Over the last few months, the sale or flotation of hedge fund businesses has been making the headlines.
There is heightened activity, including deals like Schroders buying NewFinance Capital, Man taking a 25% stake in BlueCrest and BNP Paribas acquiring Fauchier Partners. This comes with the increased acceptance of hedge funds as part of a diversified portfolio for institutional investors like pension funds, along with spectacular growth figures from the industry as a whole.
According to Fiona Sheffield, a Partner at Ernst & Young, there are a few key themes emerging in the industry. Larger scale start-ups are now more prolific: new funds which launch with a billion dollars in seed capital were unusual until recently. The evolution of hedge fund platforms providing investment teams with the benefits of a boutique environment without the distraction of running a business has also been a major trend. And then there has been the surge in M&A activity, as traditional fund managers acquire hedge fund shops in an effort to increase their alternative investment capabilities. New and established managers alike are giving serious consideration to their exit strategies, trying to position their businesses so that they may one day be a well-prepared target for an acquisition offer.
Stephen Couttie, who joined RAB Capital in 2005 as COO, sees a number of softer issues at work behind the scenes in the M&A equation, especially the management of expectations as to how a deal can be successfully executed. RAB Capital has not only listed on AIM, but has gone on to acquire Cross Asset Management and, this year, Northwest Investment Management. “A non-correlated strategy which has got a good track record and is of sufficient materiality to impact on our complexion of revenue streams in a meaningful way is arguably a sweet spot,” Couttie says. “Growth is also very important. We have stated that we won’t make any acquisitions unless we’re doing so on accretive terms, and acquired businesses need to display a growth dynamic that at least matches organic business development. The team we’re looking at has got to be brought into our economic model, and there is obviously a cultural dimension. These things are about not wanting, at any cost, to build a business within a business.”
Diversification is at the top of the list for an acquirer like RAB. A compelling growth prospect is also of interest, and a clean shareholding structure is a big plus factor. Rearguard actions against regulators and contentious tax issues will conversely work against any deal. The onus is on the vendor to put its shop in order with regard to tax and distribution agreements: the acquirer does not want to inherit these problems. Vendors need to also be very clear about their contractual agreements, as these can serve to be a deal-breaker at the eleventh hour.
“No amount of practical preparedness and no amount of perfection in the strategic fit will compensate if there is any shortfall in the commitment to the deal, or any sort of ambivalence as to whether this is the right strategic choice for a firm,” says Couttie.
Owners of small owner-managed businesses are faced with a range of strategic options, other than an outright sale, and this can confuse the issue. Acquirers like RAB like to feel they are discussing the only choice open to a seller once a potential transaction is on the table. Acquisitions take time, and over the months that a deal is proceeding strategic resolve can be tested: share purchase agreements, warranties, covenants, liabilities under the warranties, caps on liabilities, service agreements, good leaver/bad leaver clauses, all these, while soft issues in themselves, can prove testing if there is a sudden lack of strategic resolve. There has to be an agreement, a collegiate approach, in order to maintain the momentum of the deal between the parties. “If expectations are calibrated to embrace a lot of involvement in detail and full engagement in the process by the vendors, then it will be successful,” Couttie says.
Richard Ford, former COO at ORN, which was partially sold to Morley early this year, says it is essential that vendors are fully prepared when entering sales negotiations, including for visits by the FSA, HMRC or due diligence by advisors to the acquirer. “Keep your documentation clean and keep it very solid,” he says. “Have an ongoing data room, keep a vault of critical information, keep it updated.”
He says owners of businesses need to maintain a clear idea of the sort of business they want to build, what sort of partnership they might want to have with firms interested in buying a stake in that business, and which people are vital to the ongoing success of the business. As a result, there should hopefully not be any issues or disputes about ownership entitlements, profit shares, or employment agreements. If it is all dealt with early on in the business life-cycle, there should not be a problem when the time comes to sell some or all of the entity.
Culture is also important: it is vital that the key employees understand why the transaction is being entered into and that they support it. “Within the boundaries of confidentiality, amongst your team, be as open as possible,” Ford advises. “Whether that is about the business plan or about the specific discussions you’re having, I would encourage openness and honesty, perhaps with the use of additional confidentiality agreements.”
Firms also need to be prepared to cope with the demands of the due diligence process, something that always turns out to be greater than expected. Both sides of the deal have to work to control the due diligence process in order to ensure relationships stay intact. In this respect, it is worth spending money on a third party to act as a buffer.
Keeping to a deadline will facilitate the transaction. Honest and open dialogue at the due diligence stage will help to close issues that have been raised. Letting the deadlines move will risk resurrecting issues that should have been resolved already, and the reappearance of these problems in the representations and warranties. “What you think is an issue that’s closed may become a bigger issue at some point later down the line for your purchaser, and you discover it when there’s a huge retention you’re really not comfortable about,” says Ford. “At that point it may be too late.”
Integration of the firm once the deal is completed is another important aspect: in RAB’s case this is habitually mapped out prior to the closure of the deal. Ultimately, systems issues prove the most difficult to resolve, particularly deal processing. A team needs to be brought on board that can manage the systems integration risk as quickly as possible, to avoid the acquiring firm being saddled with key man risk at an early stage.
Ultimately, planning for the sale of a firm, or some form of partnership agreement, is essential to the successful completion of an agreement later on in the life of a given business. In ORN’s case, management already had a clear idea of the sort of partner they would be happy to work with long before negotiations with Morley opened. At RAB, Couttie is aware that many fund managers are thinking about the benefits of being acquired by a larger firm, and how it can help them to concentrate on continuing to manage their funds without worrying further about operational issues. This is especially so given the increased regulatory burden and heavier volumes of operational due diligence from institutional investors.
