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  • 1. Insightful investors in Asia Pacific Private Equity April 2011 KEY TOPICS: • Management fees • Distribution waterfalls • No-fault divorce provisions • Key person clauses • Limits on concentration and PIPEs • Renminbi / US Dollar parallel fund issuesINSIDE ASIA PACIFIC PRIVATE EQUITYSurvey Highlights and Information 2Management Fees 3 2010 FUND TERMS SURVEYManagement Fee Offsets 4 The rapid and continuing growth of private equity in the Asia Pacific region has heightened interest in private equity fund terms among investors (“limited partners”Distribution Waterfalls 5 or “LPs”) comparing potential funds for investment, and fund managers (“general partners” or “GPs”) seeking to benchmark their terms against the market norm.Preferential Fee Terms 6 Increasingly, private equity participants are examining how fund terms in AsiaNo-fault Divorce 7 compare with best practice principles issued by the Institutional Limited Partners Association (“ILPA”), and seeking to understand why there may be differences inKey Person Provisions 8 fund terms relative to other markets globally as well as where discrepancies may be acceptable industry differentiation.Fund Suspensions On Trigger of KeyPerson Clause 9 In response, Squadron Capital and the Emerging Markets Private Equity Association (“EMPEA”) joined forces to produce this “Asia Pacific Private Equity Fund TermsAnnual Limitations On Capital Calls 10 Survey,” providing market data and analysis on the key terms and conditions thatAbility For / Limitations On Public prevail in the Asia Pacific region, with year-on-year comparisons to track changingMarket Investing 11 dynamics and benchmarks against global norms, where available. The first survey in this annual series, covering data on funds raised in 2009, is available on request fromRMB Funds Managers’ Potential Squadron Capital.Allocation Policy Issues 12 Based on input from 94 Asia Pacific GPs that achieved a final closing during 2010 or who were actively fundraising as of 31 December 2010, this unique Survey provides a snapshot of some of the current hot topics in private equity within the Asia Pacific region, including the level of management fees and management fee offsets, key person clauses and no-fault divorce provisions. We also examine a topic of specific relevance to many markets within the Asia Pacific region - the flexibility or lack thereof for funds to invest in PIPEs - as well as a topic of specific relevance to China- focused managers, i.e. the allocation of investment opportunities between parallel US Dollar and RMB funds. © 2011 Squadron Capital Management Limited. All rights reserved.
  • 2. April 2011Survey highlights: Fund sample by investment strategy• Annual management fees in the Asia Pacific are Distressed / special situations / other higher than the global average, likely reflecting smaller average fund sizes in Asia and certain fixed 12% Venture costs of fund management irrespective of fund size; 14% Buyout• Almost three-quarters of the respondent Asia 11% Pacific funds currently grant a 100% management fee offset, compared with less than half in the 2009 Survey, reflecting the greatest year-on-year shift in fund terms;• Demonstrating best practices as per the ILPA Growth guidelines, 84% of Asia Pacific private equity funds follow a European-style “fund-by-fund” distribution 63% waterfall and 91% have a key person clause in place; Fund sample by geographic focus• Over half the funds surveyed lack a no-fault divorce Pan-regional Australia/New Zealand clause, although voting thresholds for those which 14% 14% do make such provisions compare favorably to the global average; and Southeast Asia 13%• Of the 44% of China-focused GP respondents that Greater China manage parallel Renminbi and US Dollar funds, 60% 21% allocate investments between the two purely at the Korea discretion of the GP. 9% JapanSurvey information: 2% Indian SubcontinentThe information in the Survey has been derived fromresponses to a questionnaire sent by Squadron Capital 27%to over 450 Asia Pacific GPs, with the Asia Pacific regiondefined as including Australasia, Greater China, theIndian subcontinent, Japan, Korea and Southeast Asia Fund sample by target fund size(“ASEAN”). Following the removal of GPs that were notactively fundraising during 2010 and largely incomplete $1 billion andresponses, the Survey results cover 94 Asia Pacific GPs above $500-999 Less thanthat either achieved a final closing during 2010 or were 4%actively fundraising as at 31 December 2010. million $100 million 13% 20%For funds which were still being raised as at 31December 2010, the terms stated by the relevant GPsmay not reflect what are or will be the final versionsof the limited partnership agreements or constitutionalequivalents thereof. Accordingly, the actual final termsand conditions agreed upon for such funds within theSurvey - and therefore for the sample size as a whole –will likely be more LP-friendly than the study suggests. $100-499The summary details of the sample funds have been milliondisplayed in the charts on this page. 63% 58% 2
