“It’ll Be An LP-Friendly World For Awhile:” Q&A With TA Associates

Today TA Associates closed one of the first “LP-friendly” buyout funds to emerge from the credit crunch. The firm raised $4 billion for TA XI, its fund for U.S.-based investors. (The firm has a separate fund for foreign investors.)

The fact that it was oversubscribed by $500 million only proves that one nice gesture goes a long way.

To refresh your memory, the Boston-based firm lowered the carried interest on the fund from 25% to 20%, lowered its management fee to an average of 1.74 percent of commitments, agreed to offset management fees with transaction and director fees, and added a no-fault divorce clause.

The fund received commitments from City of Philadelphia Board of Pensions and Retirement; Fire and Police Pension Association of Colorado; Indiana State Teachers’ Retirement Fund; Los Angeles City Employees’ Retirement System; Los Angeles Fire and Police Pensions; Montana Board of Investments; Purdue University and San Francisco Employees’ Retirement System.

I spoke with Managing Director Brian Conway about the motivation behind the change in terms, the negative IRR of TA’s tenth fund, and the firm’s strategy as a growth investor deploying cash in a not-growing economy.

It’s been widely reported that you lowered your carried interest from 25% to 20%. What was the motivation behind that?

We have a history of making moves like this that were voluntary and LP-friendly. In the past, voluntarily gave up a scheduled management fee increase when we thought the investment pace didn’t merit it. It was scheduled increase between June 2001 through June 2004, and we gave up because our investment pace was slow after the tech bubble burst and led to a modest recession. We also did a voluntary “makewell” across a number of funds after the tech bubble burst, between December 2000 and March 2003. The funds were up but the value had fallen for investors. It would have come out the same in the wash but we wanted to be on par with investors.

This is sort of the same thing. We did it without being asked, before people were going to committee (to discuss investing in the fund). We felt it was 2009 and the private equity industry was under pressure and our LPs were under pressure from their committees. We also thought some of the details that justified our fees in the past wouldn’t have come through to investors. So we voluntarily changed the carry. It was extremely well-received, less for the economic impact but more for what it said about GP/LP relations.
We think long term it was the right thing to do to.

Is it a permanent change?

Who knows. My guess is that it’ll be awhile before any terms improve for the GP. It will be an LP-friendly world for awhile.

How will the recession affect TA’s investment strategy?

We’ve had to visit 50% more companies to make less investments. There are fewer high-growth companies in our areas of interest in this economy. We’re covering more geography to find the same number of investments.

In which areas are you looking?

There continues to be growth companies in technology, particularly online businesses. We see that as a growing area for us. We’re doing less in consumer but there are selected areas that continue to grow. Asset management is an area that will continue to be a long term area for TA XI to invest. We’re well-known for asset management investments, and long term, it’s a great business but it took some lumps in 2008.

TA Associates also invests in financial services tech companies. How is that industry holding up?

We’re still visiting deals in fin-tech. Those companies are doing surprisingly well given the environment. There continues to be innovation in capital markets and financial services technology. It’s a tough area now, given the shrinking customer base, but we expect to invest there in TA XI.

Have you fully deployed your tenth fund?

We’re finishing off TA X, which is 75% invested. We’re still investing it, just at a slower rate.

I noticed that that fund has a negative IRR of 17.5%. Is that because it’s a young fund or are there some problem companies in there?

It’s a complicated answer. In a new fund, with the implementation of FAS 157, you get a sharp hit. The public markets are down 25% to 35 % depending on which index you look at, and we chose a particularly conservative valuation methodology. The majority of our companies are held at a discount to public comparables.

But is the portfolio healthy?

On a relative basis its healthy. The average leverage on our companies is under 3x. Our average leverage going into a new del is 3.5x. So they’re not overleveraged. Some of them were hit by the recession, but relative to other private equity firms, I think it’s in decent shape.

****

Note: I also asked how fundraising for the firm’s $750 million subordinated debt fund was going, but Conway declined to comment.