EUROZONE: Spotlight on spin-outs

It is hard to gather cold hard facts, as opposed to anecdotal evidence, about how many GPs are contemplating spinning out.

One cannot look up an index to get the number in order to gauge its prevalence. So a recent study by accounting firm, Grant Thornton, is certainly welcome because at least it throws a spotlight on current thinking among UK GPs in mainstream private equity, which in turn is a rough guide for private equity’s cousins in real estate.

In its UK private equity index second quarter index, Grant Thornton put the following statement to GPs: “Incentives have never been greater for executives to leave their firms and set up a new fund.” On one level it was inconclusive. Fifty seven percent of GPs disagreed with the statement,  while 43 percent agreed.

Nevertheless, 43 percent – or four out of 10 GPs – did agree. That’s quite a lot and makes one wonder if we are not going to see a lot of spinouts in the next couple of years.

Just as in mainstream private equity, plenty of private equity real estate funds have been caught out in terms of splurging capital at the height of the market. The issue they face right now is how they can work through those assets and reward themselves and their younger members of staff.

The anecdotal evidence available is that the majority of GPs whose fund is out of the promote are willing to stick around. They are prepared to simply pick up their salary in order to keep paying family running costs and school fees. Those that the firm wants to stick around are not finding much cause to resist – or at least not yet.

I say yet because, according to various professionals, the “vibe” is that though people are prepared to stick around, more people are having “quiet conversations” about whether now is the time to start high-level marketing on a very discreet basis.

They know that it is going to take 18 months to two years to raise a fund, so why not start discussions now?
Adam Turner, head of executive search firm Odgers Berndston’s private equity practice in London, told PERE’s sister magazine Private Equity International recently that he was working on two mandates involving teams spinning out and setting up first-time funds.  “A number of guys within the general partnerships are starting to look at each other and thinking ‘I am going to have to work twice as hard, for twice as long to earn half as much money?’”

But just how prevalent might spin outs be come the time? 

Well, things have become so difficult that one US LP advisor I spoke to recently says of around 400 private equity real estate funds globally, GPs at half of them will have to do something – be that leave, spin out, or take their chances if and when it merges with another fund manager in the next two years. This is because they are unlikely to be able to raise a next fund.

Clearly, there are forces at work that can precipitate spinning out. In the case of DLJ Real Estate Capital Partners, some sources say it’s because parent company Credit Suisse seems to want to exit the arena. Lehman Brothers was also a severe case of needing to do something with its platform.

But there are plenty of other factors that make such a thing tricky. In Europe, Roger Barris has been talking to Bank of America Merrill Lynch for months now about spinning out. It is rumoured that the MBO group would be prevented by agreement with Merrill Lynch from raising any new capital until mid-2012. So, the spin-off team is forced to focus on the assets being transferred before seeking new money. Merrill Lynch declined to comment, but these are the sort of factors that determine against spinning out. Unfortunately, the alternative for GPs may not be as abundant as one might have imagined. Even talented dealmakers might struggle to jump ship.

A different headhunter PERE spoke with said “nervousness” about the macro economic outlook globally was preventing private equity real estate firms from pursuing recruitment drives. “We are not working on opportunistic hires,” the headhunter said.

Roles such as investor relations professionals and chief financial officers, roles that have close relationships with capital sources, appear to be in greater demand, along with asset management skills. “But opportunistic hiring isn’t going to happen for a while,” the recruiter predicted.

For those motivated to spin out, making a decision about one’s future is hard at the best of times, but especially difficult  today.