There is heightened activity, including deals like Schroders buying NewFinance Capital, Man taking a 25% stake in BlueCrest and BNP Paribas acquiring Fauchier Partners. This comes with the increased acceptance of hedge funds as part of a diversified portfolio for institutional investors like pension funds, along with spectacular growth figures from the industry as a whole.
According to Fiona Sheffield, a Partner at Ernst & Young, there are a few key themes emerging in the industry. Larger scale start-ups are now more prolific: new funds which launch with a billion dollars in seed capital were unusual until recently. The evolution of hedge fund platforms providing investment teams with the benefits of a boutique environment without the distraction of running a business has also been a major trend. And then there has been the surge in M&A activity, as traditional fund managers acquire hedge fund shops in an effort to increase their alternative investment capabilities. New and established managers alike are giving serious consideration to their exit strategies, trying to position their businesses so that they may one day be a well-prepared target for an acquisition offer.
Stephen Couttie, who joined RAB Capital in 2005 as COO, sees a number of softer issues at work behind the scenes in the M&A equation, especially the management of expectations as to how a deal can be successfully executed. RAB Capital has not only listed on AIM, but has gone on to acquire Cross Asset Management and, this year, Northwest Investment Management. “A non-correlated strategy which has got a good track record and is of sufficient materiality to impact on our complexion of revenue streams in a meaningful way is arguably a sweet spot,” Couttie says. “Growth is also very important. We have stated that we won’t make any acquisitions unless we’re doing so on accretive terms, and acquired businesses need to display a growth dynamic that at least matches organic business development. The team we’re looking at has got to be brought into our economic model, and there is obviously a cultural dimension. These things are about not wanting, at any cost, to build a business within a business.”
Diversification is at the top of the list for an acquirer like RAB. A compelling growth prospect is also of interest, and a clean shareholding structure is a big plus factor. Rearguard actions against regulators and contentious tax issues will conversely work against any deal. The onus is on the vendor to put its shop in order with regard to tax and distribution agreements: the acquirer does not want to inherit these problems. Vendors need to also be very clear about their contractual agreements, as these can serve to be a deal-breaker at the eleventh hour.
“No amount of practical preparedness and no amount of perfection in the strategic fit will compensate if there is any shortfall in the commitment to the deal, or any sort of ambivalence as to whether this is the right strategic choice for a firm,” says Couttie.
Owners of small owner-managed businesses are faced with a range of strategic options, other than an outright sale, and this can confuse the issue. Acquirers like RAB like to feel they are discussing the only choice open to a seller once a potential transaction is on the table. Acquisitions take time, and over the months that a deal is proceeding strategic resolve can be tested: share purchase agreements, warranties, covenants, liabilities under the warranties, caps on liabilities, service agreements, good leaver/bad leaver clauses, all these, while soft issues in themselves, can prove testing if there is a sudden lack of strategic resolve. There has to be an agreement, a collegiate approach, in order to maintain the momentum of the deal between the parties. “If expectations are calibrated to embrace a lot of involvement in detail and full engagement in the process by the vendors, then it will be successful,” Couttie says.
Richard Ford, former COO at ORN, which was partially sold to Morley early this year, says it is essential that vendors are fully prepared when entering sales negotiations, including for visits by the FSA, HMRC or due diligence by advisors to the acquirer. “Keep your documentation clean and keep it very solid,” he says. “Have an ongoing data room, keep a vault of critical information, keep it updated.”
He says owners of businesses need to maintain a clear idea of the sort of business they want to build, what sort of partnership they might want to have with firms interested in buying a stake in that business, and which people are vital to the ongoing success of the business. As a result, there should hopefully not be any issues or disputes about ownership entitlements, profit shares, or employment agreements. If it is all dealt with early on in the business life-cycle, there should not be a problem when the time comes to sell some or all of the entity.
Culture is also important: it is vital that the key employees understand why the transaction is being entered into and that they support it. “Within the boundaries of confidentiality, amongst your team, be as open as possible,” Ford advises. “Whether that is about the business plan or about the specific discussions you’re having, I would encourage openness and honesty, perhaps with the use of additional confidentiality agreements.”
Firms also need to be prepared to cope with the demands of the due diligence process, something that always turns out to be greater than expected. Both sides of the deal have to work to control the due diligence process in order to ensure relationships stay intact. In this respect, it is worth spending money on a third party to act as a buffer.
Keeping to a deadline will facilitate the transaction. Honest and open dialogue at the due diligence stage will help to close issues that have been raised. Letting the deadlines move will risk resurrecting issues that should have been resolved already, and the reappearance of these problems in the representations and warranties. “What you think is an issue that’s closed may become a bigger issue at some point later down the line for your purchaser, and you discover it when there’s a huge retention you’re really not comfortable about,” says Ford. “At that point it may be too late.”
Integration of the firm once the deal is completed is another important aspect: in RAB’s case this is habitually mapped out prior to the closure of the deal. Ultimately, systems issues prove the most difficult to resolve, particularly deal processing. A team needs to be brought on board that can manage the systems integration risk as quickly as possible, to avoid the acquiring firm being saddled with key man risk at an early stage.
Ultimately, planning for the sale of a firm, or some form of partnership agreement, is essential to the successful completion of an agreement later on in the life of a given business. In ORN’s case, management already had a clear idea of the sort of partner they would be happy to work with long before negotiations with Morley opened. At RAB, Couttie is aware that many fund managers are thinking about the benefits of being acquired by a larger firm, and how it can help them to concentrate on continuing to manage their funds without worrying further about operational issues. This is especially so given the increased regulatory burden and heavier volumes of operational due diligence from institutional investors.
