Permira's plight

Kimberly Romaine, editor-in-chief, unquote"

Permira has again made headlines by being the first jumbo fund in a decade to offer limited partners a fair way out. By relinquishing a quarter of all profits of Permira IV, which is 52% drawn down, limited partners may reduce their commitments by up to 40%. It is the second time in as many years the buyout giant made history - two years ago it raised more than EUR11bn to become the largest fund for European buyouts.

The way Permira established itself as a trailblazer is the same reason it will remain one and persevere - it treats its investors with respect. The blue-chip roster of LPs in Permira include Washington State, Calpers, Calstrs, AlpInvest, and SVG, it's largest investor and one whose cash constraints were most publicised.

Permira had a respectable IR track record even when the market was strongly in favour of GPs, with one source revealing that raising the heavily oversubscribed fund in 2006 was the 'easy bit'; the real challenge was assuaging LPs following the final close, when commitment requests were scaled down and balanced against others'. As some other buyout houses took advantage of conditions that put them on top of the totem pole, raising fees and imposing other ill-willed measures on their investors, Permira managed to avoid an investor backlash.

Permira's move benefits itself as well as all its investors:

- LPs with cashflow problems are given an alternative far less punitive than other options (a secondary sale in an unforgiving market that would have crystallised a sizeable loss (positions are trading as low as 10% of their net asset value); or an outright default, which incurs draconian penalties, such as writing off all other drawn-down capital).

- The move also benefits robust LPs, whose feathers could have been ruffled if any plans were seen to be too lax on investors unable to 'keep up'.. However, rather than just letting struggling LPs off lightly, the measures are sufficiently punitive to make them attractive only to those truly in need, while actually benefiting those that are still able to meet capital calls. This is because LPs scaling back are forfeiting a quarter of all eventual profits on Permira IV in favour of those LPs maintaining their position. So the measures are not just punitive, they also offer reward to those that deliver.

Jon Moulton, Alchemy Partners

"Success at Dunkirk, some troops recovered. Some with rifles".

SVG was a "monoline investor" - part owned by Permira and largely investing in them. Permira has a director at SVG. SVG followed a strategy of investing ever larger amounts into one investment manager with a very severe dependency on continuing debt markets and prosperity needed to keep success rolling. The possible benefits of diversification were largely ignored - as were the risks as yesteryear's success was expected to roll on forever.

In its last accounts (March this year) SVG's chief executive stated that "the Company is well positioned to meet its uncalled commitments of £1.6 billion." Oops.

A huge commitment to Permira funds relied on either distributions from Permira or loans drawn against the value of Permira's funds to cover the calls for that commitment. In the event, in common with many megafunds, the latest Permira fund is having severe problems and these sources of funds dried up. So SVG could not fund all its potential calls from Permira.

SVG thus faced the possibility of not being able to fund its obligations as they fell due. A phrase not unassociated with insolvency.

So SVG had to reduce its liabilities and/or raise money. Acting correctly it has done both but at a very high cost to its investors who will pay the fees on their full commitment to Permira but will only invest half of that commitment - much of it already invested in manifestly troubled positions - and then lose a quarter of the distributions from this expensive investment.

The solution put other investors (probably - the legals are not public) in the same position as if SVG had defaulted. Permira presumably forgave SVG its commitment in exchange for the continuing full management fee else Permira could have probably sued SVG for a commitment it could not fund.

Overcommitment proved rash and extremely expensive to SVG shareholders - the share price is below one eighth of what it was. Permira now collect a higher percentage management fee to invest less into its fund. This fund has had a weak start and with a consequently lower chance of a carried interest. A smaller fund will enable Permira to launch a new fund with better carry prospects sooner - subject to investor demand!

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