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Current Trends in Private Equity & Family Offices
Presentation to the Houston CFA Society
May 2019
Cole Parker, Kirkland & Ellis Mickey McFarlin, Stephens Inc.
Alex Rose, Kirkland & Ellis Cole Naylor, Stephens Inc.
Agenda
M&A Activity Overview
Dry Powder in the Private Equity Market
Continued Investment in Private Equity is Strong
Industry Trends and Sectors
“Shadow Capital” Accounting for an Increasing Slice of the Market
Family Office Trends
Advantages and Potential Drawbacks of Family Office Buyers/Investors
Benefits and Challenges of Direct Investing for the Family Office and Components to Success
Family Office Direct Investing Platform Processes
Looking Within - Family Office Structures
1
2
4
5
6
3
7
8
9
10
M&A Activity Overview
Private Equity’s net asset value has grown by over 7X since 2002, twice as fast as global public equities
Private Equity Market growing not only in terms of deal value, but also in total AUM
Source: Thompson Reuters; Dealogic
Global M&A Activity Since 2000 (in US$T)
$1.6$1.3 $1.4
$2.0
$2.8
$3.7$4.3
$2.9
$2.2
$2.6 $2.6 $2.5 $2.6
$3.5
$4.2
$3.7$3.4
$4.0
5%
11%12%
15%
12%
20%
17%
7%6%
9% 9% 9%11%
8% 8% 9% 8%10%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Global M&A Value (US$t) PE as a Percentage of Total M&A Value
1
Dry Powder in the Private Equity Market
Global dry powder is at an all-time high and has more than doubled since the beginning of 2016, to $1.21 trillion
Private Equity industry grew 8.1% over the first half of 2018
Source: Preqin, through Sept 30, 2018
Global Private Equity Dry Powder by Region (in US$B)
North America$714 Billion
Europe$303 Billion
Asia and RoW$193 Billion
2
Continued Investment in Private Equity is Strong
Large institutional investors remain interested in private equity as an asset class
In a recent survey by Preqin, 46% of LPs said they intended to increase their allocations to private equity over the longer term, with only 5% looking to decrease their allocations
Debt and infrastructure are similarly popular, while hedge funds and natural resource funds saw the highest percentage of LPs intending to reduce their allocations
Source: Preqin LP survey
Results of Preqin LP Survey – Attitudes Towards Various Asset Classes
Private Equity
Hedge Funds
Real Estate
Infrastructure
Private Debt
Resources
Reduce Allocation Increase Allocation
46%
35%
29%
52%
51%
28%
5%
26%
16%
9%
9%
23%
3
Industry Trends and Sectors
Information Technology sector is the largest destination for private equity capital, but has been decreasing in size in recent years
Industrials and Healthcare sectors have been steadily growing
Telecoms, Media & Communications saw a sizeable increase in 2018, largely due to $17 billion acquisition of Refinitiv (Thompson Reuters subsidiary) by Blackstone Group LP
Source: Triago Quarterly, January 2019
4
Sector-by-Sector Breakdown of Private Equity-Backed Buyout Deals (in US$B)
“Shadow Capital” Accounting for an Increasing Slice of the Market
Private equity firms are also looking at increasing their co-investment activity, direct investments, and commitments to separate accounts as ways to further reduce fees paid to private equity managers
Source: Triago Quarterly, January 2019
Private Equity “Shadow Capital” – Co-Investments, Direct Investments and Separate Accounts (in US$B)
$63
$161$173 $179
$189
2009 to 2014Average
2015 2016 2017 2018
5
Family Office Trends
$4.0 TRN$3.2 TRN$2.5 TRN
Family Offices Hedge Funds Private Equity
6
Projected Growth Trends of Family Offices
65%of family offices invest
directly in private companies and real
estateGlobal Survey by J.P. Morgan and
the World Economic Forum
Average global family office portfolio allocates
approximately
29%to direct investments in
private equity, venture capital and real estate and 7% to
private equity funds
UBS/Campden Wealth Global Family Office Report 2016
AUM Globally as of 12/31/2016
U.S. estimated to have3,000
family offices with more than$1.2 trillionin assets and
10,000family offices globally
WSJ, March 10, 2017
Globally, family offices hold assets of more than
$4 trillionapproaching the combined $5.7 trillion of private-equity
firms and hedge funds.
“At least 20 founders or top executives of prominent U.S. hedge funds and private-equity firms have set up family offices or similar private investing ventures.” WSJ, March 10, 2017
Family offices are an increasing part of the private equity markets generally.
Family Office Trends (continued)
The transactions listed below are just a few examples of prominent family office transactions over the past 12-18 months
6
Jacob Holding’s $2.6 billion acquisition of
Cognita from Bregal & KKR
Koch Equity Development’s $500 million minority
investment in Getty Images
JAB Holding Company’s $2 billion acquisition of Pret a
Manger
CC Industries’ partnership with KSL Capital Partners in the $2.4 billion acquisition of the Intrawest, Mammoth and
Squaw ski resorts
Declaration Capital along with The Donaldson Group and DRA Advisors in the
$86.75 million acquisition of Silver Spring residential
community
PPC Partners in its acquisition of Plaskolite
MSD Capital in its acquisition of a significant portion of the high-profile
Knox district, a best-in-class, mixed-use neighborhood in
Dallas
Elysium Management in the acquisition of restaurant
chain Huddle House from Sentinel Capital
Knox District Mixed-use Property
Note: Stephens Inc. did not serve in an advisory capacity for the transactions listed above.
