THE GOODMAN AND CARR LLP
REPORT ON THE CANADIAN
EQUITY MARKET IN 2001
review of key
trends in the
Equity Market in
THE GOODMAN AND CARR LLP
REPORT ON THE CANADIAN
EQUITY MARKET IN 2001
review of key
trends in the
Equity Market in
CANADA’S PRIVATE EQUITY MARKET IN 2001
This report, prepared for Goodman and Carr LLP, documents current trends in Canadian
private equity market, including buyout activity, mezzanine financing and venture capital. Data
analyzed for the purposes of this report were drawn from The Private Equity Activity Survey,
designed by Macdonald & Associates Ltd, and conducted by them over the period August-
September, 2001. The format and analytical framework of the report are consistent with those
issued by Macdonald & Associates in the past.
Canada’s private equity market, characterized chiefly by activity in three distinct market
segments – buyout and related corporate finance, mezzanine investment and venture capital –
experienced major growth and diversification over the course of the 1990s, which has included a
steady increase in the number of national and local investor groups and funds, as well as the size
of capital pools managed by them.
Since the late 1980s, multiple factors have contributed to this growth. One influence, of
course, has been mounting demand for risk financing, from established middle market firms, in
the case of buyout/mezzanine activity, and from emerging technology firms, in the case of
venture capital. Another variable has been changes to the organization and structure of the
financial system, as well as government regulation of that system, which has greatly facilitated
supply. Still another has been the proximity of massive and highly sophisticated private equity
markets in the United States, fueled by an ever-expanding volume of assets from institutional
investors (i.e., pension funds, insurance companies, endowments/foundations, etc.).
Due to its identification with fast-growing technology sectors in the national economy,
venture financing perhaps enjoys the highest profile of the three market segments. Such
financing is typified by an investor focus on company movement along a growth path, from start-
up and early stage development to expansion, culminating in public offering or acquisition by a
larger business entity, among other outcomes. To bring young firms to this point, investors
commonly inject round after round of financing, often in strategic syndication with others, and
give entrepreneurs access to management expertise, networks and other resources.
For 16 years, Macdonald & Associates has tracked Canada’s venture capital industry,
reporting capital under management totaling $18.9 billion at the beginning of 2001. Last year,
the industry enjoyed record-breaking activity, with disbursements of $6.6 billion.
Buyout and related types of corporate investment experienced a sea change in the past
decade. In contrast with the leveraged buyout craze of the 1980s, buyout transactions in a
modern context are often equity-based, with investors pursuing a value-adding strategy that helps
businesses meet their goals. Buyout activity targets mature firms, typically situated in such
traditional sectors as manufacturing and services, that are addressing a particular “event”, such as
a significant management change, an inter-generational transfer of ownership, acquisition of – or
merger with – another corporate entity, expansion, divestiture of product divisions, or a situation
of financial distress.
Generally speaking, mezzanine financing is conducted in the same middle market territory as
buyout activity. However, the former is distinguished by the financial instrument utilized, with
subordinated debt occupying an integral position in certain event transactions, alongside equity
or, in some instances, acting as a viable alternative to equity. Consequently, mezzanine investor
groups are highly specialized and frequently organized in dedicated pools.
The Private Equity Activity Survey was sent out to major private equity investor groups
located predominantly in Ontario and Quebec, representing a balance of buyout, mezzanine and
venture investment mandates, as well as the lion’s share of assets and deal activity in national
markets as a whole. In all, 62 investor groups were contacted, with 48 (or 77%) responding with
completed survey questionnaires over the period of issue. These respondents provided data for
over 85 funds.
The survey sought to obtain data pertinent to the operational mandate of investor groups and,
where relevant, the essential characteristics of specific funds within these groups, including
capital under management, sources of capital supply, investment objectives and portfolio
holdings. For groups/funds that raise capital from external sources, questions were also posed
concerning the terms and conditions of limited partnerships.
The Private Equity Activity Survey represents a useful early effort in describing the full
universe of Canadian private equity investing. In so doing, it has gathered much original data
that have heretofore been unavailable to industry professionals, agents and informed observers.
