Andrew Sheiner worked for 17 years at Onex Corporation, a public company in Canada that has several private investment arms. One of those is Onex Partners, a large-cap-focused group he helped establish in 2001.
It was during his time at Onex that Sheiner learned the importance of flexibility in investment hold periods. The traditional private equity hold period – generally from three to five years – was established in the early days of the industry, in the 1970s and 80s. The structure that evolved was a 10-year fund life, with up to five years for deploying capital and five years for selling investments.
But the rigidity of that structure could also be frustrating, and Sheiner said he often heard concerns from limited partners about the quick investment/exit cycle of traditional private equity.
“An astute investor said to me, ‘This business is crazy; we invest in your funds, we buy businesses through those funds, you then sell them to another fund – we’re then invested in that fund.’ There’s a lot of friction in that transaction. And that would seem suboptimal and not ideal for management teams either,” Sheiner says in an interview.
Sheiner had the benefit of flexibility at Onex and decided, on formulating a strategy for his own shop, that he would apply those lessons to the new venture.
His firm, called Altas Partners, was founded in 2012 on three principles: the firm would be extremely discerning about its acquisitions; it would focus on high-quality businesses; and it would apply time flexibility to its investments, rather than abiding by a strict deadline.
Altas is happy to buy only one or two businesses a year, and hold those investments, if appropriate, for a decade or longer. It can also sell investments earlier if that makes better financial sense, Sheiner says. “We understand that those businesses are precious and hard to come by and if we have the good fortune to own one, we and our partners would feel it’s unfortunate if we had to sell prematurely,” Sheiner says.
The firm closed its debut fund in 2016 on $1 billion, and its second fund on $3 billion last year. Altas acquired eight businesses so far, investing about $8 billion of equity, and sold two of them. “That’s consistent with what we established with our investors and the strategy we set out to pursue, which is not to be rigid. Rigidity in time horizon is not helpful as an owner and investor,” he says.
Altas is an example of a growing desire on the part of GPs to break out of the confines of the traditional private equity fund structure.
For certain companies, GPs would like more time to see their plans through; to make sure they are not getting out of the company while there is still more growth to capture; and to avoid the pressure of selling at the wrong time just for the sake of delivering liquidity back to investors.
“We’re hearing with some consistency GPs saying, ‘We’re sick of selling our best assets to other private equity firms for them to hold it for the next five years and double or triple their money, when we could have held it,” says an LP who has seen this trend. “The challenge is balancing the need for liquidity.”
There’s another factor at play as well: GPs are taking much longer to deploy capital into new investments in the high-priced environment. The total number of deals done over the past five years is down 25 percent from 2014, according to Bain & Co. The calculation becomes: rather than make a bet on something new and uncertain, why not stick with an asset you know intimately, that you’ve grown and improved, with a future path to prosperity that you helped design?
These are the sorts of considerations GPs must contemplate, and LPs appear to be on board. Investors play a vital role in the evolution of this longer-hold strategy, whether it involves raising funds with long-hold attributes, or investing in existing portfolio companies across funds that require investor approval. Without the approval of the investor community this longer-hold trend would not likely be growing as quickly as it is today.
“Over time LPs have seen that, ‘Wow, you’re selling this good company out of your portfolio, and we’re buying it elsewhere in our portfolio, how does that help me? I would have been better off if you had held it another three years,’” says Adam Howarth, managing director and head of portfolio management Americas at Partners Group.
“People would have been delighted 15 or 20 years ago to hold great companies longer if they had the opportunity. But the industry perhaps hadn’t evolved to the point where managers and investors were like-minded around the value of doing that,” Sheiner says.
Buyouts spoke to dozens of sources in the market, including limited partners, investment bankers and GPs, about the growing trend of PE managers holding certain assets longer. The consensus was that the trend is real, but not everyone agreed on the risks and benefits of the strategy.
LPs especially gave mixed reviews: would longer hold periods ultimately lead to stronger returns? Or were they just a way for some larger firms to build revenue and assets under management? What’s clear, though, is that there is a paradigm shift in the industry, where all parties agree that, for some investments, the traditional PE hold period is not appropriate. This will likely help shape private equity as it continues to evolve. “If I still believe in the future of an asset and new deals are scarce, why not stay invested in the asset,” says Hugh MacArthur, partner at Bain & Co.
Meat on the bone
Longer investment holds in private equity are not the norm. In fact, hold periods in general are falling. Median hold periods fell to 4.5 years for deals exiting in 2018, compared with 5.9 years for investments sold in 2014, according to Bain & Co’s 2019 Global Private Equity Report.
“The peak in 2014 was driven by many assets invested just ahead of the global financial crisis that ended up being held in portfolios longer than expected/planned,” MacArthur says.
But with certain assets, GPs are getting much more creative than simply shopping them through an auction. This quicker turnaround likely has something to do with the amount of capital flowing into private equity funds, and the prospect of a firm being able to sell a business at a robust price.
