Five years ago, there were very few law firms in Asia that saw the need to market private equity as a separate practice area or mention it high on their list of capabilities.
How times have changed. Now, you'd find it difficult to find an international firm in Asia that doesn't purport to have deep private equity capabilities, either due to the amount of real PE business they have been involved in, or their wish to build this practice area further.
And this doesn't stop at the internationals. The domestic firms on the ground, particularly in growth markets like China and India, are also clamouring for a piece of the action.
And who can blame them? The Asian private equity party is just beginning, and has the potential to become so much bigger - no one wants to miss out on an invitation.
An informal survey conducted by ALB of a handful of the big internationals demonstrates the growth of private equity-focused teams in Asia over time. While the figures are slightly misleading, due to lawyers on the most part being more broadly corporate focused rather than being pure specialists in private equity, they give an indication of the headcount growth the practice area is seeing, and the priority it is being given.
The Asian private equity practice of US firm Debevoise & Plimpton offers perhaps a more finely tuned indicator of growth than some on the list. Traditionally conservative in its approach to growth, the firm is soon to add five new PE-focused lawyers, bringing its total number to 13.
It seems private equity has truly become the new battleground for firms in Asia.
Battle lines drawn
Law firms have had their eyes set on the pot of private equity gold ever since the market really kicked off in Asia about three years ago.
Now that the likes of The Carlyle Group, TPG Newbridge, The Blackstone Group and KKR have all entered the market, law firms are actively marketing themselves to these investment giants.
"It's not a surprise that many firms are getting into the business, and expanding the existing business they have," Debevoise & Plimpton partner Thomas Britt says.
"It's a function of investment firms in Asia having been successful in raising significant amounts of new capital for transactions," he says.
Debevoise, which has had a stand-alone private equity practice area for 20 years, has seen a large increase in the numbers of its competition over recent years in Asia.
"We now encounter a wider variety of players in this space, who are participating in these transactions, than we did a few years ago - it's a diverse universe of firms," Britt says.
However, the strength that firms purport to have in the PE arena is slightly illusory, as for the most part they are still building their practices for perceived future growth.
Jones Day's head of M&A and private equity John Kao says almost every international firm in the region professes to have a private equity practice, as well as some Chinese and Hong Kong local firms, but that in reality there is a wide list of credentials and abilities.
"Everybody's perception has been the market is promising and they want to capture the business and build it up," Kao says. "Some are building it up internally, bringing people from other areas and locations within the firm, and others are doing it laterally."
But Kao says that although the market in Asia is still growing, it is nowhere near large enough at the moment to support on a full-time basis the number of lawyers that firms market as private equity focused.
"If you look at articles in the papers, and the way people speak, it seems like the market is huge already, but if you dig down and see the real amount of bigger deals that are going on, there are really not that many," Kao says. "There are quite a few deals done by investment firms at US$50m or under, but they are not headline-grabbers."
"For most international firms, if you have a team dedicated solely to PE, it wouldn't be able to feed itself very well - so most team members have to work on private equity as well as traditional M&A or venture capital deals," Kao says.
So, though firms are marketing the strength of their PE practices, most lawyers are in reality engaged in a cross-section of corporate work, switching most frequently from M&A work to dabble in PE when they do source a deal.
Kao says Jones Day falls into this basket. "It's a relatively new area in Asia for everybody and there is a blending of the lines out of necessity," he says.
This is unlike more developed private equity markets such as in the US, where law firms often in reality do make clear distinctions between practice areas such as PE and M&A. Even investment firms in Asia are blurring the lines between the traditionally different disciplines of private equity and venture capital.
With competition in the PE market heating up and not a great deal of experience in Asia to go around, firms are leveraging their experience overseas to compete in Asia.
"Deals in Asia are often times challenging, and you have to be able to bring a depth of experience into a region where PE doesn't have that long a history," Britt says.
Kao says Jones Day is also counting on its US-based middle market private equity clients coming across to Asia and becoming more active investors in the region. Until then, Kao says it is really about getting your brand name out there and working on more deals.
