Editor’s Note July/August issue 2006

Good times have rolled for private equity investors in Europe so far this year, albeit amid moans about top of the range pricing as competition for deals shows no signs of abating. In much the same way, buyout fundraising shows no immediate signs of slowing down meaning private equity firms have ever increasing pools of money to deploy. But then the debt markets have proved more resilient and supportive of sponsor-led leverage financings for far longer than many expected them to, although the finger has been pointed at the banking market as a key factor in enabling deals to be overpriced in the first place.

Even European venture capital has had some good news stories this year. Enterprise Capital Funds, signed off last year by the European Commission (EC) as being the acceptable face of state sponsorship given the UK early stage equity gap, began to be awarded to those groups that had tendered for the funds. Although solely a UK initiative at present, if successful, the model is likely to be replicated throughout a number of other European countries, many of which have been closely monitoring the UK’s progress both in winning EC approval and getting the funds structured and launched. Larger scale venture capital funds in Europe, however, while by no means benefiting from the fundraising feeding frenzy surrounding European buyout firms, are expected to get a bite at the cherry next year when things calm down.

The calming down is likely to be attributed to institutional investors having made significant private equity commitments over this year and last, a pace much upped thanks to the unusual speed with which funds have been returned to them over the past couple of years (the over exuberant debt markets and consequently high numbers of refinancings that facilitated being as much to blame as a generally positive macro economic background). Monies returned to institutional investors has been only part of the problem; there is also the huge inflow of monies into alternative assets resulting from the moderate yields anticipated from public equity and bonds over the medium to long term.

Clearly when faced with deploying a vast pool of capital it’s preferable to do so in large chunks, but since buyout funds, which are generally larger than venture funds and therefore seek greater commitments from institutional investors, have soaked up a lot of the money in recent years, those institutional investors will be looking to diversify their exposure within the private equity asset class and possibly have the time to look at a greater number of smaller commitments than venture investing necessarily requires.

But European venture capital has, with notable exceptions, posted some fairly lacklustre returns over time and given that many are already talking about a buyout bubble in Europe, which by definition means that European buyout returns are likely, on average, to be depressed in the medium (and, therefore, probably long) term, institutional investors, once they’ve soaked up the best pickings among European venture, will have to look elsewhere.

Asia is the obvious first port of call. Although to lump Asia-Pacific into one market is about as helpful as assuming Europe to be one homogenous private equity market. Europe, or at least the 25 countries in the European Union, ought to be close in their legal and regulatory frameworks, but corporate and personal taxation issues are the biggest hindrance to this becoming a reality. National governments are unlikely to cede the power to tax to a centralised body and even if they did, the cultural nuances of business and deal doing still mean differences will abound and in some quarters be positively celebrated?

So, to Asia many institutional investors will begin looking after the summer is over and planning for 2007 begins to loom on the horizon, as well as the Middle East and opportunities within some of the less volatile Eastern and Central European countries. Given the geographical leap involved for most institutional investors who will not have footprints on the ground in these regions, the allocation of private equity could well be heavily intermediated either through consultants or some of the more renowned, internationally focused gatekeepers.

Many are already frustrated by the rise of such intermediaries in the European market. But this trend is not surprising given the limited resources that many institutional investors have to allocate to private equity and alternative investment programmes in general, a subject for a whole other debate given that many of these same institutions are relying on alternative assets to lift the overall returns in their portfolios as the bulk of funds have been allocated to equity trackers and bonds that offer stable but lowly returns. And if institutional investors continue to show an interest in emerging private equity markets, such as Asia and the Middle East, the importance of a guiding hand is bound to grow.