As buyout funds reach unprecedented sizes, fees generated from the deals being made from these mega funds are also reaching record levels. Private equity advisors don’t come cheap and recent figures reveal they are reaping the rewards of their labours with millions of dollars of fees. For JP Morgan, the highest paid investment bank in the sector, the percentage of fees generated from private equity firms is coming in at over a quarter of the bank’s total fee income. And in Europe for the first four months of the year, private equity groups have accounted for over 20% of revenues that banks have made in the last year. Angela Sormani reports
According to data from Thomson Financial and Freeman & Co, Blackstone Group was the top client globally in 2004 and 2005, spending US$522m and US$313m on investment banking fees, respectively, accounting for 6.3% and 3.4% of the total buyout market. For the beginning of this year to April 30, KKR is the top client worldwide, paying out US$143m so far in fees, which looks set to increase with the ever-increasing pot of capital the buyout giant has accumulated via both its traditional LP funds and its recent IPO offering.
In Europe for the past two years Apax Partners has topped the fees charts, spending US$144m and US$185m in 2004 and 2005 respectively, accounting for a 6% and 5.7% share of the total buyout market according to data from Thomson Financial and Freeman & Co. For the beginning of this year to April 30, Permira has been leading the way, having paid out US$96m accounting for a 7.8% share of the buyout market. This figure also looks set for a boost with a rumoured €10bn fund raising on the horizon; a sum of money that will need to be put to work.
The top earners from private equity fees in Europe are JPMorgan, reaping US$230m in 2005 and US$103m to April 30 this year, closely followed by Goldman Sachs taking US$193m and US$92m for the same periods.
Jeremy Furniss of Livingstone Guarantee says of his experience of dealing with private equity firms: “There is a clear cycle in the way private equity firms approach fees. Private equity firms are tough to work for; they have a clear understanding of what they expect from advisers and what the market rate for a job is. They will take a tough stance on fees, and there isn’t really a lot of latitude when it comes to negotiating with a private equity firm.”
He adds: “The exception is when it’s a seller’s market and advisers become the gatekeepers to deal flow and that’s where we find ourselves at the moment. Private equity firms don’t want to bite the hand that feeds them and so for deal origination we’re not experiencing a lot of pressure on fees. And if deals do happen, private equity firms are actually erring on the side of generosity.”
The relationship between private equity firms and banks is indeed a lucrative one, generating fees from a range of services including M&A advice, IPOs and loans. What seems to be a never-ending growth of the buyout market, including mega fund raisings and a continued liquidity in the debt markets, has also fuelled an increase in fees paid to banks.
Many investment banks have taken advantage of their contacts in the industry by employing a triple play approach to private equity whereby they advise, finance and co-invest alongside their client. Goldman Sachs is one such player blurring the lines as to what role an investment bank actually plays.
Inevitably the banks have to tread carefully when competing with private equity firms for deals: firms understandably may take it badly when banks have co-investment relationships with their competitors and they don’t want to see their relationship banks competing head to head on transactions. On the other hand many private equity firms are not loyal to just one investment bank and many are willing to go and speak to several about a deal and then end up working with another.
Anne Rannaleet of Industri Kapital says: “We are a mid-market firm and would tend to work more with banks which are active in that bracket. What bank you use depends very much on where the target or potential buyer universe is based and the sector. These are attractive and competitive processes for the banks, especially for the hotter deals.”
Fees vary and there doesn’t seem to be a uniform figure. In the mid-market, for example, for a £50m transaction on the sell-side an adviser might expect to be earning between 1% and 1.5% of the deal size. This can be structured as a two-tier fee and the adviser would firstly charge a retainer, which can be around £40,000 to £50,000, and a success fee, normally of about 1% to 1.5%.
If an adviser is trying to root out deals and making introductions, private equity houses seem happy to pay around 1% of the deal price for that introductory role and if the adviser is also providing an advisory role, then that could grow to 2%, provided the deal completes.
Another role an adviser may have with a private equity firm is advising management on an MBO. If the adviser is brought in on that role and is simply there to negotiate the terms of the management contract, fees don’t have as much to do with the actual deal value, but more to do with the time and resources. Fees in this scenario in the mid-market can typically range between £100,000 and £200,000 simply for advising management.
Of course for those deals that don’t complete there are also costs. According to global data from Dealogic, fees generated from incomplete deals have been increasing year on year since 2004. In 2004 there were 15 announced deals that did not complete, accounting for costs of US$1.5m, 10% of the US$15.3m total fees that would have been paid out had they completed. In 2005 there were 44 announced deals that did not complete, accounting for costs of US$17.1m. And for 2006 so far the figures come in even higher for the 122 announced deals that haven’t completed, reaching US$65.1m of a potential US$651.4m total had they completed.
James Stewart of ECI says: “The fee relationship at the top end of the LBO market where most of the investment banking fees will be earned probably depends on the relationship between the private equity house and the bank but where there is an existing, close relationship there will undoubtedly be some arrangement on the fees of an incomplete deal.”
Anne Rannaleet of Industri Kapital adds: “Only a very small proportion of fees paid relates to uncompleted deals. Most fees are success-based and fees on non-completed deals are very unusual but sometimes a smaller fee could be paid if the seller chooses to abort the transaction, but that is insignificant.”
Of course, investment banks do expect to have incomplete deals especially in such a competitive environment where there are an increasing number of bidders for deals. Most accept every fifth deal, for example, will be successful and fees from that one deal will compensate for the other four.
Mark Owen of NBGIPE concludes: “Generally speaking the majority of deal fees are naturally contingent. For example, bank fees on lending which as a percentage of the amount lent will obviously not be incurred if the deal doesn’t complete. As far as investment banking fees go, these are also often contingent on success, especially where there is a close relationship.”