Dominique Peninon is well placed to talk about the importance of keeping the lines of communication open between limited partners (LPs) and general partners (GPs). Not only does his role at Access Capital make him both LP (as a FoF) and GP (given the investors who are invested in the firm's FoFs) but he also chaired until recently EVCA's investor relations committee during EVCA's reporting and valuation guidelines review.
Unsurprisingly Peninon sees the current environment as one that is obliging GPs to improve reporting standards as a means of ensuring that a fund can be raised in a difficult market. ?The current situation presents GPs with the challenge of raising new funds at a time when realisations have been thin on the ground and firms are struggling to make disposals. Investors need to see that value is being gained in spite of a lack of exit opportunities and therefore there needs to be a steady flow of information to them.?
?The secret is to avoid surprises and to prepare investors, not necessarily for the worst-case scenario, but certainly for the possibility of bad news.?
According to Peninon, one of the key ways to preserve the confidence of your investors is to present them with coherent and consistent valuation methods that can be seen to work over a sustained period of time. As a growing number of GPs are realising, their investors can take bad news about such fundamentals as portfolio valuations but they don't like surprises. Says Peninon: ?Consistency in valuation methods is very important. It's vital you adopt one method and stick to it over the life of the fund. If you change your accounting methods from one year to the next, it sends the wrong message to investors and to the market as a whole. If there has to be a change it needs to be explained, justified and maintained over a long period of time.?
Interestingly, Peninon believes that the current calls for more openness should not be interpreted to mean that investors be given unrestricted access to every last detail of a fund's operation. He subscribes to the edited highlights principle of transparency, where core facts and figures are not embedded in a welter of more peripheral information. ?An excess of information can be as detrimental as a lack of it. Investors should be taken for what they are [experienced and wise people]; if you explain key developments on a regular basis, investors will feel more involved. The secret is to avoid surprises and to prepare investors, not necessarily for the worst-case scenario, but certainly for the possibility of bad news.?
He continues: ?This applies not only to portfolio information but to changes in management. There is nothing worse than finding out through the press that an investee company has gone bankrupt, or from a management point of view, that a partner has left or a new partner has been recruited. Transparency should mean keeping investors abreast of developments on a rolling basis. Timeliness is of paramount importance, which means that you don't wait 6-9 months to make an announcement. Information should be provided between quarterly reports if necessary, when there is an important development in the business.?
Peninon is not painting a picture of rattled LPs waiting to pounce on any less than positive news from their GPs though (something some GPs are understandably prone to imagine). Peninon is quick to remind that ?This is an asset class with high rates of return and one that, despite its high-risk label, is currently displaying less volatility than the stock market. Investors understand that there will be setbacks, and this is why it is important to keep them in the loop.?
On the much-discussed subject of management fees, Peninon prefers to downplay the significance of the debate suggesting that, for the most part, this is not a huge issue between GPs and LPs. ?With the exception of fees charged by very large funds, I don't really have an issue with management fees so long as they decline over time as realisations and write-offs are made, or investments are marked down,? he says. ?Problems do sometimes arise when fees are charged against the net asset value of a portfolio or cost minus write off/markdown. This kind of issue often happens at the end of the investment period when GPs can be quite reluctant to be too aggressive in marking down the portfolios.?
The one area where he does see greater likelihood for friction is with the mega-funds. ?Concerns about management fees become more difficult to dismiss with the €1-5bn funds that close one or two deals a year. With these funds, the level of fees can be such that managers are not sufficiently motivated by the carried interest because the management fee itself gives them very high compensation.?
Comparing the IR approach of European firms with their counterparts in the US, Peninon believes that the two groups have elected to develop methodologies along differing lines. ?A few years ago, the EVCA discussed the possibility of forming an alliance with the American Venture Capital Association (NVCA) to develop a co-ordinated set of standards. The response from the NVCA was that they saw little or no demand for such a system in the US. The NVCA felt that the responsibility should rest in the hands of each individual partnership and management company and that any association-driven set of guidelines would not be necessary.? Whether this more ad hoc approach to LP communication can be seen as one origin to the recent outbreak of litigation by LPs in the US remains a moot point. However, Peninon was keen to point out that he felt that the claims of mismanagement had little or no substance (for more coverage of this see this issue's America Monitor).
?The trend towards litigation in the US is a nonsense.?
Peninon is forthright about LPs taking to the courts. ?The trend towards litigation in the US is a nonsense. When you invest in a single industry fund you cannot then complain that it is not diversified. I cannot see any justification for LPs to sue GPs. When managers were raising $100m everyone wanted to get involved. The pressure increased on managers to increase the size of their funds from $500m to $1bn as LPs looked to make the most of a boom in technology transactions. It is wrong for LPs to tell GPs that they now don't want to pay the drawdowns because the sector has collapsed.?
Images of court room showdowns are a particularly vivid instance of failed IR, whatever the industry and Peninon takes the view that the private equity industry ? which has experienced an accelerated evolution of a few rather than many decades ? has achieved much in a short space of time. ?The need to improve the relationship between managers and investors is part of a natural evolution. Comparing this asset class with what I see in the public markets, I would tend to think that in many cases private equity funds are more transparent than listed companies, especially when you look at what has happened in the last three months. The write downs being made by listed companies such as France Telecom, Vivendi Universal, Alcatel and Lucent highlight the fact that if transparency needs to be improved, it needs to happen across the board.?