  • 3. April 2011Management fees Comparative management fees Management fees (%)Management fees continue to be a key area offocus for LPs globally, particularly with respect tothe alignment of interests and incentivization of >2%GPs to earn their fees through carry rather thanannual management income.Annual management fees in the region are in 2%general higher than those elsewhere in the world,though this may reflect the overall smaller fundsizes in the Asia Pacific. Despite higher fees, funds <2%in the region might not necessarily be generatingannual fee income levels in excess of their GPs’likely cost bases, or what the ILPA Principlesrefer to as “reasonable operating expenses and 0% 20% 40% 60% 80%reasonable salaries,” as the majority of funds that % of fundsare charging annual fees in excess of 2% are sub- Asia Pacific average Global average*$250 million in size. * Source: 2011 Preqin Global Private Equity Report Management fees by fund size Management fees (%) 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 0-99 100-499 500-999 > 1,000 Fund size ($ million)Note: Private equity fund fees have two components – an annual management fee and a share of the profit. 3
  • 4. April 2011Management fee offsets Fee income offset (%) against management fee“Transaction, monitoring, directory, advisory, % of funds 80%exit fees and other consideration charged by thegeneral partner should accrue to the benefit of 70%the fund” 60% 50% (ILPA Private Equity Principles) 40% 30%Management fee offsets has been the category 20%that has seen the greatest shift since the 2009 10%Survey, with almost three-quarters of Asia Pacific 0%funds now granting a 100% fee offset, compared 59% or less 60-99% 100%with less than half in the previous Survey. Fee income offset (%) Asia Pacific average Global average*This proportion is also significantly in excess of theglobal average, where less than 40% of funds are * Source: 2011 Preqin Global Private Equity Reportcurrently in line with what ILPA regards as bestpractice.Note: In addition to management fees, GPs in some cases also derive income from underlying portfolio companies(through advisory fees, directors’ fees and so forth) as well as from other sources. 4
  • 5. April 2011Distribution waterfalls Carry structure (Asia Pacific sample)“A standard all-contributions plus preferred-return-back-first model must be recognized as a Deal-by-best practice” deal 16% (ILPA Private Equity Principles)One issue where Asia Pacific private equity fundterms are already by and large in line with bestpractice is the distribution waterfall, wheremarket practice in the region follows a European- Fundstyle “fund-by-fund” rather than US-style “deal- levelby-deal” approach. This varies according to fund 84%strategy, however, with a disproportionate numberof venture capital funds in the Survey applyingdeal-by-deal waterfalls. Carry structure (Global sample*) Deal-by- deal 28% Fund level 72% * Source: 2010 Preqin Global Private Equity ReportNote: Distribution waterfalls govern the order in which the proceeds from the sale of investments is distributed.Under a fund level distribution waterfall, investors would be repaid all of the amount they invest into a fundplus a minimum profit hurdle before GPs start becoming eligible for their carry (the term used for incentivepayments). Under a deal-by-deal distribution waterfall however, LPs could theoretically have to start paying outcarry to GPs even though the LPs themselves have not been repaid all of their original capital investment. 5
  • 6. April 2011Preferential fee terms Equality of fee/carry terms versus preferential deals % of fundsThere has been an incipient trend in the private 100%equity industry globally for certain GPs to offerdifferential fee or carry terms to a subset of 80%investors for reasons of relationship (such as fundsponsors or parent organizations), commitment 60%size (in the case of large anchor investors) and/ortiming of entry (in particular for first close LPs). 40% 20%The adoption of such an approach may wellenable a GP to kickstart a fundraising process 0%and/or attract large commitments, but at the Yes, all LPs pay the No, certain LPs pay No, certain LPs payexpense of potential difficulties further along in same fees and carry a lower management a lower carrythe fundraising process as some LPs may view the feeexistence of such deals adversely. For a GP, thereare also obviously the financial implications ofoffering such fee or carry discounts.While the vast majority of funds in the Survey offerall LPs consistent fee and carry terms, there area small number which have granted preferentialterms to a subset of investors. Interestingly, ofthe funds which offer differential carry termsfor certain LPs, the majority of these are India-focused funds. 6
  • 7. April 2011No-fault divorce No-fault divorce clause in place“No fault rights upon a two-thirds in interest voteof limited partners for the removal of the generalpartner” (ILPA Private Equity Principles) No Yes 51% 49%The presence and nature of no-fault divorceclauses in the Asia Pacific region as a whole is amatter which is still significantly short of what theILPA regards as best practice.Over half of the funds in the Survey lack a no-faultdivorce clause, though closer analysis of the dataset indicates that this is disproportionately thecase amongst funds which have not yet achieved afinal close as at the end of 2010.Even for those funds that do have such clauses,the voting thresholds are generally higher thanthe ILPA’s recommended two-thirds figure (thoughlower than the global average), with 75% being the % vote required for no-fault divorcemost common threshold. Vote required (%) 90% + 80-89% 70-79% 50-69% 0% 20% 40% 60% 80% % of funds Asia Pacific average Global averageNote: A no-fault divorce clause refers to the ability for investors to terminate the management agreementbetween the fund and the GP, which in the ordinary course can often run for 10 or more years. 7
