FF&P Private Equity, part of the UK multi-family office, is raising money for a private equity fund and is optimistic that valuations bode well for future returns.

While some parts of the financial world thaw out from the long freeze caused by the turmoil in credit markets over two years ago, small and medium sized business sometimes still struggle to obtain funding for expansion. This credit dearth is now a hot political, as well as economic issue in countries such as the UK.

The gap in financing, however, is drawing in new sources of funds and smaller deals in the private equity space are proving to be lucrative investments, argue managers at Fleming Family & Partners’s wholly-owned subsidiary, FF&P Private Equity. And unlike the frenetic climate of 2006-07, when buyout activity boomed – based on highly optimistic assumptions about economic growth and credit – today’s market moves at a more considered pace, FF&P says.

“We are seeing and visiting lots of interesting companies and we don’t have to do the investments so quickly, so we can get to know the businesses better,” David Barbour, director at FF&P Private Equity, told this publication in a recent interview.

Clearly, the high leverage prior to the financial panic has not returned. In private equity deals at the moment, the proportion of debt leverage has fallen from its pre-crisis peak of 70 per cent or more to around 30-50 per cent, he said.

Barbour, and fellow director Henry Sallitt gave their views on the market as FF&P raised money for its third Investor Club offering, known as FF&P Investor 3 LP (or “Club 3”). It will make direct capital development investments of between £5 million to £15 million in mainly UK lower-mid market private companies. This segment is too large for tax-advantaged venture capital trusts and too small for many UK private equity firms, FF&P says.

FF&P aims to raise between £75 million to £100 million in this “Club 3” fund.

Both Barbour and Sallitt bring plenty of experience to the table. Sallitt has a background in running a business that eventually listed on AIM; he has worked in venture capital, with one of the successes being AFA Systems, a software firm, set up in 1996 and sold in 2004. He joined FF&P in 2007. Barbour, meanwhile, is a lawyer by training; he worked as an investment banker at Robert Fleming – the original business which, when sold, created the fortune of the current FF&P business. He joined the present business in 2006.

Pulling the trigger

Among the fund’s features is that clients can co-invest with FF&P Private Equity in target companies and meet prospective client firms before deciding to go ahead. Another feature is that clients participate in special situations, also outside the structure of the fund, appealing to investors who are entrepreneurs themselves with a thirst for deals and business activity.

“People like to pull the trigger – a lot of our clients are very wealthy people,” said Sallitt, talking in the firm’s elegant Suffolk Street offices in London’s West End.

FF&P Private Equity’s own press and marketing material states that it is different from much of the UK private equity industry in being focused principally on development capital with minority as well as majority stakes.

The willingness to take a minority stake is a big differentiator, Barbour explained.

Some funds can only do buyouts with a majority stake; the FF&P fund is prepared to take minority positions in growing firms. Some private equity funds are not able to do this because of their own mandates, he said. This widens the potential deals available.

Opportunities

The FF&P funds will look at firms with profits as low as £1 million to £3 million in the hope of transforming a business up towards £5-10 million or more of profit, Barbour said. “We rarely use significant debt in companies we are investing in. When banks were lending to firms on a basis of 6 to 7 times EBITDA, it was such leverage that led to subsequent problems,” he said.

The private equity investments tend to be operational businesses, rather than areas such as real estate deals, he said.

Performance

One indication of how private equity is faring comes from the cost of entering into deals in the first place, said Sallitt. “The price at which we can get into firms is significantly lower than it was two to three years ago.”

Hard numbers can do the talking – FF&P Private Equity’s funds have now been around long enough to chalk up a meaningful history. The FF&P Special Situations LLP fund, which closed on January 2001 with £15.5 million committed – all of which was invested – had a total value, as of 30 September last year, of 1.73 times (excluding fees), and achieved an internal rate of return of 21 per cent. Its FF&P Investor 1 LP, or “Club 1", which closed in December 2004, has an expected net IRR (after fees and carry), of 6 per cent. Another fund, called “Club 2”, has an expected IRR of 17 per cent.

The fact that the latest fund – “Club 3” - is on the money-raising trail in what are difficult economic conditions is paradoxically good news in the long run, because funds which are launched in tough times typically outperform others that are started when markets are stronger, FF&P explained.

This pattern of strong “vintages” originating in recessions has been noted before. For example, research by Cheviot Asset Management, the UK wealth management firm, has suggested that the best vintages are in recessionary periods when purchase prices of firms and other assets are heavily discounted. FF&P’s own marketing literature, citing data from Cambridge Associates, the research firm, shows that IRRs of vintages in recessionary periods such as 1990-92 or 2001-02 have, on average, been notably ahead of those started in other periods.

The client perspective

“Most people understand the general supply and demand issue that people should be investing and that value exists. But there are a lot of [institutions] out there which are over-committed to private equity and have a larger commitment than they’d like,” said Sallitt. “But this situation is a bit different with individuals. They have a lot more elbow room. The majority of our funding comes from family offices and individuals rather than from traditional institutions.”

Family offices are an important client class due to their general outlook, said Barbour.

“I think single family offices are quite interested in private equity at the moment; they are able to take a flexible view on their asset allocation. They feel that maybe this is the time to do some individual deals and find interesting funds that can get them some diversification,” he said.