Deal Mechanic: Evoco repowers zombie NEI

Evoco’s restructuring of an ailing private equity portfolio (backed by independent secondary firm Headway Capital) illustrates one way that the industry can deal with its many dysfunctional funds.

In 2001, a Swiss private bank called Sarasin – then owned by Holland’s Rabobank – had promoted to its clients a vehicle called New Energies Invest (NEI), raising about €90 million from institutional and private investors. A local Swiss M&A boutique called Remaco was brought in as investment advisor, and NEI set about building a portfolio of mostly minority venture and growth capital stakes in renewable energy companies.

Initially, everything went pretty well. But in the aftermath of the financial crisis, amid a difficult period for the renewable energy industry, performance went backwards. By 2011, the vehicle was basically a lame duck: some of the six remaining businesses in the portfolio were in urgent need of restructuring and/or refinancing, but the vehicle was fully invested and so had no way of injecting extra capital.  NEI had not yet distributed any capital to its investors (any proceeds had been used to make new investments and cover the management fee), and market conditions made it particularly difficult to exit these ailing companies. In addition, many of the original team were no longer with the advisor.

Enter Evoco, a relatively new group founded by Felix Ackermann and Michel Galeazzi, who had previously worked together at 3i Group (before the latter moved onto HgCapital for three years). Evoco specialises in taking over and restructuring ailing funds, injecting capital as required and managing out the portfolio in a way that delivers liquidity for existing LPs.
 
Having come across NEI, it got in touch with the management team and persuaded them that a fundamental restructuring was required. In practice, this meant pulling the plug on the existing vehicle and transferring the portfolio to a new closed-end Jersey-domiciled limited partnership, with Evoco acting as the new GP. The financial backing for this €20 million transaction was provided by Headway Capital, a UK-based secondaries firm that specialises in small and complex deals like this.

Since the deal closed in the third quarter of last year, Evoco has largely focused on restructuring the portfolio companies (which, it admits, took longer than expected due to the ongoing woes of the underlying market). However, it’s now starting to move into harvesting mode; indeed, it has already started distributing capital to LPs, thanks to a partial divestment.

It’s planning to exit all the assets within three years, so it will be a while before the merits of the deal can be assessed fully. Nonetheless, it does seem to be heading in the right direction – and it does seem to illustrate three of the key aspects necessary for a restructuring like this to work.

1. A situation that demands action

One of the biggest problems in dealing with ailing funds is inertia: GPs have little incentive to move the process along, as long as they’re continuing to pick up the management fee; and while LPs may be dissatisfied with the situation, there’s often no particular impetus forcing them to address it. The result is that funds limp on much longer than they ought to (and the inevitable restructuring ends up being all the more painful).

In the case of NEI, however, doing nothing was not really an option. This was a quasi-public vehicle that published its accounts annually (it had previously hoped to float one day). So the problems in the portfolio were very clearly visible to the outside world: net asset value was declining, and the vehicle’s running costs were painfully high. 

It was also in the interests of Sarasin find a solution that would benefit investors, many of whom were long-standing clients of the bank (NEI’s chairman worked at Sarasin, as did one of the other independent directors).

Equally, changes were urgently and patently needed at asset level. “The fund was fully invested and the companies needed money – so it was clear that a deal had to be done,” says Galeazzi.

2. An engaged and capable seller

Significantly, NEI’s management recognised and accepted this urgency. Ackermann admits that when Evoco first approached them, he was worried that they would be reluctant to engage – not least because they were aware of the time and effort it would require, and because the vehicle’s quasi-public nature made it impossible to conduct the process behind closed doors (as LPs often like to do in a restructuring situation). 

There was also a concern that they might be too hands-off. “You might have thought that they would not be very close to the situation, so they wouldn’t be interested in talking to active restructuring specialists. But in fact the contrary was true: they were very professional and very aware of the issues.”

Another important point was that NEI’s management had the power to make change happen. As Galeazzi points out, this is not always the case with dysfunctional funds. In some cases, the LP group is too disparate or divided to act collectively; in others, they don’t have sufficient resolve or clout to take on a strong-willed GP.
 
In this case, the fact that the principals were talking to each other directly, without an intermediary, clearly made the process much easier.

3. A deal structure that works for all concerned

According to Ackermann, the first problem in negotiating the deal was agreeing on valuations. “When things turn sour, there’s obviously going to be a gap between what the new GP thinks a portfolio is worth and what the existing GP thinks it’s worth.” 

The key to resolving this, he says, was to put in place a flexible structure. Evoco would not be drawn on the details – citing confidentiality constraints – saying only that the structure allowed them to share some of the risk with existing investors (by rolling over their interests) while giving the new money a share of any upside.

There was also the related issue of negotiating an exit for the existing adviser, who ultimately received a package compensation (Evoco wouldn’t say what, but in previous situations like this it has tended to be about six months of management fee).

It didn’t help that the portfolio continued to be, as Galeazzi puts it, “a moving target”. One of the companies even went bust in between the signing and closing of the deal, further delaying the process and eventually requiring an extra injection of capital.

On the other hand, the fact that Evoco started its portfolio management activity even before the completion date was one of the main reasons the deal was able to “get across the line”, says Ackermann – because it showed the other parties involved (particularly the management teams of the operating companies) what difference an active partner could make.

These were lengthy and complex negotiations, taking over six months to complete. But since due diligence is always going to be more difficult in this sort of deal (given the number of assets and the time and access constraints), structuring becomes more important. Says Galeazzi: “Our focus is on having a structure that works when it’s sunny and when it’s rainy … There were both positive and negative surprises, but the structure we had in place worked quite well to iron those out for the benefit of all concerned.”