  • 8. April 2011Key person provisions Key person clause in placeKey person clauses remain a key area of focus in Nomany of the Asia Pacific private equity markets, 9%perhaps more than elsewhere. The high volatilityof Asia Pacific markets combined with the factthat many Asia Pacific GPs have not as yet gonethrough a full investment cycle means there is alower opportunity cost for teams or team membersleaving or spinning out of their existing firms.Indeed, a significant number of spinouts haveoccurred during the course of 2010 and 2011 todate. YesIn addition, a greater proportion of GPs in the 91%region continue to be overly dependent on asingle founder or individual compared with themore institutional partnership structures of GPsin established markets, which increases the riskof problems should such an individual leave or beunable to continue with the GP.While the majority of funds within the sample sizeare in line with the revised ILPA Principles on thismatter and have a key person clause in place, aminority of funds are not. 8
  • 9. April 2011Fund suspensions on trigger of key person Automatic suspension of investmentclause period if key person clause is triggered“Automatic suspension of investment period,which will become permanent unless a definedsuper-majority of LPs in interest vote to re-instate within 180 days, when a key-person event No Yesis triggered or for cause” 51% 49% (ILPA Private Equity Principles)What happens in cases where the key person clauseis triggered? If suspension is automatic:Approximately half the funds within the data set % of LP interests or advisory board requiredapply best practice automatic suspension of the to lift the suspensioninvestment period, while the other half requiresan LP or advisory board vote in order to suspend or % of fundsterminate the fund. 35% 30%For suspensions which are not automatic, the 25%median threshold of 75% is a surprisingly high 20%figure. 15% 10%Where the suspension is automatic, lifting of 5%the suspension can generally be achieved by the 0%approval of either a simple majority or two-thirds 51% 67% 75% 80%of LP interests or the advisory board. Practice in % LP interest or advisory board vote requiredthe Asia Pacific region is thus broadly in line withstandard practice elsewhere in the world. If suspension is not automatic: % of LP interests or advisory board required to suspend/terminate % of funds 60% 50% 40% 30% 20% 10% 0% 51% 67% 75% 80% % LP interest or advisory board vote required 9
  • 10. April 2011Annual limitations on capital calls Annual restrictions on investment activityVintage diversification is a key tenet of private Yesequity investing. This is arguably even more true 11%in the case of many of the markets within the AsiaPacific region, where historically higher levels ofmarket volatility imply that timing has an evengreater than usual impact on returns.Despite this, barely 10% of Asia Pacific privateequity funds have per annum limits on capitalcalls - approximately the same percentage as lastyear’s Survey (8%) – with most GPs and LPs taking Nothe view that full temporal flexibility in investing 89%becomes more rather than less important in thevolatile markets within the region if they are toinvest opportunistically to maximize returns. 10
  • 11. April 2011Ability for / limitations on public market Investment restrictions ininvesting publicly listed companiesPrivate investments in public entities (“PIPEs”)remain a topic of significant debate within theregion, being viewed by members of the privateequity community – both GPs and LPs – eitherwith disdain, reluctant acceptance or as unique Noopportunities to generate value. 41%A majority of funds (59%) in the 2010 data set have Yesformal restrictions on PIPEs, which is a statistically 59%similar proportion when compared with the 2009data reported in last year’s Survey (57%).Where restrictions are in place, there appears tobe a polarization of the market between fundswith ceilings of 10% or less and those with ceilingsof 20% or more (at the expense of those with a 15%ceiling). Limitation of investments in listed companies % of funds 35% 30% 25% 20% 15% 10% 5% 0% 0% Up to 10% 15% 20% 25% or higher Public investments ceiling as % of fundNote: Where applicable, the ceilings above represent the proportion of each fund that can be invested in publiclylisted companies, beyond which any such investments can be made only with the approval of the fund’s LPadvisory board. 11
  • 12. April 2011RMB fund managers’ potential issues relatingto allocation policy Do you manage RMB-denominated private equity fund(s) as well as USD-denominated fund(s)?As it becomes increasingly common for China-focused GPs to manage parallel Renminbi andUS Dollar funds, the topic of managing potentialconflicts of interests between parallel funds has Yesbecome a key matter of concern for LPs globally. 44% No 56%In excess of 40% of China-focused GPs whoresponded to the Survey now manage parallelRenminbi and US Dollar funds. Of these, 60%allocate investments between the two funds at thediscretion of the GP.The fact that a large proportion of China-focusedGPs managing parallel funds have discretion overthe allocation procedure could indicate on thepositive side that LPs have taken a pragmatic viewof the issue, and on the negative side that LPs mayin certain cases be too willing to accede to thesepoints in order to ensure access to certain GPs in What is the basis of allocation of opportunitiesthe market. between the RMB and USD funds? Strictly pro rata for all encouraged/permitted sectors 40% Purely at the discretion of the GP 60%Note: The pro rata category also includes GPs which to a large extent avoid the potential conflicts of interestsissue by having entirely separate teams managing each of the Renminbi and US Dollar arms. 12