To assist analysis of these data, Macdonald & Associates has provided a broad methodological
framework that is comparable to recognized market parameters in the United States. This said, it
is important to note that the first-time nature of this exercise, plus the limited sample on which it
is grounded, prevent an in-depth understanding of the current state of the national private equity
market. For this reason, readers of this report should view survey findings as a first step in this
As there have been no published estimates of the magnitude of Canadian buyout and
mezzanine activity prior to now, it is impossible to state precisely what proportion has been
captured by the survey. However, Macdonald & Associates estimates that buyout and
mezzanine capital under management totals well in excess of $17 billion, nationwide. It is
further estimated that between 40-45 investor groups have funds with dedicated buyout
mandates, or with significant exposure to the buyout market. Working in the same environment
are an estimated 25-30 investor groups with dedicated mezzanine pools, or pools with some
focus on such activity.
When actual venture capital resources and actual/estimated buyout and mezzanine resources
are added, the estimated size of the Canadian private equity market in aggregate is shown to be at
least $36 billion in 2001. This compares against the American private equity market, the capital
under management of which has been estimated at over $680 billion (US dollars) in the same
These statistics point to remarkable growth and development in Canada’s private equity
markets – from a nascent period in the 1980s, when private equity activity was limited in mass
and scope and largely undifferentiated regarding its business targets, through the 1990s, when a
steady increase in the number of Canadian-based investor groups and funds was accompanied by
heightened market specialization. As in the United States, time and experience led to the three
fairly distinct market segments identified here.
Further data taken from the survey suggest that much of this market growth occurred very
recently, as a great number of funds polled saw inception in the period 2000-2001. In the
buyout/mezzanine arena, some the newest (and largest) funds include Borealis Private Equity,
CCFL Subordinated Debt Fund III, Clairvest Equity Partners, Kilmer Capital Fund, NB Capital
Mezzanine Partners II, ONCAP, RBC Capital Partners Mezzanine Fund, Schroders Canadian
Buyout Fund II, TD Canadian Private Equity Partners and the Tricap Restructuring Fund. In
venture financing, examples include Borealis Financial Technology Fund, Brightspark Ventures,
Celtic House Fund II, Skypoint Telecom Fund II, the latest Technocap Fund, VenGrowth
Investment Fund V, Ventures West VII and the Working Ventures Technology Fund. In
addition, the new Novacap II features both buyout and venture sides to its mandate.
This accelerated spurt in new fund formation is confirmed by Macdonald & Associates in the
venture capital industry, which witnessed particularly large inflows of new resources between
1999 and 2000, with the national pool expanding by 56%.
Since 1997, Macdonald & Associates has reported some renewal in commitments of pension
fund and other institutional capital to limited partnerships in the venture capital realm. This
trend has also led to a modest proliferation of new buyout funds in the past couple of years.
Beginning in 1983, labour-sponsored venture capital corporations (LSVCCs) have been
established by federal and provincial government statutes and tax credits on a national basis, and
in eight out of ten provinces, to fill a perceived gap in the supply of risk financing. Today, there
are approximately two dozen LSVCCs in existence, including the Canadian Science and
Technology Growth Fund, CI Covington Fund, First Ontario, Fonds de solidarite des travailleurs
du Quebec (FTQ) and Working Ventures Canadian Fund.
The LSVCCs responding to the survey manage $6.4 billion, or 27% of private equity
resources represented by the survey as a whole. The primary venue for LSVCC investing is the
venture capital market, where they are currently responsible for 39% of all national resources,
according to Macdonald & Associates.
Representing 18% of the total pool described by the survey, or $4.1 billion, corporate
investor groups – or the subsidiaries of major Canadian financial and industrial corporations –
assumed a highly influential position in private equity markets during the past decade. By a
country mile, corporate-financials represent the most sizeable component of these groups and
are, in turn, dominated by the country’s largest banks.
Since the restructuring of the banking sector in the 1980s, which included new freedoms and
strictures offered by government regulatory changes, corporate-financials have gradually
established a comprehensive presence in all three market segments – buyout, mezzanine and
venture capital – though strategic emphasis of these differs among them. Today, nearly all of
Canada’s leading banks and non-bank financial institutions have a stake in private equity, led by
such subsidiary operations as BMO Nesbitt Burns (and BMO Capital Corporation), HSBC
Capital, RBC Capital Partners, Scotia Merchant Capital Corporation (and Scotia-owned Roynat)
and TD Capital.
