GP spinouts a game of planning, PR and partnerships

Spinouts are an integral part of today’s private equity industry. As our GP survey revealed earlier this year, of those GPs contemplating a move from their current firms, over a fifth are considering doing so by spinning out and creating a new fund. For individuals keen to strike out on their own from more established groups, spinning out can offer the best of both worlds: independence, combined with an investor following and goodwill based on the managers’ track record at the larger firm.

The advantages of spinning out are of course not limited to the private equity professionals themselves. Investors are attracted by the opportunity to back teams they already know well, which have the proven ability to source the best new investment and achieve high returns.

Investec Fund Finance recently brought together two managers with experience of spinning out – August Equity’s Tim Clarke and Mauro Moretti of Three Hills Capital Partners – alongside two advisers with deep experience of the process, Bridget Barker from law firm Macfarlanes, and Simon Gold of placement agent Asante Capital. In a wide-ranging conversation, they discussed the practicalities of setting up a new fund, the positive reasons for doing so and some of the challenges along the way.

The key question is of course: “Why spin out?” While the perceived wisdom is that people often launch their own fund to escape friction at their current firm, or simply for better compensation, there are many other positive reasons to make the leap.

You have to look at existing arrangements – the fund documents, whether there’s going to be a key man event and how that’s dealt with. It can take a long time to negotiate terms with an institution, even before you get to working out how you’re going to finance the new fund" – Bridget Barker, Macfarlanes

For Clarke, who before setting up August Equity was managing client money in the private equity team at Kleinwort Benson, it was simply to avoid a conflict of interest. He recalls: “The bank was proliferating the number of teams, doing what we were doing but using its own balance sheet. We realised that we were competing for the same assets with our colleagues elsewhere at the bank and that provided the catalyst for us to spin out.”

Moretti spun Three Hills out from Hutton Collins. Moretti developed a specialism in so-called “sponsorless” investments – alternative financing and providing hybrid capital to companies directly. “We had an edge in that sponsorless space, especially in southern Europe, and wanted to leverage that competitive advantage and experience,” he says. “The idea was to put 30- 40% in those markets, rather than the typical 10-15% of a fund.”

Moretti also wanted to target private wealth investors, offering his strategy as an alternative to fixed-income allocations. That necessitated being able to structure the fund to appeal to that market in different ways, such as incorporating a short-term investment period. With all those factors at play, the obvious answer was to spin out.

Once the decision has been made, a lengthy period of preparation is essential. “From a legal point of view, it’s complicated,” says Barker. “You have to look at existing arrangements – the fund documents, whether there’s going to be a key man event and how that’s dealt with. It can take a long time to negotiate terms with an institution, even before you get to working out how you’re going to finance the new fund.”

Building blocks
A critical element is infrastructure: managers spinning out might have proven investment expertise but limited experience of the practicalities of running a business. Barker remembers a team who got to an advanced stage before spinning out but, having considered the reality of running their own business, drew back at the last moment.

Gathering the right stakeholders – especially supportive investors and experienced advisers – is an essential part of spinning out, says Clarke, as managers rise to the challenge of running their own enterprise. GPs at large firms frequently spend their lives focusing on investment, but spinning out requires them to be all-rounders, not specialists.

While sourcing and securing the right assets is of course the primary function of a new fund, investors also want to be assured that the right infrastructure has been put in place for the firm to function efficiently. With that assurance, investors can pursue a long-term partnership with confidence. Clarke says: “You are building a business and have to have the infrastructure, the client base.”

The challenge is not so much how you raise a fund as how you can show that the team is best placed to source the best deals and invest the capital relative to their peers” – Simon Gold, Asante Capital

Proving that you have a differentiated pipeline is critical once the infrastructure planning has been done, as LPs invest on the basis of managers’ ability to source assets. “The challenge is not so much how you raise a fund as how you can show that the team is best placed to source the best deals and invest the capital relative to their peers,” says Asante Capital’s Simon Gold. “Prospective investors will want to see that they can continue to source and execute at the same levels of high-quality deal-flow as part of the new organisation.” Only then are they ready to think about fundraising.

This is, of course, essential to a fund, whether a spinout or part of an established management company, but for GPs that have been focused on deal-making, the changing ways in which investors provide capital may be unfamiliar.

Gold says it is critically important to explain why investors should choose the new fund: “Fundraising is a first impressions game in an incredibly crowded market place and you need to have thought carefully about how your offering is differentiated from the pack.”

Support team
While Tim Clarke enjoyed the committed support of both Kleinwort Benson and existing investors when he co-founded August Equity, were he to do it again he would enlist the help of a placement agent, he says; more specifically, “a good agent that knows how to present an emerging manager and helps investors do their due diligence. I’ve seen their help with messaging and contacts lead to very successful fund raises”.

Of course, the process is about more than simple marketing, whether of the team, their track record or their pipeline of deals. Managers of new funds must be flexible and ready to provide the structures investors need, especially when they have a finite time to secure the assets they have lined up.

“We’ve come across the situation a few times where GPs have a good deal lined up but need to align the deal and fund closings,” says Matt Hansford of Investec. His team have worked with both new funds from established managers and spinouts, providing financing for acquisitions to send a message of momentum to the market.

The common theme is timing – closing on a deal the fund otherwise might lose, keeping credibility in the market, and ensuring there is sensitivity to the speed that LPs can move at" – Matt Hansford, Investec Fund Finance

“The common theme is timing,” says Hansford. “Closing on a deal the fund otherwise might lose, keeping credibility in the market, and ensuring there is sensitivity to the speed that LPs can move at.”

Co-investment is a helpful tool to secure funding, and one that investors and funds are using in innovative ways. Hansford recalls one LP that took a primary position in order to gain a co-investment, eventually selling out the bulk of the initial investment. Every case is different but devising a plan for each element – infrastructure, pipeline and funding – is critical to the success of a new fund. As the needs of LPs, in particular, evolve, it is crucial for would-be spinouts to seek the right counsel as they put their strategies in place.

At an early stage, seeking the right partners to deliver in these areas is key. Any one of the moving parts involved in establishing a new fund may shift, requiring the support of people with the experience and adaptability to act nimbly as they help managers on their journey.