PE KeyTrends – SEC Debates Broker-Dealer Registration for PE


– SEC Debate: Has PE Unfairly Escaped Broker-Dealer Oversight?
– A Record-Sized Secondary Deal is in the Works
– PE’s Credit Bubble Deals are in the Black
– More Evidence That Purchase Prices are Exceptionally High
– Mid-Sized VC Funds are Getting Squeezed Out
– PE KeyTrends Quick Question Results

IS PE BENEFITTING IMPROPERLY FROM “A FREE PASS” TO COLLECT FEES? According to The New York Times, some officials at the U.S. Securities and Exchange Commission want to make registering as a broker-dealer mandatory for private equity firms if those firms charge their portfolio companies transaction and advisory fees. Obliging most investment banks to submit to broker-dealer regimes where potential conflicts of interest are strictly policed, but not applying the same standards to private equity firms is “inconsistent” the Times argues. Broker-dealer oversight is much stricter than the investment adviser regulations that the SEC currently imposes on PE fund managers. “Brokers receive more frequent audits and examinations – only 9 percent of investment advisers are examined annually, compared with 55 percent of broker-dealers – and face capital requirements and greater legal liabilities.” The debate within the SEC is likely to intensify since a “whistle-blower” has filed a complaint with the regulator contending that PE fund managers charge their portfolio companies “illegal fees.”



A RECORD-SIZED SECONDARY DEAL IS IN THE WORKS, writes The Wall Street Journal. J.P. Morgan is in “advanced discussions” with secondary market investment specialist Lexington Partners and PE fund manager Carlyle over the sale of half the bank’s $4.5 billion in investments in One Equity Partners’ private equity funds. Since J.P. Morgan announced in June 2013 that it was spinning off its One Equity Partners subsidiary into an independent entity, it has “been in talks with various buyers of secondhand private equity investments.” The One Equity Partners transaction would be the biggest deal ever in the private equity secondary fund market. The sale of the stakes will probably be a stapled transaction, with the buyers committing cash to One Equity Partner’s next buyout fund, according to the Journal. Stapled secondary transactions are increasingly popular, since they reduce the j-curve associated with primary fundraisings. By bringing on board prominent investors, they also help newly independent teams build positive fundraising momentum.



PE’s CREDIT BUBBLE DEALS ARE IN THE BLACK. Evidence for this contention comes from the Financial Times’ analysis of Carlyle’s second quarter earnings. Carlyle’s net income for the second quarter was $237 million, up from $123.2 million last year, with the rise notably fueled by the strong recovery of Carlyle’s once troubled $7.2 billion European buyout fund, raised in 2006, “at the peak of the credit bubble.” In a year, the value of the fund’s holdings rose 47 percent and it is returning a 70 percent cummulative gain, “nearing the 80 percent gain of the group’s North American pool, raised in 2007.” The gain for the European fund means it’s now generating performance fees, or carried interest. “Leveraged buyout funds raised and invested on the eve of the global financial crisis have recovered and have recently starting generating profits” for their managers, the FT notes.



HERE’S MORE EVIDENCE OF EXCEPTIONALLY HIGH PRICES FOR ASSETS. Unquote reports that purchase prices in Europe for lower mid-cap companies “reached their highest level in nearly eight years” in 2014’s second quarter. Companies sold for between $20 million and $200 million in the second quarter were valued at 8.6 times cash flow, the highest multiple since late 2006, when the average company in this category went for 9.1 times cash flow. The average price for lower mid-cap companies in Europe in the second quarter was 28 percent higher than it was in the same period last year.



IN VENTURE CAPITAL, MID-SIZED FUND MANAGERS ARE BEING SQUEEZED OUT. That’s the contention of Scott Kupor, a managing partner at Andreessen Horowitz. Noting that small funds account for 67 percent of all new VC investment vehicles raised in 2014 and that a small handful of the largest GPs account for an increasingly large percentage of annual VC fundraising, Kupor makes the case that market dynamics mean mid-sized funds are having a tough time. Because of low-cost cloud-based technology, it takes less money to launch a startup today “than it has at any other time,” providing rich investment opportunities for small funds, says Kupor. “But the biggest transformation” of recent years is the development of a huge global marketplace: Kupor estimates that the worldwide online audience that tech companies can potentially tap is 5.9 billion individuals. Ironically, that means that “winning” as a tech company today requires more money than ever before, as companies “build expertise in customer service, global operations, regulatory affairs and so on.” There are few good opportunities for mid-sized funds today because “it’s vastly more efficient” for startups “to seek partners who have the capital” to finance global ambitions.


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