IM Dealssm, in the first of a series of Q&As relating to investment manager deals, received the following feedback from David Silvera, Managing Director of Rosemont Investment Partners, a private equity firm which makes investments in asset managers.
IM Deals – David, please start by telling us the general description of the types of investment managers that Rosemont seeks to partner with.
Silvera – Rosemont will invest in asset management businesses across the entire spectrum of asset classes and client mixes provided that they have a disciplined, robust and differentiable investment process and an organization that encompasses not just outstanding investment professionals but also strong non-investment professionals in all the non-investment functions such as sales, marketing, client service, trading, operations and compliance.
Rosemont will invest in management buyouts (“MBOs”) of established businesses that are buying themselves back from a parent company as well as recapitalizations and generational transfers in which equity is changing hands between outside investors and/or a founding generation that is retiring. Rosemont will also evaluate “franchise start-ups” which are not true start-ups but rather existing, complete businesses with all the functional attributes of an established firm that we will fund as a new company when a team leaves its previous employer.
In all cases, Rosemont seeks to partner with a proven and motivated group of professionals who are focused on growing the value of their equity in the business alongside Rosemont.
IM Deals – We understand Rosemont normally takes minority equity positions in its portfolio companies – describe the structure of these deals.
Silvera – Rosemont believes that the concept of “control” is illusory in an asset management business. What Rosemont seeks to achieve is a strong alignment of interests among the business, its clients, its shareholders and its employees. This alignment is achieved through the proper use of equity and compensation incentive mechanisms that instills a culture of ownership and long-term value creation. Even as a minority partners, Rosemont shares certain unanimous consent rights over critical business issues such as compensation and bonus methodology, budgets, indebtedness and equity sales. Rosemont’s companies also implement certain restrictive covenants that are linked to the employee’s equity with respect to non-solicitation of clients and employees.
IM Deals – Some of your investments have been in groups that are “lifting out” of another organization to start their own business – what do you look for to conclude that such a group has good prospects?
Silvera – Rosemont will consider “franchise start-ups” or team lift-outs of groups that represent complete and cohesive businesses and where there is no prospect of the group being able to buy their business back through an MBO or other means. The “franchise start-ups” the Rosemont has backed have typically engendered a great deal of client goodwill but are unable to achieve success at their current firm because of structure, cultural or other impediments. They therefore seek to launch an independent business with Rosemont’s financial backing where they can better align their interests with their clients and operate in an independent, autonomous manner that is not influenced by the vagaries of a “parent” company.
Rosemont will not simply invest in a group of smart investment professionals unless those professionals are accompanied by an equally smart and accomplished group of non-investment professionals. Ideally the entire team has worked together previously and share a mutual respect and unified view of the compensation and ownership model that Rosemont believes will allow the business to grow and prosper.
The prospects of these opportunities is predicated less on the ability of the group to bring assets from its existing relationships than it is on their ability to attract new clients to an independent, employee-owned business with a client-centric culture.
Rosemont will avoid any “franchise start-up” situation when there are binding and enforceable restrictive covenants in place with a current employer or where a investment cannot be evaluated with compromising the team’s duty of loyalty and standing confidentiality obligations.
IM Deals – In addition to capital, what does Rosemont provide to assist its portfolio companies to achieve their growth objectives?
Silvera – Rosemont will work closely with its management teams to implement a “best practices” compensation and equity ownership model that is incorporated into an operating agreement that is designed to serve the business well beyond Rosemont’s tenure. Besides a compensation model, the operating agreement is designed to address the various for buy/sell/forfeiture provisions for the firm’s equity owners. It also addresses the governance of the company and what issues require unanimous consent or a lower threshold of approval.
In addition to the operating and other legal agreements like employment contacts, Rosemont works closely with its management teams to ensure that its operations, reporting, compliance and other business functions are managed in the best possible manner. Rosemont can offer advice and make referrals but has no say is a company’s choice of trading platform or back and middle-office technology; those and other day/day decisions rest with management. However, Rosemont will ensure that whatever systems, technology and controls the company elects to use are implemented and managed well.
Rosemont also actively networks across the asset management industry with consultants, gatekeepers, family offices and other groups that might assign assets to our portfolio companies. Rosemont makes introductions and encourages meetings but is careful not so promise to serve as a marketer, seeder or “sugar daddy” to its portfolio.
IM Deals – What is the typical investment period for Rosemont before it looks to exit a portfolio investment?
Silvera – Rosemont seeks to partner with its portfolio companies for at least 4-5 years before engaging in discussions about its exit. This allows adequate time for the Company to grow and establish itself and minimizes the potential for disruption that might be caused by any transaction. Rosemont negotiates put rights with all of its portfolio companies that allow it to sell its stake back to the company based on a valuation that is set by a pre-determined multiple of EBITDA after the 4th or 5th anniversary of the investment. If exercised, the put proceeds are payable under the terms of a note payable over not less than four years. The note carries certain mutual protection provisions that allow for the revaluation of the outstanding principal amount in extenuating circumstances and limits on the free cash flow the Company that can be applied to pay the note.
By incorporating a put right and the related note terms into all of its deals, Rosemont anticipates and pre-negotiates what is often the most disruptive and difficult elements of the financial partnership relationship. As a private equity fund, Rosemont requires a liquidity event in a reasonable time period following its investment but it recognizes that it cannot ever force a sale of one of its portfolio companies against management’s wishes. Therefore the put right serves as a liquidity backstop for Rosemont while serving as a catalyst for some rational “end-game” discussions. Most importantly, the portfolio companies’ clients can be comfortable in knowing that Rosemont can exit the capital structure without disrupting the business or forcing a sale.
IM Deals – Tell us about a great investment success story for Rosemont and how it reflects on the type of managers you look to partner with.
Silvera – Rosemont is fortunate to have had a number of successful investments since 2000. Champlain Investment Partners and Perimeter Capital Management both standout as successful “franchise start-ups” that have gone on to become thriving, 100% owned, independent asset management firms managing over $4 billion and $2 billion respectively. It is especially satisfying to see that both of those firms have grown assets and added to their teams during a market period that has been exceptionally difficult. The success of these firms in a difficult environment highlights to value of investing with high quality teams of people who share common goals and ambitions.
IM Deals – To be balanced, without naming names, tell us about an investment that went wrong and what you learned from the experience.
Silvera – Not every deal has been successful. Some have failed to attract or retain clients while others suffered as difficult markets have eroded assets and revenues. Through one experience, Rosemont has become acutely sensitive to the risk of client concentration and to the need for diversity of client base. Rosemont also compromised its tenet of only investing in “complete” teams that incorporate all the non-investment functions alongside those of the investment team. The lack of support from non-investment functions proved to be a problem as the firm was unable to attract clients to its investment-only business.
Fortunately, Rosemont has been correct in its estimation of the quality of the people with whom it invests thus far, as even in those cases where the businesses did not succeed, Rosemont and the management teams worked together to find an appropriate solution.
IM Deals – Many thanks David for providing us with your perspective on private equity investing within the investment management industry.