North American private equity and mezzanine funds raised $274.9 billion as of November, up from last year’s tally of $178.7 billion around the same time. And purchase price multiples generally remain high, at an average of 11x to 12x across all industries, Buyouts reported in the third quarter.
What’s more, equity checks in deals have increased to 50-60 percent from 20-35 percent, meaning firms are taking even more risk in individual deals, Sumit Rajpal, global co-head of Goldman Sachs’ merchant banking division, told Buyouts in the third quarter.
“If you take this angle or perspective that there’s more uncertainty about where we are in the economy – and if you’re trying to reduce your risk – finding something you know well makes sense,” Ian Fowler, co-head of Barings Global Private Finance Group previously tells Buyouts. “Especially if you think there’s more meat on the bone.”
DuBois Chemicals is a nearly 100-year-old company that supplies specialty chemicals to help facility operations in sectors like manufacturing, food and beverage, paper and pulp and water treatment.
Around 11 years ago, DuBois’ owner at the time, JohnsonDiversey, decided to carve it out to raise money. DuBois’ current CEO, Jeff Welsh, was helping JohnsonDiversey package up assets for sale, and worked to bring in potential buyers for DuBois.
Eventually Riverside Co. emerged as the buyer for DuBois, with Welsh moving in as CEO. Riverside held the company until 2012, when it sold to Aurora Capital. Aurora owned it until 2017, when Jordan Co. and repeat investor Riverside acquired DuBois, Welsh says in an interview.
Finally, earlier this year, Altas acquired DuBois, a private equity owner that, for the first time, brought flexibility around the length of its hold period. “It’s important to have that optionality, to be able to hold a business if you go into a situation where it might be better to hold it for a longer period of time,” Welsh says. That means being able to hold through a down cycle, when the business may underperform, and sustain it until it emerges into a better environment.
Welsh adds that the long-holding mindset should not be totally tied to anticipated investment holds. “Potentially there’s the option of investing in things that are going to have a little longer time horizon than they would in sort of a traditional three-to-five year plan,” Welsh says. “You have to be a little cautious as a portfolio company in lulling yourself into thinking this will undoubtedly be a long-term hold.”
While DuBois has grown over its private equity ownership years, it only has around 8 percent market share, Sheiner says.
Outside of a long-hold option built into a fund structure, like Altas or Boston-based Cove Hill Partners, GPs are achieving longevity through traditional M&A processes. Many GPs retain minority stakes in businesses they are selling to be able to continue capturing a company’s growth. Others are taking an even more aggressive approach by re-investing in existing portfolio companies held in older funds.
Late last year, Nordic Capital sold its stake in eResearchTechnology out of an older fund, and at the same time re-invested through its new fund for a smaller interest. Nordic sold down its 70 percent stake in ERT to hold an equivalent stake alongside Paris firm Astorg as part of the investment, announced in October.
GTCR last year re-acquired AssuredPartners less than four years after selling the company to Apax. GTCR owned the company from 2011 to 2015 before exiting for a 4x return, Wall Street Journal reported in February 2019.
Growth investor TA Associates recently launched a unique fund that would give it a way to retain interests in companies it was selling where it saw more room for growth.
The fund targets companies in TA’s portfolio that have achieved certain performance goals. The beauty of the strategy is that while giving the firm more time with growing assets, it also allows TA to deliver proceeds back to investors in older funds.
TA Select Opportunities Fund is targeting $1 billion, a fundraising goal several investors expect the firm to hit.
“[TA’s fund represents] the ability to… continue to play in those assets where they think having longer hold periods is beneficial but at the same time, taking some capital off the table and derisk it,” according to an investor who committed to the fund, who requested anonymity.
The LP view
Sources say the trend toward longer-term holds is being driven by limited partners. For LPs, longer hold periods could mean less cost, especially as related to those costs involved in transactions, sources said. Each time a company turns over, there are fees related to the deal, which sources described as “frictional” costs.
“The friction in these things is tremendous,” DuBois’s Welsh says. “Every time we’ve sold this business over the years, there’s a 5, 6, 8 percent friction rate where you’re spending that in transaction costs. I’ve talked to LPs who say, ‘What have I gained? I’ve bought and sold this asset and had 5, 6 or 8 percent come out of it as friction.’”
But LPs also have concerns about how these longer holds are executed, especially when it comes to a GP’s new fund buying companies out of older funds.
Cross-fund investments cause a bit of consternation on the part of LPs because of an inherent conflict: A GP’s new fund wants to pay a low price for the company, while the old fund wants to sell for as much as possible. It’s essential, then, in cross-fund investing, for a GP to get a market value from an external investor, sources said.
“[The GP] has to go through various gymnastics to get that socialized [with investors] and approved through the advisory board and figure out a way to get pricing that’s deemed fair to all parties involved,” according to Scott Reed, co-head of private equity USA at Aberdeen Standard Investments.
