06 Oct 2016

Managing Your Spinout: Planning and Partnership

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 spinning out. 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 advisors with deep experience of the process, Bridget Barker from law firm Macfarlanes, and Simon Gold of placement agents 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 received wisdom is that people often spinout to escape friction at their current firm, or simply for better compensation, there are many other positive reasons to make the leap.

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.

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.

Tim Clarke, August Equity

Moretti spun Three Hills out from Hutton Collins. After developing a specialism in so-called “sponsorless” investments – alternative financing and providing hybrid capital to companies directly – he decided he wanted to specialise in this niche area, focusing on assets in Europe but with an added edge in Southern Europe.

“We had an edge in that sponsor-less space, especially in Southern Europe, and wanted to leverage that competitive advantage and experience,” he says. “The idea was to put 30% to 40% in those markets, rather than the typical 10% to 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.”

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 realty of running their own business, drew back at the last moment.

Gathering the right stakeholders – especially supportive investors and experienced advisors - is an essential part of spinning out, says Clarke, as managers rise to the challenge of running their own enterprise.

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

Only then are they ready to think about fund-raising. This is of course essential to a fund, whether a spinout or part of an established management company, but for GPs who have been focused on deal-making, the changing ways in which investors provide capital may be unfamiliar.

Gold says it’s critically important to explain why investors should choose the new fund: “Fund-raising 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.”
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: “A good agent who 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.”

The process is of course 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,”

- Matt Hansford, Investec Fund Finance

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,” 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 which 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 move, requiring the support of people with the experience and adaptability to act nimbly as they help managers on their journey.