Spinoffs are nothing new to private equity, and most major firms in the market can trace their ancestry back to one of the large investment banks. Lehman Brothers, Bear Stearns, BancBoston, Morgan Stanley, Drexel Burnham Lambert and a few others all serve as progenitors to many of the bigger names in the business, whether one generation removed or even four or five generations separating the link.
Elevation Partners, for example, sprouted off from Silver Lake Partners, which descended from the Blackstone Group, which is one of the many buyout shops that emerged out of Lehman Brothers.
Elevation is among the new guard of buyout firms, having launched in the past year and a half. In the coming months the firm can anticipate that its peer group will grow considerably as a throng of new spinoffs are expected to emerge. And thanks to a confluence of factors, this era could represent the baby boom generation for new buyout groups.
Already there is a large contingent of fresh faces that have either launched or are preparing first-time funds. Most recently, Michael Madden left Questor to found Centurion Capital Partners. He followed similar moves from Flexpoint Partners’ Donald Edwards, who left GTCR Golder Rauner; Diamond Castle Holdings Head Lawrence Schloss, who left DLJ; and Monomoy Capital’s Michael Presser, who cut ties with KPS Special Situations.
The common thread connecting most spinoffs relates to timing, as departing execs look to breakaway from their former firm at the end of a fund’s investment cycle. The primary motive behind the timing is clear. If they left earlier they’d be leaving before they were fully vested in the fund’s carry. But there are other factors at play as well, such as how a limited partner would perceive someone that left midway through an investment cycle.
“As long as you are reasonably happy, you really shouldn’t leave when you’re halfway across the river in terms of committing the capital,” Centurion’s Madden says. “If you’re a senior guy, one of the reasons the limited partners invested was because of you,” he adds, noting that an ill-timed exit would alienate more than just a pro’s former partners.
The New Guard
As evidenced by the huge number of firms raising funds, there are a lot of groups that have either approached the end of their investment cycles or have seen that window already lapse. Because of this, there will be more candidates than ever before eyeing splits. Further, given how flush the limited partner community seems to be, that could serve as the added incentive for someone considering such a move, especially as LPs appear intent on finding the “next generation” funds.
“While the investment landscape is crowded, the environment as far as available capital [goes] is radically different today than in 2002 or 2003,” Madden says. “Allocation is up and people are looking for new ideas.”
Another factor is that as fund sizes continue to increase and firms outgrow their previous mandate, there will be some pros that don’t totally welcome the change. Blackstone, for instance, grew from four pros hammering out deals with $400,000 at their disposal to an organization with over 500 employees across the world that is currently out raising a $10 billion fund. As the firm’s focus broadened, Blackstone lost a few pros that wanted to operate in a narrower niche, including David Stockman, who founded Heartland Industrial Partners to target the Rust Belt, and Glenn Hutchins, who helped launch tech-focused Silver Lake.
And while some may yearn for size, others can get disenfranchised with the bureaucracy associated with a larger organization. As deal sizes increase with the growth of a fund, pros adept at working in the middle market get thrust into large corporate transactions devoid of the intimacy found in smaller deals and lacking the influence to really affect change. Firms such as Audax Group and Golden Gate Capital came about in part because of this scenario, with each emerging from Bain Capital to focus on the middle market just as the parent was establishing itself as a large market player.
The No Spin Zone
But as appealing as launching a new shop may seem, it is still hard work. LPs, flush or not, expect more from buyout shops today, and some firms will have to prove they can operate as a group before LPs will entrust them with any money. When Terrence Mullen started Arsenal Capital, for example, the Thomas H. Lee Partners veteran still had to close on three deals before investors became fully comfortable investing with Arsenal.
And if new shops want to hit the ground running, it requires a lot of planning well before the split. “It takes a lot of shoe leather,” Madden says. “You have to start immediately. You can’t waste even a day when you’re in the business of doing deals… In the two days after I left Questor, I registered the name of the firm, set up an accounting department and rented office space in Detroit and New York.”