Along with private independent funds, corporate-financials have become especially
influential as drivers of the recent expansion in new Canadian buyout pools. Indeed, these
groups are converging – for instance, in the launching of TD Canadian Private Equity Partners.
Corporate-industrial funds are more prominent in venture financing, as these funds typically
have a dual interest in returns and having a strategic window on up-and-coming products and
companies in technology sectors. Two high profile examples of this trend in Canada are BCE
Capital and the venture arm of Telesystem.
In American private equity markets, the involvement of pension funds, insurance companies
and other institutional investors is predominantly facilitated by limited partnerships and related
vehicles. In Canada, several large institutional investors, such as Manulife, OMERS and Ontario
Teachers PPB, have taken the unique step of hiring in-house teams of senior private equity
professionals who conduct a significant portion of their overall activity on a direct basis. Like
bank subsidiaries, the internally directed activity of such institutional investors is frequently felt
right across the three market segments.
Because of the sheer volume of assets allocated to direct institutional investment, such
groups have very recently emerged as a powerful force in buyout, mezzanine and venture
investment in Canada, accounting for $3.2 billion, or 14% of total capital under management in
Government-owned investor groups usually undertake investments that might not otherwise
be made in private equity markets, such as small deals or activity located in rural or remote
communities and regions of the country. This is the rationale behind the integral role of the
Business Development Bank of Canada in mezzanine and venture capital markets, as well as that
of Innovatech du Grand Montreal in Quebec. This survey found government funds accounting
for 3% of capital under management, or $810 million.
Like pension funds, insurance companies constitute a key source of private equity supply in
the United States, a situation that is not comparably reflected in Canada, despite the active
market engagement of such groups as Clarica Life Insurance Company and Manulife Capital.
Nonetheless, insurance companies accounted for $1.2 billion of the commitments supporting
buyout, mezzanine and venture capital industries, or 5% of the total. As in the case of pension
funds, this share captures both direct and indirect investment activity.
Interestingly, the supply levels of pension funds and insurance companies, as described in
this survey, surpass those that are typically attributed to them by Macdonald & Associates for
venture financing. This suggests, as will be expected, that these institutional investors prefer
buyout and mezzanine investing, chiefly because the latter are associated with larger funds and
larger transactions, shorter investment horizons, and less perceived risk, among other factors.
In what is a sharp contrast between Canadian and American private equity markets with
respect to capital supply infrastructure, individual investors occupy an especially important
position in this country, representing $7.5 billion or 32% of aggregate sources, as determined by
respondents to this survey.
There are two essential components to the individual investor category in Canadian supply
conditions. The first is the literally hundreds of thousands of Canadian individuals that own
shares in LSVCCs. Indeed, with the use of government tax incentives, LSVCCs have
demonstrated a remarkably potent capacity for raising capital on a retail basis, ensuring that
individuals leveraged 55% of all new commitments to the venture capital industry alone in 2000,
according to Macdonald & Associates. The second component is high net worth individuals – in
some instances, angel investors – seeking participation in corporate and private independent
funds. A high profile illustration in venture financing is the privately backed Celtic House.
Based on survey responses, major Canadian financial and industrial corporations contributed
$5.8 billion to the dollar value of buyout, mezzanine and venture capital funds, or one-quarter of
amounts recorded overall. The lion’s share of this supply constitutes the internal allocations of
corporations to their private equity subsidiaries. In addition, several banks and non-bank
financial institutions are pivotal to the capitalization of numerous limited partnerships.
As well as backing their own venture and/or mezzanine divisions, Canadian governments
also provide resources to some private independent funds. The survey found over $1.0 billion in
government-sourced capital supply, or 4% of the aggregate.
As private equity increasingly becomes cross-border in nature, American and other foreign
investors will more regularly form a vital part of limited partnership supply. Survey respondents
reported $291 million from this source, or 1% of the whole.
Other capital sources identified in the survey, totaling $758 million and 3% of all private
equity suppliers, comprise a diverse category. Much of this amount was simply undisclosed,
with the balance made up by the contributions of general partners to funds managed by them,
other institutional sources, etc.