Family Office Trends (continued)6
Market perception of family capital is still evolving
− Informal, fickle, flakey
− Ill-equipped, or too inexperienced or too slow to compete in a process
− However, sellers are intrigued by the attributes versus PE (more on that later)
We are all aware that families are increasingly allocating more capital to direct private investments
− Declining risk adjusted net returns in institutional PE
− Preference for deal by deal decision making
− More visible roadmap of success
Availability of strong, experienced execution teams with PE background
Many families are creating formal direct investing platforms staffed with investing professionals
− Defined strategies and criteria
− Credible in a process
But, some are still more comfortable with an ad hoc approach
In any case, the deal market is very competitive, and partnership / resource sharing is the key thematic takeaway
Advantages and Potential Drawbacks of Family Office Buyers/Investors7
Advantages
– Long-term, patient capital– Less likely to rely on debt financing– Often have deep sector knowledge and “peer networks”– More flexible than institutional investors
Potential Drawbacks
– Longer deal timelines (e.g., slower diligence process)– Due to long hold, must structure for liquidity events to incentivize management– Capital constraints for long term growth/further investment into the business
Institutional Sponsors Family Offices
Objective Internal Rate of Return Let Profits Run
Economics Earning a Carry No Carry (paying a carry in some cases)
Exit Driver Shorter Term Gains Multiple of Investment
Hold Period 3 – 7 Years Often Indefinite
Reinvestment Risk Embrace Avoid
Control Often Required Upfront Not Always Required / Path to Control
Likelihood to Transact Paid to do Deals More Reasons to Say “No”
Visibility of Investment Criteria Highly Defined Varies by Group; Can Fluctuate
Benefits and Challenges of Direct Investing for the Family Office and Components to Success
8
Benefits
– Greater control of investments
– Reduces management fees and carried interest expenses
– Potential for increased returns
Challenges
– Increasingly competitive landscape, especially vis-a-vis private equity firms
– Accessing deal flow
– Sourcing and diligence process can be expensive and time-consuming for smaller teams
– Capital constraints
– Incentivizing deal professionals
Build a professional team
Develop an industry focus and check size “sweet spot”
Find other like-minded investors as potential partners
Consider complete ownership vs control vs co-invest
Find opportunities where you bring intellectual and
investment capital to the table
Develop an investment thesis – knowing when to buy
and when to sell
Define how to participate in a process
Utilization of leverage
Key Components of a Successful Direct
Investing Platform
Family Office Direct Investing Platform Processes9
• Firm financial, operational and thesis criteria– Return thresholds
– Operating ratios vs. benchmarks
– Market opportunity analysis
• A standard approach to analysis
• Leverage existing portfolio for expertise and management bench strength
• Cast the “net” as wide as possible– Intermediaries
– Other families
– Cold calling
– Thesis driven
• Frequent, clear and broad communication of investing statement to minimize incoming noise
• Greater context and sense of market when weighing potential investments
• Lean on investment thesis / approach as a screening tool – must fit to be evaluated
• Active or passive management preference will inform screening / selection– If passive, existing
management team due diligence is especially important
– If active, matching bench strength with opportunity set is key
• Standardized reporting across portfolio
• Idea / best practice sharing summits
• Criteria / triggers for exit
• Standardize and replicate to minimize frictional costs, delays and blind spots
• Develop a “deal team” of repeat providers to increase buying power
• Standard areas:– Accounting / Q of E
– Legal
– Risk
– HR
– Environmental
– Management personality evaluation
SelectionScreening ManagementDiligence
Looking Within - Family Office Structures10
Management Company
Individuals, Trusts, and Related Entities
Expenses
Mgmt Team, Individuals, Trusts and
Related Entities
Profits Interests [X]% [Z]%
Venture Capital Investment Entity
Private EquityInvestment Entity
[Y]%
Hedge FundInvestment Entity
Issue: Tax Cuts and Jobs Act eliminated deductibility of management fee expenses
Kirkland Solution: Establish profits interest family office structure to recapture economics of lost deductions
Benefits of Structure: Investors no longer incur non-
deductible management fees, instead allocating profits to the management company
Management company expenses deductible as “trade or business” expenses
Potential for significant tax savings for family office and owners of investment entities
Example of Kirkland Model Family Office: Profits Interest Structure
Increasing number of family office formations
Structures, size, and investment philosophies vary widely among family offices
Certain internal structures can create significant administrative and tax efficiencies, helping family offices compete in themarketplace
Looking Within - Family Office Structures (continued)
Assumptions: Family pre-tax, pre-expense earnings = $100M/year Tax rate on earnings = 40% 3rd party management fee rate = 1% Overhead = $1M/year Profits interest of family office management company in profits interest structure = 2%
10
“De Facto” Family Office Structure
Even family offices that do not have large teams or portfolios can benefit from implementing a profits interest structure.
