European Solutions to Secondary Portfolio Sales
Most investors into private equity expect that money committed to a fund will be invested once, and then sent back as underlying assets are sold. Generally, the manager is not allowed to re-invest the proceeds of investments (or if it is, only on a very limited basis), and investors are not usually able to get out of the fund early. That model (which is normal but not universal) fits the asset class well, but contrasts with other types of fund - including hedge funds - which are re-investing, and do allow investors to get out more easily by redeeming their interests, or selling them on a public market.
Some have argued that the private equity fund standard should be updated, and that some other way to offer liquidity would be better than a model that requires managers to go on the fund raising trail every few years. There are some trends in the industry which support that view - some say, for instance, that longer holding periods would be more efficient than forcing one fund to sell to another in a secondary buy-out. Others, though, argue that the discipline of forcing managers to make reasonably quick realisations and then raise a new fund is healthy for an asset class that is hard to mark to market until assets are sold.
There is one trend - now very well established - that does allow the industry to offer liquidity to investors without the hassle of a public market quotation: the ever-growing secondaries market. It is clearly not a universal panacea for LPs who don't want to tie up their money indefinitely, but it does provide an alternative model when an early exit is necessary following an unforeseen change in strategy, or a shift in the global investment landscape, or perhaps just for portfolio management reasons. That is undoubtedly helpful for private equity as an asset class, as most fund managers now recognise - although their consent is generally required, most GPs now feel comfortable with secondary investors in their funds. Indeed, for many it provides a welcome opportunity to access a new source of capital, or to rescue it from the consequences of a disaffected or defaulting investor.
The secondaries market is rapidly maturing, and has come a very long way since it was dominated by a very small number of specialist players. As competition between secondary purchasers increases, it has become clear that negotiating a secondary sale is not a zero-sum game: buyer and seller have complex objectives. Clever structuring, innovation and flexibility play a key role in agreeing and closing deals, and "win-win" solutions are common. These are some of the themes that we shall explored at seminar in London last Fall.
IPOs in Europe
For those involved with early stage companies, an important conference was held last November in London. Hosted by the UK, as part of its presidency of the European Union, the summit on Risk Capital considered a number of issues that are close to the heart of those investing in European venture capital. One of those issues was the need for a pan-European stock market for high growth companies, something that the industry has long viewed as critical if venture capital is ever going to deliver the returns that have been seen in the US.
Picking up on the themes emerging from a workshop held in Brussels in May, the summit looked at some of the reasons why attempts to create an integrated market have failed, and tried to understand why a fragmented environment was less than perfect for high growth companies. In this respect, the conclusions of a paper issued by the European Private Equity and Venture Capital Association (EVCA) last week - timed to co-incide with this week's summit - are instructive. EVCA's High-Tech Committee argues that none of Europe's exchanges (and there are over 20 of them) has the "critical mass and market focus to be effective ... for small cap growth stocks". The paper calls for real steps, from European lawmakers and from the exchanges themselves, towards the formation of the "pan-European stock exchange that Europe's young companies desperately need".
Some of Europe's stock exchanges might dispute that they are not focussing on growth companies: a number do. And some markets have made very great progress in improving liquidity (which is key to the success of a market), and in becoming more international. But AIM - already the most international of the European small and mid cap markets - used the conference as an opportunity to announce that it is planning to attract many more companies from continental Europe, with a series of roadshows, and by creating a European network of nominated advisers (otherwise known as NOMADs - firms which oversee AIM companies and bring them to market).
EVCA wants more concerted action. Among its suggestions is a call to harmonise listing criteria across exchanges, and in particular to standardise the requirements for minimum total assets, years of trading history and the number of independent directors (although it is unclear what that would achieve), and the implementation of low cost settlement systems. EVCA appear to favour "light touch" regulation, taking the systems adopted by AIM and, more recently, Alternext, as models for the future.
Still, although the European Commission can (and should) help, the fact remains that the artificial creation of a single market is unlikely to succeed. As is widely recognised, the best solution is for one of the existing exchanges to grow to a point where it achieves critical mass, and ultimately dominates. What we are likely to see in Europe in the next few years (catalysed by AIM's announcement this week) is a battle to become Europe's answer to NASDAQ -and may the best exchange win. What must be avoided is a battle that just holds all the markets back - and perpetuates the existing fragmentation.