Private equity: smaller remains beautiful

The private equity industry has been reshaped to a dimension that was hardly predictable in 2013. Amid a constant search for high summits, we also assist our General Partners to further increase their funding capabilities with the structuring of less prominent, albeit highly tailored, co-investment entities and have been instrumental in helping private equity sponsors to bridge the gap between private equity and retail money.

Co-investments in full swing

Managers have been deploying large efforts to promote co-investment strategies among their base of investors, permitting limited partners to be exposed on certain deals in order to support identified targets in their needs for development. The natural scale of co-investments, which invest monies alongside the main funds, also shows that sponsors are not reluctant to share their profits.

Managers have been deploying large efforts to promote co-investment strategies among their base of investors

-Xavier Le Sourne, partner, Elvinger

In a context of geopolitical and economic uncertainties, GPs will continue to encourage co-investments from their limited partners willing to seek additional investment opportunities. The current volume of transactions can certainly explain how private equity funds are best placed to offer such possibilities to their partners. Hence more funding to their portfolio companies to foster their respective development.

Co-investing has become a key element of our clients’ growth. Amounts in terms of investments and the number of partners interested are de facto smaller and easily manageable by the GPs. The ease in structuring co-investment entities under Luxembourg law, whether under the form of fully taxable entities or fully transparent SLPs, combined with the importance of structuring them under the auspices of the AIFMD and their possible AIF qualification have also made Luxembourg a place of choice to structure these smaller and very flexible vehicles.

Retail distribution, raise less – grow more

In a capital-raising environment where retail investors are widely spread, Luxembourg has been instrumental in offering solutions permitting GPs to raise capital within their diaspora.

To foster this appetite for retail monies which is to be seen positively from an asset but also branding perspective, practitioners, with the support and efficiency of the Luxembourg regulator, have given the so-called Part II funds a new breath by replicating certain mechanisms implemented in US entities¹[1].

Such Part II UCIs, semi open-ended and evergreen, offer individual investors the ability to seek exposure to private asset portfolios. The use of such structures has proved to fit the purpose of reaching out to retail investors. Placements are made to semi-professional investors in certain jurisdictions, or generally through the use of external distributors and feeder or parallel funds for certain other countries, such as Spain or France, respectively. This is a promising development for reaching the objective to fill the gap between retail investors and private equity.

The chase for retail monies is also supported at European level. The European Commission is currently finalising its review of the ELTIF Regulation of 2015, which follows the objective to channel capital towards long-term investments in the Union’s real economy and with a distribution passport to encourage investments that promote smart, sustainable and inclusive growth. Among the salient points of ELTIF 2.0, GPs shall gain more flexibility in terms of underlying investments, notably with the proposed removal of the minimum value of real assets, the permission to engage in fund of funds or co-investment strategies (by the inclusion of UCITS and EU AIF managed by EU AIFM) but also by allowing more flexibility in terms of diversification, concentration and borrowing limits.

Co-investing has become a key element of our clients’ growth.

- Xavier Le Sourne, partner, Elvinger

The Commission also addresses some green objectives to the ELTIF reform. It remains coherent with the current election made by private equity sponsors which favour their funds to qualify as “Article 8” under SFDR, i.e. as funds that promote environmental or social characteristics but do not have them as an overarching objective (as opposed to Article 9 funds, which specifically have sustainable goals as their objective). ESG investments have now become a necessity for any sponsors willing to raise capital in Europe. One important element is the change of paradigm whereby ESG investments are perceived as investments offering the highest growth potential because of their impact on green gas emissions, feminisation of boards and management committees or equal treatment between all employees within portfolio companies. ESG designates criteria that we perfectly understand but a lack of uniformity in terms of reporting and sanctions at portfolio level will also need to be quickly addressed to give the fund’s reporting its full and entire meaning.

Size clearly matters

These developments and initiatives may constitute a major change and permit Luxembourg to further foster the private equity industry by permitting the deployment of additional capital towards the real economy, while also benefiting retail investors. Size then definitely matters and skyrocketing in terms of capital raise makes it easier for PE sponsors; but smaller remains indeed beautiful in light of the size of co-investments and the appeal of retail investors to tag along with their professional peers.

This article first appeared in the "Paperjam Private Equity 2022".