New UK players going back to private equity's roots

Recent months have seen the establishment of two new UK players targeting the small-cap market: Frost Brooks, set up by former LDC investment manager Miles Frost and Peter Brooks, who was previously managing director of LDC's London team; and Agathos, established by former RCapital senior executive William de Laszlo and Better Capital investment director Charles Oakshett.

Both new entities are funded by family offices and high-net-worths. "We are fortunate in that we have close relationships with a number of family offices and high-net-worth individuals, who make up our LPs," said Frost when speaking to unquote" about the launch of his firm in November.

Meanwhile, De Laszlo was approached by a US-based family office, which had not invested outside of its domestic market and is testing the water in the UK with Agathos. Once the new firm's cornerstone investor was on board, de Laszlo secured commitments from two more family offices. "We're investing old money," he says, "we're here for the long term to plug the funding gap, backing strong management teams for growth."

Small world
In addition to similar types of funders, both new firms are targeting the small-cap market (deals in the £1–10m range) as they agree this segment offers more opportunities.

Frost believes the higher number of opportunities is due to established private equity firms neglecting the small-cap market. "This is partly driven by the need for traditional PE investors to make money on fees. If you're targeting fees, your deal size creeps up as you chase larger denominators. If you're focused on the multiple of your own capital, it's one simple priority – the quality of the investment pound for pound."

De Laszlo echoes this sentiment: "It's about supporting UK SMEs; the small-cap market is fairly non-competitive for UK private equity as few have committed funds. It's the £100m+ fund market that is very crowded, as the same amount of work is needed to buy a £30m company as a £100m company – the incremental costs are the same. So that's why PE funds move into targeting larger companies."

As well as benefiting from a less crowded market, the duo believes the small-cap space offers greater scope for genuine operational improvement. "The impact of the investment is much bigger for smaller companies. In larger companies they tend to have a lot of specialism in-house already, leaving less room for operational improvement or private equity value-add," says de Laszlo.

Different strokes
Where the new firms differ greatly is in their attitude towards investing from a fund or on a deal-by-deal basis. For de Laszlo, it was essential to have committed capital in order to move quickly on deals: "We were originally looking to do deal-by-deal, but I knew that I needed committed capital in order to transact quickly. Businesses in complex situations often have very tight deadlines and can't wait around. We need the ability to transact within 14 days – otherwise we would be dishonest to businesses if we said we wanted to invest but didn't have the capital available and couldn't move at speed."

For Frost, time is not a crucial factor: "We can move fast if needed, and have done so – we completed our investment in BizEquity in nine weeks. But the nature of how we meet businesses, get to know them and partner with them means there is little need for four-week deal processes. No business worth backing that I've met is fussed if a deal completion is four weeks or nine weeks - they want the right partner, not a rapid cash dump. This is a relationship they will be in for many years – it needs to be right."

The split opinion between deal-by-deal and a committed fund comes down to varying aims for each GP – Agathos is open to a much wider range of deal types and with the co-founders' background in turnarounds, it is little surprise the GP feels the pressure to move quickly. Says de Laszlo: "We are looking for complex situations, MBOs, MBIs, growth capital, working capital and distressed deals. We have the capability to deal with turnaround situations, but we like to work with strong management teams that might have fallen on hard times."

Chips on the table
What really brings these firms together is their attitude towards putting their own money into deals. "Every business we look at seriously as a possible investment begins with that question: 'Do Peter and I want to put our own money into this?' And then we invest, not in a diverse fund, but directly in that business," explains Frost.

Meanwhile, de Laszlo says he has invested everything he has into the fund: "I've put all of my chips on the table."

This seemingly refreshing stance towards GP commitments is, of course, the way in which the industry was set up to operate. However, despite continued requests from LPs, it would seem that GP commitments in established funds are still slipping.

In order to genuinely ensure the deepest alignment possible between investor, GP and portfolio company, Agathos has an interesting deal structure, whereby one-third of the investment will be contributed by the fund, another third by the management and the final third by employees.

Targeting the small-cap market might seem an obvious starting point for new entrants; it seems sensible to cast the net as wide as possible and create maximum operational improvement. Other new entrants to the market in recent years have also done this, notably Synova. However, not all have adopted this approach; Vitruvian and Castik Capital both target the mid- and large-cap markets. For Frost Brooks and Agathos, only time will tell if they stick to this remit or whether deal sizes creep up alongside fees.

The new pair's approach to fundraising also seems sensible; it would be a mean feat to target institutional investors without a team track record. Again, it remains to be seen whether these new players stick with current funders or look to traditional LPs as the exits pile up.

But whatever the future holds, it is clear these new players are, for now at least, intent on deepening the alignment between LP, GP and portfolio company. The significant contributions from both founding partners mark an important step in recalibrating the industry.

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• Topics
• Fundraising
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• Frost Brooks
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• Unq2015Apr