Louis Elson, co-founder and managing partner of pan-European private equity firm Palamon Capital Partners, reflects with amusement on the hook that meant Palamon's debut fundraise never struggled to get the attention of limited partners. “People were so surprised we'd left Warburg Pincus that they took the meetings out of curiosity. Then they waited until the end of the meeting to tell us they didn't have any money.”
The ‘we’ referred to by Elson includes fellow co-founder and managing partner Michael Hoffman. The latter, a dual American/Austrian national, spent 15 years as a management consultant before launching the London office of Warburg Pincus in 1987. Elson, an American, joined him at Warburg two years later to help build the franchise, having previously been an investment banker at Goldman Sachs.
In an interview at Palamon's headquarters in London's West End, the two men reflect on the relatively humble nature of European private equity when Warburg was first making its mark in London. A large fund back then was in the region of £200 million, they recall, and the almost ubiquitous strategy was ‘growth capital’. The use of inverted commas is deliberate. So common was the approach that it didn't require a label – it was simply how private equity was done. Hoffman says he remembers Paris-based LBO France being viewed by some as an intriguing curiosity back in 1985, when it first introduced a leveragefocused approach to European private equity (the clue was clearly in the name).
By the mid-1990s, times had changed significantly, with the largest global vehicles beginning to edge over the billion-dollar mark. Warburg Pincus embraced the zeitgeist fully by amassing a $5 billion fund, which closed in 1998. Hoffman labels it “the first megafund” and recalls how it was a turning point not just for Warburg – whose largest prior fund was $2 billion – but also for himself and Elson. “We could see the focus [of the firm] would change,” he says. “They would still do a wide variety of deals but they would have three or four times as much capital to deploy in Europe, and that meant doing larger buyout deals we'd not experienced.”
Eschewing the mega-trend, Elson and Hoffman ended up becoming part of a different fashion when they elected to launch Palamon as a new entrant to the European mid-market in 1998. Just the previous year, Duke Street Capital had catalysed a trend for establishing new, independent London-based private equity firms, which continued through Palamon before the likes of Phoenix Equity Partners, Charterhouse Capital Partners and Permira followed the same path.
TRUE TO ITS ROOTS
Palamon did, however, find a way of standing out from the crowd by staying dedicated to the growth capital roots of its founders. While the firm prefers to take majority positions, only around half of Palamon's investments include the use of leverage. Although many of its contemporaries continued to dabble in growth capital to a greater or lesser degree, buyouts had clearly attained the strategic ascendancy by the time European private equity prepared to greet the new millennium.
People were so surprised we'd left Warburg Pincus that they took the meetings out of curiosity. Then they waited until the end of the meeting to tell us they didn't have any money
By sticking with an established style of investing rather than flocking with the buyout crowd, the likely success or otherwise of Palamon's debut fundraising was hard to call. Would investors reject the firm as an anachronistic outlier, or instead welcome its endurance in a space that others had vacated? Advised by CSFB, Palamon set out with a target of €300 million. The nature of this target in itself marked the firm out as idiosyncratic – not in terms of size, but with respect to being the first ever private equity fund denominated in euros. “When we started raising the fund, the euro didn't officially exist,” reflects Elson with a smile. “The lawyers required the bankers to actually define it in the PPM.”
Given this irregular aspect to the fund's launch, perhaps the rollercoaster ride that followed was not entirely surprising. Elson takes up the story: “We launched the fund in mid-August  and soon after we turned on the TV to find that the Russian government had defaulted on its debts and financial markets had bombed. The mood in September was not good . Gradually, the economic impact levelled off and then along came the Asian debt crisis, which delivered a massive jolt. By Christmas, we were struggling to explain that what we were doing was a good idea.”
By the end of 1998, Palamon had received only one commitment worth just $8 million. But, in a vivid illustration of how fortunes on the fundraising trail can be transformed almost overnight, Elson recalls that a recovery in global markets meant that in early 1999 many limited partners ended up revisiting information memoranda they had passed over in the fourth quarter of the previous year. With allocations to private equity now soaring, Palamon's fund was oversubscribed by May. The previous January, an institutional investor had imposed a hard cap of €400 million. Such was the level of demand by May that the firm asked to be released from the cap. This was agreed, but only to a maximum of ten percent of the total. Hence the fund eventually closed on €440 million.