Of buyout and mezzanine investor groups/funds responding to the survey, over 80%
identified three types of transactions that are key to their mandates: medium-sized/large company
expansions, mergers/acquisitions and management buyout-outs (MBOs), along with other types
of buyouts. These results are consistent with research attesting to increasing middle market
demand for expansion/buyout capital and the rising rate of mergers and acquisitions, among
other trends in both Canada and the United States.
Weighted almost as heavily were corporate divestitures, which have also been in growth
mode since the late 1980s, succession financing, which is vital to a growing number of family-
owned businesses started in the postwar years (and that seek to transfer ownership to younger
generations), and company re-financings.
Somewhat less priority was given to investment in publicly listed firms, which may involve
so-called “orphans” or deal making that is too complex or cumbersome to be handled in
exchanges. This was also the case with transactions emphasizing financial distress, restructuring
Despite some of the differences in survey ratings, what stands out is the relatively equal merit
given to most event transactions by respondents. This suggests that most Canadian buyout and
mezzanine investor groups/funds are pursuing a “balanced” strategy and are not as yet as
specialized as their counterparts in the United States. There, an exclusive focus on core activity
is quite common. This conclusion vis-à-vis the Canadian situation was confirmed in interviews
conducted prior to the release of The Private Equity Activity Survey, with buyout/mezzanine
professionals arguing that domestic deal opportunities were too few, and the market too under-
developed, to permit extensive specialization at this juncture.
However, notable exceptions to this general rule have emerged very recently. Examples of
specialized approaches include the Shotgun Fund and Succession Fund of Argosy Partners, the
Tricap Restructuring Fund, which focuses on under-performing companies that require
comprehensive restructuring plans, and several sector-specific funds, such as those managed by
RBC Capital Partners and TD Capital.
Buyout/mezzanine professionals interviewed prior to the survey’s issue also noted that
preferred investment size was probably the more appropriate measure of market distinctions at
the present time. This observation was also borne out in the data.
The average preferred investments of responding buyout/mezzanine funds ranged between
$10 million and $50 million. However, certain groups – such as some corporate investor groups
and institutional investors – clearly favoured the upper end of the financing spectrum (e.g., $20-
75 million and above), while private independent funds were more inclined towards the low end
(e.g., $5-20 million, with many fund ranges below the $10 million level, especially in the
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This degree of attention paid to the early stage end of the investment spectrum is illustrated
by the recent rise in seed financing, or financing of the initial commercialization of laboratory
research and technical innovation. Prior to the late 1990s, seed deals were almost unheard of,
however, they are now a substantial fraction of industry activity (4% of disbursements in 2000),
as groups like Brightspark and Ventures West Management have gained expertise in this field.
Another measure of specialization is the increased propensity of investor groups/funds to
adopt sector-specific mandates. This is a key aspect of industry evolution, as the diversity and
complexity of new technology products require more focused expertise among venture
professionals. Examples abound among the respondents to the survey, including Celtic House
(communications and electronics), Skypoint Capital Corporation (communications and computer
software), RBC Capital Partners’ Life Science Fund and XDL Intervest Capital Corporation
(communications and internet-related products).
Not surprisingly, preferred investment sizes among venture capital industry respondents
ranged far below those on the buyout and mezzanine sides of private equity. The average
captured by this survey was between $3 million to $8 million. Venture investment ranges were
almost uniformly below the $10 million dollar mark, with only a handful of funds expressing
preferences for a maximum level of $20 million. It is worth noting however, that venture
financing is more likely to be syndicated, with larger deals often attracting four or five different
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Venture portfolios held 1,210 companies of the total. As was also noted earlier, these are
often fledgling technology companies, without a history of profitability. For this reason, very
few venture investor groups/funds specified preferred characteristics with regard to revenues or
age for target investments. Those functioning with a threshold suggested a minimum of $1
million in annual sales and one year of operation.
The rate of capital invested across the Canadian private equity spectrum appears to have
gained considerable momentum in the past couple of years, which is in line with the recent rate
of new fund formation. Disbursements by responding investor groups/funds stood at $2.8 billion
in 2000, with venture capital leading at 62% of the total, followed by buyout activity at 27%
mezzanine financing at 11%.
Despite volatility in public markets and an uncertain economic climate, capital flows appear
to be as strong, or even stronger, in 2001, with respondents perhaps finishing the year at over $3
billion, though amounts invested to date may be heavily influenced by a small number of
exceptionally large buyout transactions in the first six months.
