A long and winding road

Late 1989, a Swedish graduate of the Harvard Business School goes knocking on doors. He is selling private equity to Nordic investors. Until now, buyouts were a phenomenon reserved for US investors who had been doing buyouts since the mid-1970s. In the UK, private equity developed from the venture capital industry looking at an alternative to technology investing. Buyout giants such as Apax Partners and Cinven began doing small to medium-sized buyouts, what today many refer to as typical growth capital investments.

The Swede, Bjorn Saven, was not interested in venture, however. He wanted to introduce European and Nordic institutional investors to the more mature US buyout model. "From working in the States, I had heard of buyouts and knew people in the industry," Saven recalls. When changes at the large Swedish corporate in which he worked offered an impetus to try something new, he decided to give it a go. "I had acquired and disposed of businesses when I was at Esselte. But I realised that with more time and private investors we could have done larger money multiples on these deals."

Cold calling

And with Swedish Bank Enskilda backing them, Saven and a team from Enskilda Corporate Finance set up one of the first European buyout firms, focusing on investing in Nordic and Continental Europe, Enskilda Ventures. One would think that investors would have shied away: the new firm had no track record, sought to operate in a little known asset class and was asking them to tie up capital for 10 years. "It actually didn't prove as difficult as some thought," says Saven. "Investors had heard of talk of this asset class from the US."

Yet, commitments were cautious in size. The first fund, Scandinavian Acquisition Capital (SAC), which later changed name to IK1989 Fund, was launched in 1989 and closed a year and a half later on EUR108m. The investor base was a plethora of investment companies, institutional investors, banks and family offices. Most pension funds did not yet have the mandates to invest in such a high risk profile asset class (it wasn't until 1996 that The Sixth Swedish Pension Fund started investing in private equity). But gaining the confidence from investors was only the first step - convincing entrepreneurs and management of the new ownership model was another challenge. "We weren't invited to bidding processes and auctions until the late 1990s, before that we cold called companies and pitched the model," Saven explains. He adds that once they were 'in', convincing management was mainly no hard task. "Forward thinking management quickly realised our value-add."

The difficult second fund

Deregulation had paved the way for a boom in lending and, subsequently, investing, which irrevocably led to a major banking crisis in the early 1990s. Economists referred to the crisis as the worst systemic risk encountered since the 1930s. A lesson learned one would think. "In 1989 you had buyouts in the US with one turn of equity and ten turns of debt," Saven points out, "even more leveraged than the LBOs at the height of the credit boom in 2006 and 2007."

As today, the industry was left shell-shocked. "We didn't make any investments in 1993," Saven notes. This is a pattern the firm has stuck to: In the year since the collapse of Lehman, IK just closed a single transaction, acquiring the Benelux-based international trust and corporate service provider Vistra, together with a group of investors. Saven believes it will be another year or two before the credit markets are fully restored and a generation-and-a-half before the next major credit crisis. Further drawing parallels with today's market, it was a long time before fundraising returned to normal levels as LPs licked their wounds. Although IK's second fund, launched in 1994 and closed in 1995, doubled in size compared the first fund, it had been a difficult job securing commitments. In fact, it wasn't until the late 1990s that investors were queuing up for tickets.

Riding the wave

For IK, the shift was evident when the firm raised its third fund in 1997, which closed oversubscribed on EUR750m in just a few months. With a drastic increase in fund size, investment focus also had to shift. From 67% of the first fund invested in Sweden, the third fund invested only 40% in its home country, investing in larger businesses and increasing deal sizes and bracket.

Competition also increased. By the late 90s the number of fund managers multiplied into double digits. In the early 2000s, another wave of new shops were established, some even started up by ex-IK professionals, such as Harald Mix' Altor in Sweden. This trend again finds a mirror image in the current market, mostly fall-outs from larger financial institutions. As reported in unquote" last week, IMAS reported in their quarterly review of authorisations for FSA-regulated companies in the UK that the number of private equity authorised has doubled from Q1 to Q2 2009. Examples of spin-outs are ex-Man Group CEO Stanley Fink, who has set up sustainable investment firm Earth Capital Partners LP, and Absolute Energy Capital LLP, a spin off of Deutsche Bank's clean technology team.

The shake out

Across the industry, turnover time was drastically reduced. Quick-flips became a common feature of the market and LPs found GPs coming back with new funds in ever shorter intervals. IK was no exception, closing a fourth fund at the start of the boom in 2005 and raising the fifth in 2007 in only a few months. But then, inevitably, came another banking crisis - this one on a much wider scale. As with so many other firms that were cash rich in the boom years, there will be bad eggs in the portfolio. In many cases, operationally sound companies struggle because of an unbalanced capital structure - basically, too much debt. Some press reports have announced the end of an era in private equity, and predicted an industry shake-out. But even Boston Consulting Group, author of the now infamous report predicting that 40% of GPs might fall, have moderated their estimates. "The study underestimated firms' willingness to survive and what radical measures they are willing to take to do so," Saven says. "But chances are some will not be able to raise new funds," he admits. "The strong will survive and no doubt the survivors will be the very strong."

Back to the future

The veteran buyout specialist asserts that in fact, LPs need private equity. "Alternative assets like private equity have become an important component of any balanced and diversified LP portfolio." Moreover, Saven is confident private equity will continue to deliver good and stable returns. He disagrees with academics calling for risk-adjusted returns, arguing the cost of risk is built into the return requirements of 16%-20%. "There is no need for LPs to offer their return requirements, and even if they did it would not change the nature of the industry significantly," he argues.

But surely the private equity landscape will change? Having been through two rounds of booms and bust, Saven should be fit to predict the future. Yet he adheres to the industry standard of the day: "These are uncertain times." The market, has however, made a few adjustments, proving the adaptability of the industry. Fund targets are increasingly modest, and the deal size scale has shifted downward.

But particularly because of these two main characteristics, uncertainty and adaptability, Saven raises an eyebrow at the proposed regulatory framework from the European Commission, questioning the timing of the Brussels directive. "This is a time of great uncertainty and change, it amazes me that they seem in such a hurry to create this new regulation, which will significantly reduce investment capital."

The proposal, along with some vastly reported PE-backed bankruptcies and painful restructurings, have left the industry and some of its brand names tainted. "Private equity firms must shift their focus back to what they're good at," Saven decrees. He particularly highlights the virtues of operational value-add, giving businesses the financial and operational tools to drive them through the recession. But with increased public scepticism, it might just be that buyout houses must again hone their persuasion skills. Just as Saven and his team did in the early days of 1989.

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• GPs
• Nordics