Private equity talent is also being highly contested, especially at the senior level. With teams growing rapidly in size, this is only likely to continue.
The capital magnets
If there are two PE markets that international firms will increasingly lock horns over, they are China and India, which have been the two stand-out growth markets in 2006.
In total, the industry in Asia recorded US$5.6 billion in fresh capital in the first quarter of 2006, while the investment sums directed to 82 companies across the region during that period aggregated to a US$11.3 billion.
According to figures from the Center of Asia Private Equity Research, 20 China-based operations attracted US$4 billion or 35% of the transaction total. India, though recording only an aggregate US$699 million due to smaller average deal sizes, was the location of 37 transactions, making it the busiest market for private equity investors.
When combined, they accounted for 70% of the 82 deals done in the first quarter.
According to Thompson Financial, an analysis of offshore private equity investments into China and India in the first half of the last five years has shown an upward trend.
And the trend is accelerating. Foreign investments in both nations more than doubled in the first half of 2006, when compared to the same period in 2005.
Rabindra Jhunjhunwala, partner at Indian firm Khaitan & Co, says private equity has become a "big chunk" of the firm's work in recent years. At any one time, it would be 35% of the work the corporate team is involved in, he says.
"We are in a phase where the IPO boom has taken a hit, but in terms of the number of PE transactions we haven't seen a change - there is interest every other day," he says.
Jhunjhunwala says now that PE players have seen the huge potential of the Indian market, there is enough work for everybody, with the majority of Indian firms having added private equity to their list of capabilities. Unlike the internationals, he adds, Khaitan is not seeing the heat of competition with other locals, due to the availability of work.
Debevoise's Thomas Britt says increasing numbers of companies and private equity investors are looking more closely at India as a potential market.
"Our clients are active in India, and are looking to become more active. Some clients that aren't yet are also looking to become involved - just like lots of companies have a China strategy, they are looking to build one for India," he says.
It is the increasingly affluent middle class in both India and China that is the source of most investment opportunities in these markets. The airline industry, education providers, consumer brands, financial institutions and health care providers are all benefiting from the millions more consumers with a higher disposable income.
However, India can be a tough market to pursue for international firms that are legally unable to operate there; they are usually only following their existing clients in.
And the combination of China and India is still not enough to keep firms busy just yet.
"If anyone says they have so many private equity deals now that they have to hire a whole lot more lawyers solely dedicated to this area of practice, then they either didn't have many lawyers to begin with or they are the luckiest firm in the world," Kao says.
Over the next five years, however, it is likely that firms will be hiring a considerable number of people, as competition for the growing number of private equity clients grows. Watch this space.
To do or not to do ... a question for a PEF Manager
Overview
A PEF (private equity fund) is established by a joint company under the Indirect Investment Asset Management Business Act of Korea ("IIAMBA"). This joint company is comprised of one or more members with unlimited liability and one or more members with limited liability. Based on the agreement of the members of the PEF, one or more members of the PEF with unlimited liability becomes the manager of the PEF (the "Manager") and carries out the business of the PEF.
General Duties of the Manager
The manager of the PEF is in charge of the day-to-day business of the PEF. Therefore, the Manager has the right to enter into contracts for and on behalf of the PEF. Since the Manager has rights and obligations with respect to the management of the assets of the PEF, the Manager may not delegate certain matters relating to the PEF to any third party, including but not limited to selecting target companies for the PEF to make investments in, selling and purchasing investments securities, and exercise of rights relating to such investment securities. The Manager must perform the aforementioned tasks itself. The limited liability members of the PEF must not intervene in the aforementioned tasks of the Manager.