Generally consistent with these findings, Macdonald & Associates has recently reported
sizeable deployments by the entire venture capital industry, including $6.6 billion invested across
the country in 2000. Thus far in 2001, capital invested has remained remarkably durable under
the circumstances, totaling $3.8 billion in the first nine months. In other words, the Canadian
industry continues to invest at 2000-like levels, unlike the industry in the United States, where
disbursements this year have now fallen by more than 60% back to pre-1999 levels.
The bulk of the $4.5 billion disbursed during 2000-2001 by groups responding to the survey
should find its way to Canadian companies. This statement is based on the expressed intention
of most respondents to invest primarily in this country (an estimated 72% of managed resources).
This includes the vast majority of venture investors, which are traditionally active close to home
– and, in particular, LSVCCs, which are legally required to do so – in contrast with buyout
investors, which frequently function with mandates that extend into North American and other
When it comes to deal making, roughly half of all respondents to the survey indicated a
preference for syndication and assuming a lead among co-investors. The vast majority of these
were venture investors – a trend that is increasingly evident in large financings in technology
sectors. Less than 20% of respondents preferred co-investment on a more passive basis.
Close to half of buyout and mezzanine investor groups/funds signaled a strategy of
infrequent syndication, which is quite common in non-venture private equity markets.
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(II.IV) Investment Activity of Private Equity Funds: Exit
Strategies and IRR Targets
When it comes to strategic plans for exiting investments and projecting returns at the time of
dispositions or fund liquidations, buyout, mezzanine and venture investors reveal key similarities
and differences. Responding investor groups/funds to the survey provided important information
on these matters by indicating their anticipated timing for exits, and the typical nature of these, as
well as target returns, by fund and by transaction.
While investment duration is highly dependent on economic and market cycles, on average,
respondents aimed to exit – or based on recent history, expected to exit – a portfolio company
within 5-6 years, with few distinctions apparent between the three private equity segments.
When exits take place, most respondents (61%) hoped they would occur through company
acquisition by, or merger with, another business entity. Initial public offerings accounted for
close to one-fifth of anticipated exits, though this was largely driven by the responses of venture
investor groups/funds. Very few other exit opportunities were preferred, with the exception of
company buybacks, which represented somewhat less than 10% of the total.
Most private equity investor groups surveyed had established target rates of return (IRRs) on
a per fund basis, while a sizeable fraction also had such benchmarks on a per transaction basis.
Target IRRs by fund in the buyout and venture capital domains were largely comparable,
typically ranging from 25% to 35% (though a minority of funds had higher and lower
benchmarks). Where these existed, target IRRs by deal were more variable, but most tended to
fall within the higher range of 30% to 40%.
Because they feature quasi-equity instruments (which include characteristics of debt),
mezzanine investor groups indicated lower target IRRs for their activity, with these ranging from
15% to 25% for projections per fund. Most funds used the upper end of this range (i.e., 20-25%)
for benchmarks on a transactional basis.
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(III) Limited Partnerships: Key Terms and Conditions
The terms and conditions of a limited partnership are vital to both limited partners (LPs) and
general partners (GPs) and can be the subject of intense discussion as the two sides hammer out
agreements and negotiate issues over a partnership’s lifetime.
In interviews conducted prior to the release of The Private Equity Activity Survey, senior
fund managers expressed doubt about whether partnership terms were likely to vary substantially
across Canada – regardless of the private equity market segment. This view was borne out on
many items discussed by respondents to the survey. One of the reasons for this result is that LPs
and GPs have apparently worked hard to advance their primary concerns. In so doing, they have
sought to observe “best practices” recognized among management professionals and institutional
investors across North America on matters pertaining to fund management, organization and
Like investment data, data relevant to partnership terms and conditions suffer somewhat from
reticence on the part of some investor groups/funds to share details of their operations, as well as
the limited sample on which the survey is grounded. Nonetheless, the survey findings
summarized below – derived from 45 Canadian private equity funds – do provide an interesting
and informative sketch of this evolving business.