Earnings $100MProfits Interest N/ATax Base $100MTax Liability ($ 40M)Mgt Fees ($ 1M)Overhead ($ 1M)
Net Pre-Tax Income $ 98MNet After-Tax Income $ 58M
Fee StructureProfits Interest Structure“De Facto” Family Office (limited staff or overhead)
Earnings $ 100MProfits Interest ($ 2M)Tax Base $ 98MTax Liability ($39.2M)Mgt Fees N/AOverhead N/A
Net Pre-Tax Income $ 98MNet After-Tax Income $ 58.8M
Looking Within - Family Office Structures (continued)10
Family offices may also take on capital from outside investors, sometimes resembling their private equity peers in structure, but retain control and other benefits of a family office.
Kirkland recently published an article on this topic that can be viewed on the Kirkland website: The Evolution of Alternative Family Capital
New Fund
Family Office
Investment I
Other Partners
Co-invest
GP capital or special LP capital
Alternative Family Capital Structures
Investment II
Benefits
– Eliminates or can address some of the challenges faced by family office investors• Capital constraints / deployment
• Attracting/maintaining strong deal team
• Increase competitiveness
– Broaden investment mandate and scope• Move upstream in market
• Capture opportunity
• Improve deal flow
– “Relevel the playing field”
Challenges
– Regulatory considerations
– Sensitivity around opening up family office to third party investors
– Loss of control
– Increased costs to compensate deal team and back office expenses (costs increase due to regulation, reporting, etc.)
Speakers
Cole Parker, Partner | Kirkland & Ellis | +1 312-862-2963 | [email protected]
Cole Parker is a corporate partner in the Chicago office of Kirkland & Ellis. His practice concentrates on negotiating and structuring complex business transactions, including leveraged buyouts for private equity funds and family offices, domestic and cross-border mergers and acquisitions and general corporate representations for publicly and privately held/family owned companies and private equity funds and their portfolio companies, and family office structuring.
Alex Rose, Partner | Kirkland & Ellis | +1 214-972-1667 | [email protected]
Alex Rose is a corporate partner in the Dallas office of Kirkland & Ellis. His practice concentrates on the representation of both public and private companies and private equity funds in connection with complex transactions such as mergers, acquisitions, leveraged buyouts, going private transactions, joint ventures, tender offers, divestitures, private financings, recapitalizations, debt and equity security investments, fund formation and other general corporate matters. Alex has broad experience counseling clients in a variety of industries, including manufacturing, consumer products, retail, energy, healthcare, real estate, transportation, technology, financial services and telecommunications.
Speakers
Cole Naylor, Vice President | Stephens Inc. | +1 214-258-2792 | [email protected]
Cole Naylor joined Stephens in February 2018 as Vice President and is a member of the Private Company Advisory team. Prior to joining Stephens, Mr. Naylor was a Vice President at BlackhillPartners and has a diversified background of transaction and operational experience serving publicly-traded, sponsor-owned and privately-held companies across a variety of industries. Mr. Naylor received his Bachelors and Masters of Accountancy from the Rawls College of Business at Texas Tech University and holds the Certified Public Accountant (CPA) designation.
Mickey McFarlin, Managing Director | Stephens Inc. | +1 501-377-8040 | [email protected]
Mickey McFarlin is a Managing Director and the Head of Family Advisory Services at Stephens Inc. In this capacity, he is responsible for providing family businesses and family offices with a comprehensive set of solutions to fulfill the needs unique to families including Investment Banking, Wealth Management, Risk Management and other services. Mr. McFarlin began his career at Stephens in 1999 as part of the Mergers and Acquisitions advisory group. During his career, Mr. McFarlin has advised on dozens of transactions with a combined value of greater than $10 billion across a wide range of industries and transaction structures. In recent years, Mr. McFarlin has concentrated on transactions involving family owned businesses and family offices. Mr. McFarlin graduated cum laude from Hendrix College with a BA in economics and business, and an MA in accounting.
The foregoing material was prepared for informative purposes only and is not an offer to buy or sell any securities. The foregoing material is not intended to recommend the purchase or sale of any securities or to provide information on which an investment decision to purchase or sell any securities could be based. Information contained in the material was obtained orderived from sources considered reliable, but has not been independently confirmed or verified. The foregoing material does notpurport to contain all of the information that may be required to evaluate all of the factors that would be relevant to any person considering entering into a transaction, and no representation is made that the information is accurate or complete. Any personconsidering entering into a transaction should conduct its own investigation and analysis and should consult such person’s own professional advisors. Stephens and its directors, officers, employees, affiliates and representatives expressly disclaim any and all liability based, in whole or in part, on any such information, errors therein or omissions therefrom. Stephens is not a legal advisor, accounting advisor or tax advisor. Nothing in the foregoing material is intended, or should be construed, as legal,accounting, regulatory or tax advice. Any discussion of tax attributes is provided for informational purposes only, and each recipient should consult such recipient’s own tax advisors regarding any and all tax implications or tax consequences of any investment or any other transaction or course of action. Stephens in a member of the NYSE and SIPC.