The next task was finding a home for the money. To this end, Elson and Hoffman insist that there was – and still is – demand from vendors to work in partnership with empathetic buyers rather than just those with the fattest wallets. “If it's an interesting business, the vendor knows it can get a good price,” Elson reasons. “Once you've got that price guaranteed, then you look for something else.” There have always been sellers, he contends, with deep roots in local communities for whom choice of buyer will always be about more than just money.
A vendor wishing to retain a minority interest in the business post-sale might also, like the ‘socially aware’ seller, be enticed by a firm like Palamon's emphasis on growth. “If there are two or three rival bidders, it's pretty obvious that you can win by how you join in partnership with the owner,” says Hoffman. “They want to know how your ownership can make them more money in future.” As an example, he cites Team System, an Italian software provider for SMEs. Some of its original management team remained invested in the business when Palamon took the reins in 2000. According to Hoffman, the firm had been “transformed from a regional player into a national player” by the time it was sold to Bain Capital in December 2004 for a “substantial multiple”.
DEVOTED TO DILIGENCE
But while keeping minority stakeholders happy is one means of ensuring that Palamon is viewed favourably by would-be sellers, an arguably more important aspect of the firm's strategy is to find ways of identifying those businesses most likely to generate out-performance in the first place. For this reason, due diligence is an area that the firm takes extremely seriously. The centrepiece of the effort is an in-house research team headed by Mark Matthews, a former Accenture researcher and managing director of Nasdaq Europe. The team seeks to understand the dynamics affecting industry sectors and sub-sectors, and helps the firm to discover, for example, themes that are well developed and proven in one country but yet to be applied elsewhere.
Demonstrating that life is rarely completely scientific, the methodology employed by Palamon may not necessarily lead to an appropriate target straight away – by the cofounders' admission, the journey to the pot of gold may on occasion be a circuitous one. One such example, related by Elson, was the research team's identification of quick-service restaurants as a potentially profitable area for investment. Within this, coffee bars were seen as having particular potential. The search then narrowed further to Spain, which, says Elson, “we found wasn't the right place after all…but Sweden turned out to be very interesting.” Having consequently diverted its focus to Nordic climes, Swedish intermediaries pointed Palamon in the direction of Espresso House and Coffee House, two leading (but small) operators of branded coffee bars. In May this year, the firms were acquired by Palamon for a combined €10.9 million.
Speaking of the attractions of the deal, Elson says: “The Swedes are high coffee consumers; the coffee bar is seen as a social environment and coffee drinking seen as a leisure activity – and yet none of the big international players have gone there. We feel we can grow the rebranded company to 200 sites [Espresso House and Coffee House had 37 sites combined at the time of writing] and take it into neighbouring countries.”
Hoffman refers to this kind of buyand-build investing as “supporting businesses that have the wind at their backs”. But despite this appealing imagery, growth capital remains a diminished force in today's European private equity market as LBO funds continue to court favour. Hoffman's theory is that growth capital is too closely associated in many investors' eyes with venture capital. One byproduct of the dotcom bubble and telecoms blow-out earlier in the decade, he suggests, was scepticism toward all types of growth strategy, whatever the size of the target company: “Growth came to be seen as illusory and people concluded it was difficult to make money in the space. Investors sought safer havens and that meant supporting GPs focused on more traditional leveraged situations.”
iN WITH THE NEW
This legacy meant that Palamon continued to have its patience tested when it returned to the fundraising circuit for a second vehicle. Hoffman says: “We had immediate success within weeks of launch in terms of getting re-ups. Most that backed the previous fund came in and wanted more. But it took a long time to get in the new investors we wanted. The ones we were targeting were so busy with re-ups to other funds that they said they couldn't even talk to us for ages and, when they did, they would need to do a lot of due diligence to get inside our unusual portfolio.”
He adds: “Differentiation works against you because you've got to shout louder than everybody else to get people to hear. There's a standard fund that investment committees are perfectly comfortable with – and we're not it. People often couldn't put us in a box so they said they'd have to pass.”
Despite scepticism from certain quarters, Palamon nonetheless succeeded in closing Palamon European Equity II on €670 million in July this year – 50 percent more than the amount raised for its debut fund. Among 30 LP groups, a number of notable newcomers eventually came to the table, among which were AlpInvest Partners, the Irish National Pension Reserve Fund and Macquarie Global Private Equity Fund.
With a successor fund under its belt, Palamon has shown that a European growth capital strategy in today's European private equity market is viable – even if persuading those unfamiliar with it takes a lot of time and effort. Eight years on, the decision of its two founders to fly the Warburg Pincus nest no longer appears quite so hard to justify.