  • 13. April 2011ABOUT SQUADRON CAPITALSquadron Capital is a private equity investment firm based in Hong Kong andfocused on the Asia Pacific region. On behalf of its clients, the firm constructsand manages portfolios of private equity funds, with aggregate assets undermanagement currently well in excess of $1 billion.Squadron Capital has one of the largest professional investment teams dedicated Responsible Investor of the Yearto private equity in the region, with investment professionals hailing from eight in Asia: Squadron CapitalAsia Pacific countries. The firm is widely recognized as a leader in the industryand has won several industry awards.ABOUT THE SQUADRON CAPITAL WHITE PAPER SERIESIn order to provide existing and potential limited partners with an overview ofkey private equity trends and activity in the Asia Pacific region, Squadron Capitalcompiles a series of “white papers” that are updated regularly. This Survey,which is conducted annually by Squadron Capital, is part of the firm’s white paperseries.In preparing these white papers, the intention is neither to set out a definitiveanalysis of the state of the private equity markets in the Asia Pacific region, norto execute a ‘data dump’ of raw information, but rather to provide a consideredand insightful overview of the key factors and trends likely to influence the levelof private equity activity over the investment periods of the underlying funds intowhich vehicles managed by Squadron Capital are likely to invest.The data contained in the Squadron Capital white papers has been compiled fromvarious publications and databases and in certain cases has been directly quotedfrom the relevant sources. The identification and selection of key factors andtrends is our own, and the qualitative evaluations represent our opinion based onour own analysis.While Squadron Capital seeks to ensure that the information contained herein isaccurate, no representation or warranty of any kind, express or implied, is madewith respect to the accuracy or completeness of any such information. SquadronCapital reserves the right to change any such information, at any time, withoutnotice. No reliance may be placed for any purpose whatsoever on the informationcontained in this document or on its completeness.No information contained in this document constitutes an offer to sell or aninvitation to subscribe for any securities.The data and charts contained herein may be reproduced, distributed orpublished on the express condition that you attribute any data and charts youuse to Squadron Capital.Squadron Capital Advisors Limited is licensed by the Securities and FuturesCommission in Hong Kong to conduct Type 4 (Advising on Securities) and Type Squadron Capital Advisors Limited9 (Asset Management) regulated activities and may only deal with professionalinvestors. The Company is also registered with the United States Securities 46th Floor, Cheung Kong Centerand Exchange Commission as an Investment Adviser. 2 Queen’s Road Central Hong Kong© 2011 Squadron Capital Management Limited Tel: +852 2826 2000 Fax: +852 2297 0880 eMail: 13
  • 14. April 2011ABOUT THE EMERGING MARKETS PRIVATE EQUITY ASSOCIATION (EMPEA)The Emerging Markets Private Equity Association (EMPEA) is an independent, non-profit, global industry association that catalyzes private equity and venture capitalinvestment in the emerging markets of Africa, Asia, Europe, Latin America andthe Middle East. EMPEA’s more than 250 members comprise a broad array of fundmanagers, institutional investors and other industry stakeholders, representingmore than 50 countries and over US$1 trillion in assets under management.The Emerging Markets Private Equity Association (EMPEA) was founded in 2004 by ahandful of visionaries at the heart of the industry who shared the belief that privatecapital has the potential to unleash economic growth in emerging markets whilesimultaneously generating strong returns for investors.EMPEA is unusual among membership associations in producing proprietary researchthat provides an authoritative global view of the market in support of our mission.We leverage the scope and connectivity of our membership to help deliver researchand insight built on solid empirical data. We also organize conferences and uniquemember events around the world, often in partnership with global media brandswhere the EMPEA network facilitates powerful business networking opportunities.EMPEA provides the asset class with a voice on key public policy issues to globalregulators and policymakers, and works to advance the dialogue on emergingmarkets opportunities and challenges among institutional investors.For more information, please visit Markets Private Equity Association EMPEA Headquarters 1055 Thomas Jefferson St NW Suite 650 Washington, DC 20007, U.S.A. Tel. +1.202.333.8171 EMPEA Asia Headquarters Suite 3205 No. 9 Queen’s Road Central, Hong Kong Tel. +852.3713.4879 14