Rollover co-investments: ‘Handle with extreme care’

Permira, Nordic Capital and EQT are all examples of GPs who have acquired minority stakes in assets they've just exited in so-called 'rollover co-investment' deals.

In an environment where quality assets are scarce and competition is fierce, rollover co-investments are providing an attractive source of dealflow for GPs.

European buyout shops Permira, Nordic Capital and EQT ’s re-investments in assets they already owned – advisory firm Duff & Phelps, clinical trials data and technology company ERT and pest control Anticimex – are recent examples. NB Renaissance, Neuberger  Berman’s arm dedicated to private equity investments in Italy, also recently re-invested in Rome-based IT services company Engineering Group.

This was also the case for UK mid-market firm Livingbridge when it re-invested as a minority shareholder in Sykes Holiday Cottages this month, after having exited the company to Vitruvian Partners in October.

“It was such a no-brainer to re-invest because it feels like they’re at such an interesting moment in their story,” Susie Stanford, an investment director at Livingbridge, told Private Equity International. “The business has taken a leap forward, having built their technology platform and ramped up their M&A in recent years.”

Aside from providing liquidity to investors, Stanford noted that timing was also one of the reasons for the re-investment. The asset was “sitting in a fund that was nearing its fund cycle and didn’t coincide with where the firm thought the growth and value creation can really sit”, she said.

Vitruvian led the deal and holds the driving equity stake, with Livingbridge co-investing alongside the firm and picking up a significant minority shareholding.

Such deals, which allow managers to maintain exposure to marquee assets while delivering an exit for LPs, could increase as GPs face an increasingly competitive and expensive investment environment.

In January, Blackstone co-founder Stephen Schwarzman noted there were fewer buying opportunities because markets and assets have become so expensive.

“Everything is up. You have to see something reasonably remarkable in terms of your ability to improve the operations of a company,” Schwarzman told CNBC.

Jean-Francois Le Ruyet, a London-based partner at fund of funds manager Quilvest, told PEI that rollover co-investment deals are accelerating, particularly with large outside co-investors or existing LPs wanting to maintain exposure to an asset.

The strategy is attractive for GPs because they are already comfortable with the asset and know it well, Le Ruyet added.

According to Alex Green, a partner at law firm Macfarlanes, such deals make sense when a GP believes an asset can continue to deliver high returns.

“A GP can crystallise value for its investors through the exit process but at the same time retain exposure to an asset which it has diligenced and managed for an extended period of time and which it believes has the capability to deliver further material upside for its investors,” Green wrote in a guest commentary for PEI in mid-January.

This deal type can sometimes be seen as suggesting a lack of good quality dealflow, which reflects caution in the market as a result of assets being highly priced, Le Ruyet noted.

Some GPs are creating dedicated structures to house rollover co-investments. TA Associates raised $1 billion in November for TA Select Opportunities Fund – a vehicle that that reinvests minority stakes in portfolio companies its main fund has sold, sister publication Buyouts reported.

Managing potential conflicts

Such transactions are fraught with inherent conflicts of interest, and GPs need to ensure that any issues arising in respect to the transaction are appropriately managed and carefully navigated. This is especially so where the reinvestment is being made by another fund managed by the GP, and there is the potential for misalignment between investors in the GP’s relevant funds, according to Green.

Pricing in such transactions is key. One way to justify pricing is to have a third-party investor – which could be a major LP in one of the funds of the GP or another PE firm – set the price, or price the deal in an auction through a secondaries process, Le Ruyet noted.

To manage this in the Sykes transaction, Stanford noted that Livingbridge has Chinese-walled teams.

“I worked on the re-investment, but I had nothing to do with the original deal and was not sat on the board nor part of the transaction of the first team,” Stanford said. “It’s run 100 percent like a new investment for us. To keep that integrity, we ran a completely distinct and separate process so that all potential conflicts are managed.”

LPs will also take into consideration the returns from the original fund, according to Le Ruyet.

“The bigger the returns for the fund that made the initial investment, the less problematic it becomes, and the LPs ask fewer questions,” he said. “If the returns are borderline, it opens a Pandora’s box around conflicts of interest.”

The size of the equity stake and what the GP brings to the transaction for the re-investment is also crucial. Other questions to consider include whether the transaction is being driven by carried interest considerations or if the GP is struggling with a fundraise.

“In today’s environment, the GP needs to be cautious and address all these questions. It’s not simple. And the GPs need to be really careful about it because it can really – and we have seen that in the past – come back and haunt the GP in the future,” Le Ruyet said.

“These transactions have to be handled with extreme care.”