Ex-KKR Pros Offer Rather LP-Friendly Terms: CORRECTED

At its mid-September meeting the Oregon Investment Council, which manages the roughly $59 billion Oregon Public Employees Retirement Fund, conditionally approved a $100 million commitment to Public Pension Capital LP, an evergreen fund with an initial $500 million target.

Launched by two former investment professionals at Kohlberg Kravis Roberts & Co., Perry Golkin and Michael Tokarz (also chairman and portfolio head of business development company MVC Capital), the firm plans to pursue a generalist strategy, acquiring or taking minority stakes in small to mid-sized companies in such industries as consumer products, energy, financial services, health care, industrials and specialty chemicals. Through a spokesman Tokarz declined a request for an interview, while I was unable to reach Golkin for comment.

The state’s commitment is contingent on Public Pension Capital securing at least $500 million in total commitments within a year, according to a document presented at the Oregon Investment Council meeting; the firm’s aim, the document says, is to try to line up four more commitments of $100 million each from other “prominent public pension funds.” The proposed terms suggest that Golkin and Tokarz want LPs to feel they are getting a far better deal than they can with other buyout shops.

“I’ve known them for a long time,” said Jay Fewel, senior investment officer in charge of private equity for the pension fund, referring to Golkin and Tokarz. “They’re very well connected, very sharp. What they’re proposing is not without risk by any means.” But, he added, “We felt if they’re able to execute, from an economic perspective it’s potentially attractive. Time will tell.”

Here is a quick breakdown of the major terms:

  • The firm would have an annual operating budget determined by an advisory board comprising members of the initial investors in the fund; the budget, in turn, would determine annual management fees. Fewel said he expected the average management fee over the first five years to be about 1 percent. By comparison, most North American buyout firms charge an annual management fee of between 1.5 percent and 2 percent of committed capital during the investment period of a fund, and a reduced rate after that, according to the study PE/VC Partnership Agreements Study 2012-2013, published by Thomson Reuters (publisher of Buyouts).
  • The investment professionals would collect a carried interest after returning management fees and generating a preferred return of 4 percent for investors. After that the carried interest would be 5 percent for producing an “annually compounded rate of return between 4 percent and 8 percent,” according to the document, and 10 percent for producing a return above 8 percent. It’s not clear if there would be catch-ups. In comparison, most North American buyout shops charge a 20 percent carried interest after returning management fees and a priority return (8 percent is common).
  • The firm anticipates holding an initial closing on March 31, 2013; under its proposed evergreen structure the fund would open to new investors every year on that date, as well as allow prior investors to add more to the pot. In comparison, most private equity funds have discrete periods of fundraising, investing (typically five years) and terms (10 years is common, with the possibility of extensions).
  • Investors must commit to a three-year lock-up of capital, after which they can choose not to have any more money drawn down should there be undrawn commitments.
  • In addition to approving the annual operating budget, the advisory board would have especially strong governance rights, including the ability to fire and replace Golkin as CEO.
  • Should active capital commitments fall below $500 million, the Oregon pension fund would not have to fund fees or capital calls until the board approves a new operating budget; the pension fund could also decline to make future capital calls without penalty.

Will LPs besides the Oregon pension fund bite? They’ll have to put overlook at least one big red flag. The documents suggests that, while the fund is attractive, analyzing the track record of the key executives is “difficult for several reasons.” It notes that deal work at KKR is done through teams, suggesting that teasing out individual contributions is a challenge. “Additionally,” the document says, “the transaction sizes at KKR were much larger, and at MVC much smaller, than the transactions [Public Pension Capital] will target.” The document concludes that the opportunity presents “greater than usual start-up and execution risk.”

MVC Capital makes mezzanine and equity investments in small and mid-market companies as part of acquisitions and recapitalizations. According to the document, the BDC has invested more than $260 million in at least 30 transactions. The firm is advised by The Tokarz Group Advisers LLC; The Tokarz Group is a merchant bank that Tokarz founded in 2002 after an 18-year career at KKR. Seven of MVC Capital’s senior investment professionals will “round out” the Public Pension Capital investment staff, according to the document. Fewel said he expected the MVC Capital portfolio to be liquidated over time, and that new investments would be made through Public Pension Capital.

According to a bio available on the University of Pennsylvania Law School Web site, Golkin (class of 1978) joined KKR in 1986 and served as a director on several portfolio companies, including American Re-Insurance Co., Primedia Inc. and Rockwood Chemicals. Golkin worked as a corporate attorney at Simpson Thacher & Bartlett prior to joining KKR.

The latest 10Q of MVC Capital lists 33 investments as of July 31, with a total cost of $342.0 million and a fair value of $425.5 million.

(Correction: MVC Capital in its latest 10Q lists 33 investments at a cost of $342.0 million and fair value of $425.5 million. The original version of this story mistakenly gave these figures as billions.)