided good returns, LPs like re-ups.” Vaaka recently hit the hard-cap for its third fund after three months on the road. “LPs are increasing their allocation to the asset class, and there is an increased interest in private equity from smaller institutions. With a stable, and growing, LP base in the region, and with no major changes anticipated in the industry, I expect the fundraising environment to stay positive.”

Future focus
Looking ahead, prospects for private equity in the Nordic region are looking good. Economic expansion is forecast to continue across the region, and local GPs across the size/AUM spectrum will be able to take advantage of this through their long-standing relationships with entrepreneurs and institutional investors. With private equity increasingly being seen as a legitimate means for small business owners to exit companies, local firms should continue to see strong deal-sourcing opportunities.

The region also benefits from a relatively stable political climate, reducing uncertainty that typically puts limited partners off allocating capital to risk assets. With LPs from across the world looking to begin investing in the region, fundraising for local GPs over the next fund generation seems likely to be a straightforward process.

Although competition from international GPs has increased, and is likely to do so in the future, the benefit gained from a long track record and proprietary deal-sourcing expertise should stand local GPs in good stead for future fundraising, and may also provide a boost to exit multiples for secondary buyouts.

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