Travers Smith's Alternative Insights: Gaining liquidity and retaining control

A regular briefing for the alternative asset management industry.

With some notable exceptions, the private funds industry grew from founder-led partnerships and spin outs from financial institutions. Independence and specialisation have been prized qualities. Even now that private funds are a central part of the financial community – and despite some significant consolidation in previous business cycles – many alternative asset managers remain owner-managed and have committed to stick to their chosen market niche.

That market structure will not change overnight, of course, but increasing investor appetite for the asset class – and for multi-strategy, multi-jurisdictional investment managers offering a suite of products – has been driving M&A activity in the sector. Alternative asset managers who want to expand their product offering have hired new teams, but they have also acquired whole firms. At the same time, well-established public fund managers have been increasing their exposure to alternative strategies. These trends mean that successful financial sponsors can often attract investment at valuations which are highly attractive to their current owners.

But, as private equity investors know well, founders do not always want to let go – and, in many cases, their investors also want them to be motivated to stick around. That means that partners in financial sponsor businesses may want to realise some value but retain control of the business they have built. And, in particular, they want to hold on to their allocations of carried interest in existing and, at least to some extent, future funds.

There are, of course, a number of options. For some, an IPO is the right choice, although current market conditions probably mean that is off the table for a while. Equity and debt solutions offered by traditional or boutique financing providers can be attractive, especially for founders who want to retain management control and economic upsides but get an advance on future management fees. For growing businesses, external investors can also help to finance expansion and, although a minority investor will expect some veto rights and board representation, they can also offer strategic and fundraising support: a story very familiar to growth and venture fund managers! Adding the option to acquire the remainder of the business further down the line can sweeten the deal, potentially for both sides.

But if the current partners are ready to step back – or, perhaps, want to take on a new challenge as part of a larger business – an outright sale, or sale of a majority stake, may be optimal.

Sponsors can expect their businesses will be attractive investment and acquisition targets for the time being...

Although buyers in majority deals may expect founders to cede management control, founders have been known to hold firm and insist on entrenched rights to sit on the investment and management committees (or other key decision-making bodies) for at least the period of any earn-out. This mitigates the immediate impact – for the firm and its investors – and helps to reassure the selling shareholders that their economics will be protected.

Future entitlements to carried interest in existing funds, for both partners and other executives in the firm, can also be monetised. Sales of interests in carry vehicles can be tricky to structure, and some tax, regulatory and contractual hurdles need to be navigated. For example, buyers will typically expect that any clawback due to investors will be treated as a price adjustment, while sellers will want to achieve as much certainty as they can.

Although they might not determine the commercial terms of the deal, tax, regulatory and legal issues will affect the timetable and structure – often in ways that are not anticipated. For example, requirements to obtain regulatory consent to the acquisition of regulated businesses may delay the transaction by several months. And both parties will usually want to structure the deal so that acquisition of a regulated target does not trigger obligations under European laws for the enlarged group to comply with regulatory capital and remuneration requirements as if it were one single undertaking.

Sponsors can expect their businesses will be attractive investment and acquisition targets for the time being, and the trend towards even greater consolidation may be further boosted by the growing regulatory compliance burden that follows from the industry's maturity and ever-increasing external scrutiny. But, while no deal is ever straightforward, firms that are not themselves used to buying and selling regulated businesses where people are the main asset may have to navigate some unfamiliar territory. That may include the sometimes unexpected – but very important – need to integrate two heavily regulated businesses with different cultures and divergent attitudes to regulatory compliance.

Congratulations to Victoria Bramall, Sacha Gofton-Salmond and Danny Riding, who have been promoted to partner, in Travers Smith's largest promotion cohort to date.

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