On the whole, this survey picked up relatively few differences between the essential
frameworks of funds residing in the buyout/corporate finance, mezzanine and venture capital
segments of private equity investment. As key differences have been reported in much larger
and more comprehensive treatments of this topic in the United States, including Key Terms and
Conditions for Private Equity Investing (William M. Mercer, 1996) and Private Equity
Partnership Terms and Conditions (Asset Alternatives, 1999), it is likely this is due to Canada’s
smaller and still developing market.
The following findings on partnership terms and conditions are generally presented in the
order questions were asked on the survey questionnaire.
1. Practices in Fund Management/Organization
Limits on Fund Size
The vast majority of survey respondents (84%) indicated pre-established limits on the size of
their private equity funds, though very few specific details were given. For the most part,
upward limits were provided, with respondents pointing to the final levels at which funds closed,
suggesting they had met their targets. A small handful of respondents noted the use of ranges to
determine the targeted size of funds, reflecting minimum and maximum parameters.
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Life of the Partnership
Consistent with standard practice in American and Canadian private equity markets, the
average lifetime of a partnership, according to survey respondents, was 10 years. Several funds
also noted an option to extend terms, subject to the approval of the LPs (and sometimes at the
discretion of the GPs) for 2 years or more.
Virtually all respondents to the survey identified restrictions of some type on the investment
activity of a given fund.
The most commonly identified restriction referred to the percentage of fund capital invested
in a single company in the portfolio. 45% of respondents cited 20-25% of total fund assets as the
standard limit in this regard, with other answers ranging widely, from as low as 10% to as high
as 49.9%. Lower threshold levels were more typical in venture capital funds, while higher levels
were more typical in buyout funds.
Approximately one-third of respondents highlighted prohibitions on investment in particular
sectors, such as real estate, natural resource extraction, the financial sector, gaming, etc. Several
venture capital funds also specifically ruled out non-technology sectors.
Other investment strictures were less frequently mentioned, but were clearly important to
individual funds. In the case of several buyout and mezzanine funds, there were prohibitions on
transactions involving start-up and other early stage companies in the domain of venture capital,
while some venture capital funds excluded deals involving publicly listed firms. Other excluded
activity included particularly long investment horizons (e.g., 10 years) and investments in other
private equity funds.
Over two-thirds of survey respondents (68%) indicated a policy enabling the participation of
non-resident investors in fund activity. A common method for implementing this policy was the
establishment of parallel funds.
Reflecting the strong and growing interest of many LPs to obtain rights of co-investment
alongside on-going fund activity, 82% of survey responses flagged this particular provision.
About one-fifth of respondents confirming the existence of co-investment features said they
extended these rights to all LPs – in some cases, at the discretion of the GPs. However, the
majority specified that such rights exist only for “lead investors” or “significant limited
partners” – in other words, LPs with very substantial equity stakes in funds (e.g., in excess of
10% or 20% or total capital under management).
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GP Co-investment Rights
Only 10% of survey respondents indicated the existence of rights to co-investment
opportunities for GPs and their affiliates (e.g., employees in a given investor group). Such
provisions tended to be found where major corporate investor groups were the
sponsors/managers of funds and, consequently, sought co-investment rights that approximated
their equity stake.
Post-expiry Capital Calls
Forty-six percent of survey respondents indicated that capital calls could be made following
the expiry of the commitment period for specific uses, the most frequently cited being
completion of pre-determined investments, follow-on financings of existing portfolio companies
and significant expenses of the fund.
Re-investment of Capital Gains
A minority of survey respondents (32%) confirmed an ability to re-invest a given fund’s
capital gains, usually within specified limits of time (i.e., only within the first 1 to 5 years of the
Eighty-four percent of survey respondents confirmed there was a formal advisory committee
attached to their funds.
According to respondents, committee functions tend to be chiefly input-oriented and related
to broad matters of fund governance. These matters pertain to the resolution of conflicts of
interest, changes to LP agreements, issues that were not covered by LP agreements, and the
review and approval of valuations, et al. Committees also act as forums for GP status reports to
the LPs, as well as other kinds of information sharing. They may also feature consultative
discussion of fund strategy, private equity market trends, potential deal opportunities, etc.,
however, almost all respondents were clear that these bodies had no direct role in investment
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Key Person Provisions
To address LP concerns about a potential loss during the partnership’s term of managers
possessing essential skills and experience, the vast majority of survey respondents (77%) flagged
the existence of key person provisions.
