New Regulations Leave Buyout Shops Out on Their Own

February 9, 2014, 6:06 p.m. ET

New Regulations Leave Buyout Shops Out on Their Own

By Ryan Dezember

Most private-equity firms have to raise funds by sending executives around the world to drum up interest from investors. For years, executives at Ridgemont Equity Partners never had to leave Charlotte, N.C., home to both the buyout firm and its lone backer: Bank of America Corp.

But in 2010, the bank spun off Ridgemont. Since then, it has had to raise money like other independent firms do. This past summer, Ridgemont’s executives wrapped up 18 globetrotting months in which they gathered $735 million from new investors.

The fundraising, says Ridgemont partner Travis Hain, was “challenging and lengthy,” but also galvanizing. “It forced us to demonstrate how and why we compare favorably to the best investors in the industry,” he says.

The firm raised about 9% more than its goal.

As banking rules are redrawn, many other private-equity executives will earn more air miles. The principal reason: A post-crisis provision known as the Volcker rule is forcing financial institutions to shed their buyout businesses.

The rule–part of the Dodd-Frank law–aims to limit the risks big banks can take with their own capital. Under the rule, approved by five federal financial-regulatory agencies last year, banks have to sharply reduce their stakes in their private-equity units, or shed them altogether, by 2015.

Banks weren’t always in the buyout business. They piled in during the boom years leading up to the 2008 financial crisis, taking part in some of the era’s biggest corporate takeovers. Doing so sweetened their bottom lines. Some bank executives, who were able to invest in buyout pools, got a chance to taste the huge profits earned by their peers at private buyout shops.

Now, those profits, and the risks they brought with them, are being curtailed due to the Volcker rule and, sometimes, the banks’ own business priorities. For newly independent firms and their executives, the shift offers a chance to see if they can thrive on their own.

J.P. Morgan Chase & Co., for example, is in the process of spinning out One Equity Partners, a private-equity arm. The bank, which had been the firm’s only investor, won’t put money into a new fund One Equity Partners is raising and is exploring a sale of its stake in the buyout shop’s existing investments, according to people familiar with the matter.

Goldman Sachs Group Inc. plans to keep its private-equity businesses, but is reducing the amount of capital it holds in existing funds. To comply with a Volcker requirement that funds’ names don’t evoke those of their parent banks, it is replacing the moniker GS Capital with Broad Street on new funds.

As for Ridgemont, it was separated from Bank of America in part to free up capital on the bank’s balance sheet that was held against the firm’s investments, as well as to comply with the Volcker rule, according to people on both sides of the split.

Losing a bank’s financial support presents a challenge for private-equity firms that used to be nestled within financial institutions. Out on their own, they must vie for investors’ cash against big firms, such as Apollo Global Management LLC and Warburg Pincus LLC, that are coming off hugely profitable stretches. In general, newly independent firms have raised less on their own than when they had bank backing, even if they are exceeding their own goals, according to securities filings and private-equity executives.

As an example, Wells Fargo & Co. four years ago spun out Pamlico Capital. The firm last year capped off a $650 million buyout pool, which was 30% more than it set out to collect. The total was far less than the $1.1 billion it raised in 2007, when it was known as Wachovia Capital Partners.

Wachovia Capital became part of Wells Fargo when Wells and Wachovia merged in 2008.

After dipping to as low as $670 million in the aftermath of the financial crisis, the average size of new private-equity funds rose to $1.2 billion in 2013, according to Preqin, a data provider.

Newly independent firms will have to “anticipate managing more modest funds with more aggressive return targets” to cover new costs, such as offices and support staff, while competing with returns offered by rivals, said Rolf Lindsay, an attorney with the law firm Walkers who helps private-equity firms create investment funds.

Private-equity executives say there are benefits to being on their own. Freed from a big bank’s constraints, such as internal limits on exposure to particular industries or regions, and potential conflicts around investments, like bidding on companies being sold by bankers at a fund’s parent company, the private-equity firms can have greater latitude in choosing investments. A broader selection of deals can become available to them.

“It was difficult for J.P. Morgan to bring us deals because they couldn’t be perceived as favoring their in-house firm,” said Stephen Murray, the chief executive of a former J.P. Morgan Chase unit now known as CCMP Capital Advisors LLC, which was spun out of the bank in 2006. “The relationship is better now that we’re separate than when we were together.”

CCMP works often with J.P. Morgan bankers these days. It recently enlisted them to help them with the initial public offering of the food-services company Aramark Holdings Corp., which CCMP and three other private-equity firms bought in early 2007.

A $3.4 billion fund it raised in 2006 was up 48% through June 30, but even CCMP is facing a Volcker-related test. It aims to raise $3.5 billion in its first buyout fund that won’t include a contribution from the bank, according to people familiar with the matter. Mr. Murray declined to discuss CCMP’s fundraising.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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