One way this could happen is the GP brings in an external minority investor to share control and contribute equity into the deal, Reed says. “This helps provide a third-party external valuation of the pricing in which the transfer occurs,” he said.
Not every LP is enamored with the idea of private equity managers holding investments longer. “There’s something to be said for the discipline you get with traditional fund structure; you know you’ve got five-to-seven years with assets, and then it’s time to move on,” the LP said. “There’s very few businesses that compound at 15 to 20 percent returns forever.”
Risks include a company that is being held longer suddenly encountering a slowdown that cuts into profitability. The GP will have to spend material time and resources on the company rather than working to deploy capital into new investments.
“A large portion of fund LPs would say they don’t want that distraction,” Reed says.
Update: This report was updated with attribution on a quote from Hugh MacArthur.
Healthcare sponsors double dip
When Paris firm Astorg took a piece of eResearchTechnology in 2019, the clinical trial technology company’s existing investor base wasn’t ready to cash out entirely
Rather, Nordic Capital and Novo Holdings A/S opted to press the reset button, despite the company’s valuation more than doubling over their three-and-a-half year hold, writes Sarah Pringle.
In connection with the transaction, Nordic monetized 100 percent of its initial investment, which was made through Fund VIII, a source said. Simultaneously, the European shop put more chips on the table, reinvesting in the fast-growing Philadelphia company through Fund IX.
Financial terms of the October transaction were not disclosed, but Buyouts learned the deal commanded an approximately $3.8 billion valuation, or about 18x EBITDA.
“If you’re holding onto a gem asset, in some [cases], you can generate better returns by keeping that asset and doing more with it, as opposed to starting from scratch,” says Kara Murphy, who as a partner in Bain & Co’s Boston office co-leads the firm’s healthcare private equity team.
Murphy said that while it’s a compelling strategy, it doesn’t go without opportunity risk: “The risk: should you take the money and be happy, versus rolling the dice… It’s a fine balance.”
For ERT, you could say the clock is starting again. While fairly inactive on the M&A front during the 18 months prior to Astorg’s investment, ERT is likely to be acquisitive with a new injection of capital, one source said. In other words, bringing on a new investor provides the incumbent investor with adequate financial capacity to ride continued growth.
Other selling PE firms have found rolling equity, or rather, holding successful investments across multiple funds, a compelling strategy.
For instance, when Genstar Capital preempted the sales process this past summer for Advarra, existing shareholder Linden Capital reinvested through Fund IV, even while it was poised to generate an 8x return on its initial investment, which was made through Fund III.
The agreement valued provider compliance-related services for clinical research at approximately $1.3 billion, or approximately 18x EBITDA, Buyouts reported.
In the case of ERT, Astorg and Nordic now own equal controlling stakes in the company, while Novo remains a minority shareholder, one of the sources said. Similarly, Genstar and Linden agreed to a partnership governance structure, Buyouts reported.
While complex transactions certainly raise the bar as far as how governance is structured, the ultimate goal is to turbocharge management, Murphy says. In her view, “the pros outweigh the cons.”
“The more cooks in the kitchen, the more tricky it can be to get things done,” she says, “[but] different investors come with different lenses.”
In other words, one investor might bring to bear an expertise in business development and M&A, while the other might be an expert in operations-driven organic growth. “All of a sudden, you may have the best of both worlds.”
Going Dutch on a business
Another way GPs are holding treasured assets beyond the three-to-five structure of a traditional private equity fund is by selling joint control of the business to another GP.
Some PE firms are holding exposure to their assets by selling a 50 percent stake to another PE firm, while retaining a co-control position in the company, writes Milana Vinn.
This approach has become especially popular among software investors that chase companies with high valuations, GPs and bankers recently told Buyouts.
GPs who were not considering a sale of their software assets have become more open to exploring liquidity options amid the temptation of high prices, the sources said.
“You are sitting here today and thinking, ‘Wow, how much of my gain is simply because multiples have expanded? Let me sell some of it.’ And I do think it’s factoring in some decisions,” one of the sources said.
PE firms typically hold assets for three to five years after which they seek to fully exit the investment. However, Vista was able to extend its holding time for both Advanced and Eagleview – two portfolio companies that the firm acquired in 2015. This year, Vista sold 50 percent of Advanced to BC Partners and 50 percent of Eagleview to Clearlake Capital. GTCR also sold 50 percent of Park Place Technologies to Charlesbank this year, after holding the company for four years.
Sellers of these high-quality software companies often want to dictate what kind of deal they want to do, Hythem El-Nazer, managing director at TA Associates, tells Buyouts. When a selling firm believes in the future growth prospects of an asset, this firm wants to continue driving the decision-making in the business, El-Nazer says.
“Most buyers acknowledge this, and so when the alternative to a 50-50 deal is no deal, people put egos aside and the result is the increased number of joint-control transactions,” El-Nazer adds.