In general, key person provisions dealt with the possibility of turnover of certain named
individuals in GP management groups or retention of a specific number of managers (e.g., one-
fifth or one-half of the overall GP team), since the fund’s inception. Some funds specify an LP
notification process in the event of management turnover and “exceptional circumstances” if
turnover cannot be reasonably prevented.
Depending on the nature of the turnover, respondents identified several allowable actions on
the part of the LPs, including suspension of any further capital calls (beyond those already
advanced) or termination of the fund. Another action may be postponement of any new
investment activity until LPs agree on the replacements for lost managers.
Guidelines for Fund Wind-downs/Liquidations
Concerning the act of winding-down or liquidating funds, very little information was
supplied by respondents to the survey, with several stating they had no formal policy in place.
Those that did comment on this topic cited standard procedures in private equity markets
whereby GPs or their agents assume full responsibility for settling accounts and distributing all
remaining cash proceeds and in-kind assets linked to the partnership at its termination date. The
manner and timeframe for this process are usually at the discretion of GPs, though some
respondents mentioned a requirement for input from LPs/Advisory Committees in certain
Although examples of LPs defaulting when a capital call is made are considered fairly rare,
79% of respondents to the survey identified policies and processes for handling such an event.
In general, GPs introduce penalties, such as forfeiture of the LP’s stake in the partnership or
access to profits, as a means of discouraging defaults. Other legal actions may also be pursued.
In addition, GPs look to fill the capital supply gap by offering all or part of the defaulting LPs’
interest up for sale to other investors.
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2. Financial Terms and Conditions
GP Capital Commitments
LPs are strongly interested in a GP equity stake in private equity funds – reflecting a
commitment over and above their responsibilities as managers – as a way of more closing
aligning interests between the two parties. It may not be surprising then to see that virtually all
survey respondents indicated some level of GP capital commitment to their funds, usually within
a range of 1-5%. A handful of respondents reported GP commitments that surpassed the 5%
Management fees were reported by all respondents to the survey, calculated as a percentage
of total capital commitments in a given fund. The average fee was 2%, with only minor variance
in some funds.
The extent to which portfolio firms were charged investment-related fees for such services as
originating the transaction, monitoring company progress over time, and other kinds of
consultation, etc., varied among surveyed funds. Only about one-third of respondents (34 %)
observed this general practice and most of these were in the buyout/mezzanine fund segments of
private equity, as is commonly the case.
Very few survey responses were given with respect to organizational expenses (e.g., travel,
legal, accounting and other expenses), as a percentage of total fund size, often because the
calculation was infrequently made. Those responses that were obtained indicated organizational
expenses to be 0.2%, on average. This is an interesting finding, as LPs in American private
equity markets are increasingly trying to gain insights into such expenses, and to control them.
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Almost universally, survey respondents indicated the rate of carried interest to GPs to be
20%, which is, of course, standard practice in American and Canadian private equity markets.
In a few funds, carried interest was directly linked to performance and could, as a consequence,
vary by several percentage points, plus-or-minus, from the 20% standard. In this way, treatment
of carried interest complemented or replaced the use of preferred returns (see below) in these
For reasons of confidentiality, most survey respondents declined to disclose the portion of
carried interest that is held by, or is available to, fund managers.
Close to two-thirds of funds (64%) indicated a policy whereby carried interest was subject to
claw-back if judged too high relative to overall returns at the time of termination.
The large majority of survey respondents (79%) indicated having a preferred (or hurdle) rate
of return that is generally available to the LPs prior to GP receipt of carried interest. The
preferred rate differed from fund to fund (i.e., from a low of 5% to a high of 25%), with an
average set return of 8%, on balance.
For the most part, the policy for LP distributions prior to GP receipt of carried interest –
where it was articulated by survey respondents – is clearly linked to the delivery of preferred
returns and other essential items, such as return of original capital contributions, repayment of
fees, etc. A small number of respondents noted detailed schedules for making these minimum
distributions over the lifetime of the partnership.
Nature of LP Distributions
Survey responses provided little information about frequency of cash/in-kind distributions to
LPs over the course of a fund’s term. Most respondents noted that major distributions were
made only when investments were fully matured, while shorter-term streams tended to comprise
dividend, interest or fee income, et al, when realized. Some funds had schedules for distributions
(i.e., annually, semi-annually, quarterly, and where divestments have occurred), while
distributions in other funds were more at the discretion of GPs.
