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French (Canada) - UK Local Government Pension Fund
- Summer 2019
- Private Markets
- TBC
- Wider local area
- c. 10% - 15% IRR
- TBC
- TBC
Our specialist says:
While ESG continues to be of crucial importance for many of our clients, the focus on impact objectives (which are often highly client-specific) grows stronger. This investor sought to generate impact for their local business and investment eco-system, making this an unusual project since few managers focus on this specific segment. The open-ended ‘permanent capital’ vehicle structure was also unusual: private equity remains very attached to the typical closed-end fund, although we are seeing innovations including permanent capital structures like this and shorter-term closed-end funds. It is important to understand the suitability of the vehicle structure for the type of investment and structure commercial terms carefully in these non-traditional arrangements.
Engagement at a glance
A UK local government investor was looking to build exposure to small and medium-sized companies in their wider local area. As well as financial objectives of c. 10% - 15% IRR, the investor had “impact” objectives to be fulfilled by focusing on the lower-mid market in their region. bfinance was appointed to conduct due-diligence on the manager that might be able to fulfil this mandate, assist in structuring the vehicle and negotiate key commercial terms - cost savings, alignment of interest and ongoing monitoring requirements.
Client-Specific Concerns
While the UK lower mid-market is a well-established investment segment, few managers specialise in the particular geography that the investor was seeking: the investor needed to gain conviction on manager capabilities not just in general but in this region specifically, and the opportunities available.
The investor was increasingly interested in a structure that allowed easy recycling of capital over a significant period of time and, eventually, a self-sustaining investment vehicle. This meant that the typical private equity structure (5 years investment, 5 years harvest) was not suitable. Finally, the investor was keen to achieve lower fees without inappropriately undermining GP incentivisation.
Outcome
- Better understanding of the manager’s ability to create value, particularly in this region/segment. As well as analysing the manager’s capabilities to originate, execute, drive operational value and exit investments, it was important to focus on the opportunities in the region and understand the relevance of the past track record to this environment. Since this narrower regional approach represented an ‘emerging strategy,’ it was important to analyse the approach to first-time-opportunities and start-up elements such as team composition and build-up. The investor’s specific ESG and impact objectives were strongly prioritised throughout this process.
- Creative structuring of an evergreen / permanent capital vehicle.An evergreen vehicle structure was developed for this mandate, enabling the permanent recycling which the investor preferred. This vehicle was structured to allow the investor to retain control over the mandate and deployment of capital, including the ability to exit investments in a timely manner should they choose to in future. Given the longer-term nature of this mandate, ongoing monitoring and governance requirements – including a range of key metrics produced annually – were critical.
- Negotiations to reduce costs and improve alignment.Highly competitive fees were secured for mandate, involving a significant cost saving for the investor amounting to at least c.10% of the total commitment just in the initial 15-year period. Given the evergreen structure of the mandate, carried interest was structured on a hybrid-American waterfall basis – this provided an incentive for the GP to benefit from returns, but strong investor protection in the form of an escrow was also put in place. Additionally, the GP increased their commitment to this fund by 50% following the negotiations, which also better aligned long term interest with investor.