Forty-one percent of survey respondents acknowledged incurring placement fees in their
funds. GPs bore this expense in approximately 60% of the reported cases (with LPs assuming
such costs in the others).
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Valuation practices in private equity investing vary quite widely from fund to fund, with few
broadly accepted guidelines in the industry. It is not surprising then that only 43% of survey
respondents reported the existence of a clearly defined policy regarding the determination of
fund holding values. It is likely that such policies exist among other funds polled, however,
several respondents were reluctant to disclose these for reasons of confidentiality.
Where guidelines were noted, illustrative details were restricted. Some funds rely on formal
methodologies established for evaluating privately owned assets, supplied by auditors, and as
described by the British Venture Capital Association or the National Venture Capital Association
(in the United States). Others rely on recognized “best practices” in private equity markets in
Canada and the United States, such as GP-LP agreement on fair value based on recent market
experience, peer performance, benchmarks against public markets, and other credible financial
techniques. A reliable means for some fund managers is basing valuations on the last round of
financing in a portfolio firm that is conducted with the participation of a third party investor.
Other approaches were also mentioned.
Fifty-seven percent of respondents indicated that fund valuations were performed by GPs –
often subject, however, to the review of independent auditors, as well as LPs/Advisory
Committees – 20% indicated valuations were undertaken externally by independent auditing
firms, and the rest declined to answer.
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It is evident from the findings of The Private Equity Activity Survey that the Canadian
market is currently enjoying an unprecedented period of expansion and diversification, rooted in
mounting business demand and improving supply conditions underlying the activity of private
independent funds, corporate funds, LSVCCs and other major investor groups. These trends are
best documented for the venture capital industry; however, this survey indicates that the same
may be broadly asserted in the case of buyout and related corporate investment activity and
mezzanine financing as well.
Nonetheless, all segments of the private equity market in Canada remain in an early phase of
growth, as compared to the United States, and are likely to encounter significant challenges in
the years ahead. Among the most critical to longer-term market development is a still reticent
community of Canadian pension funds, insurance companies, endowments/foundations and other
institutional investors, which largely remains uninformed about private equity as a viable and
strategically important asset class. This is no small point, as American institutional capital
infusions over the 1990s effectively led dynamic market growth in that country and continues
uninterrupted today. It is difficult to imagine a comparable Canadian experience without this
institutionally sourced participation.
As was noted in the Introduction, this survey has been a major first step in describing the
size, scope and dimensions of Canada’s entire private equity universe. More work will be
required to flesh out the details of evolving market segments to give industry professionals,
institutional investors, market intermediaries and observers the data and analysis they need to
address challenges and monitor trends in capital supply, deal opportunities and investments over
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List of Respondents to The Private Equity Survey
Argosy Partners MWI and Partners Merchant Banking
BCE Capital NB Capital Partners
Business Development Bank of Canada Novacap Investments
BMO Nesbitt Burns ONCAP LP
Borealis Capital Corporation Ontario Municipal Employees
Brightspark Ventures Retirement System
CAI Capital Group Ontario Teachers Pension Plan Board
CCFL Mezzanine Partners Orchard Capital Group
Canadian Science and Technology Growth Fund Penfund Management
Celtic House International Primaxis Technology Ventures
Covington Capital Quorum Funding Corporation
Clairvest Group Roynat MB I & Company
First Ontario Labour-sponsored Investment Fund RBC Capital Partners
Fonds de solidarité des travailleurs Scotia Merchant Capital Corporation
du Québec (FTQ) Schroders and Associates Canada
HSBC Capital (Canada) Skypoint Capital Corporation
Innovatech du Grand Montreal Technocap
Jefferson Partners Capital Telsoft Ventures
JL Albright Venture Partners TD Capital
Kilmer Capital Partners Tricap Restructuring Fund
Manulife Capital VenGrowth Capital Partners
McCarvill Mezzanine Financial Corporation Ventures West Management
McKenna Gale Capital Working Ventures Canadian Fund
McLean Watson Capital XDL Intervest Capital
MM Venture Partners
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