One point to note is that, even though the Manager is in charge of managing the PEF, the Manager needs to appoint various independent professionals to carry out the management of the PEF. In connection therewith there is an issue as to whether the PEF or the Manager should bear the costs of such independent professionals. The Manager frequently seeks the advice of legal counsel and accountants, and sometimes receives assistance from a financial advisor in respect of a particular transaction. If the PEF has received any benefit from the service provided by any of the independent professionals, the PEF should, in principle, bear the costs of such services. The general practice is for the investors' agreement entered into among the members of the PEF and/or the Articles of Incorporation of the PEF to stipulate in detail the cost allocation between the PEF and the Manager. Ultimately, the level of bargaining power that the Manager has, as compared to that of the other limited liability members of the PEF, will determine the exact scope of cost allocation between the Manager and the PEF with respect to the costs of retaining the services of independent professionals.
Fiduciary Duty of the Manager
Although the IIAMBA does not require the Manager to have any particular qualification, the Manager, as the manager of the PEF managing the assets of the funds contributed into the PEF by the limited liability members, has a fiduciary duty to the limited liability members. On the other hand, the IIAMBA contains various special provisions with respect to the Manager. These provisions relate, in one way or another, to the fiduciary duty of the Manager.
The PEF is required to have in place detailed conduct rules that the Manager must comply with, and such conduct rules must be reported to the Financial Supervisory Service of Korea. The conduct rules are enacted by the unanimous approval of all the members of the PEF at the time the PEF is established. Depending on the content of a particular conduct rules, the fiduciary duty of the Manager may be more or less onerous than what is required under the general principle of law or the IIAMBA.
Generally, a restriction on concurrent business is applicable to any party executing the business of a company. However, since the IIAMBA provides a waiver of this restriction on concurrent business, a Manager of one PEF may act as the Manager of another PEF or another investment fund. Nevertheless, notwithstanding such waiver contained in the IIAMBA, an issue regarding fiduciary duty may arise in the event a Manager of a PEF also acts as the Manager of another PEF or another investment fund. For example, in the case the Manager of a PEF, which is also the Manager of another PEF or another investment fund, finds a target company to make an investment in, an issue may arise as to which PEF (or investment fund) should the Manager provide an opportunity to make the investment. In particular, if the Manager provides an investment opportunity to one particular PEF (or investment fund), there may be an issue as to whether or not such Manager has breached its fiduciary duty owing to the investors of the other PEF (or investment fund) in which such Manager is also the manager. In order to prevent this type of issue from arising, an investors' agreement entered into among the members of the PEF and/or the Articles of Incorporation of the PEF often contain a provision that restricts the ability of the Manager from becoming a Manager of another PEF (or investment fund) (eg there may be a provision that prohibits the Manager from becoming a Manager of another PEF (or investment fund) until a certain period has elapsed after the establishment of the subject PEF).
To prevent a situation where the Manager enters into a transaction with the PEF, in which such Manager is the manager, in its own interest that is prejudicial to the interests of the other members of the PEF, the IIAMBA only permits the Manager to enter into such transaction with the PEF if there is unanimous approval of all the members of the PEF. One related issue deals with a situation where the PEF enters into a transaction not with the Manager but with a specially-related party of the Manager. Although the IIAMBA does not expressly deal with a transaction between the PEF and a specially-related party of the Manager of such PEF, taking into account the intent and purpose of the IIAMBA, it appears that the same restriction applicable to a transaction between the PEF and the Manager of such PEF should apply also if a transaction between the PEF and a specially-related party of the Manager of such PEF is one where the economic benefit derived therefrom by the Manager is substantially similar to a transaction where the Manager is a party.
A PEF is a private fund. As such, any solicitation of members targeting 50 or more persons of the general public, through such means as an advertisement in a newspaper, magazine, or TV is strictly prohibited. Since interests of the PEF cannot be sold through a public offering, the Manager must be careful not to violate such restriction at any time the Manager conducts any promotion of the PEF.
By Je Won Lee and Song-ll An
Lee & ko, 18th Pl., Hanjin Main Bldg
118, 2-Ka, Namdaemun-Ro, Chung-Ku
Seoul, 100-770 Korea
Tel: +82-2-772-4000, Fax: 82-2-772-4001/2
E-mail: mail@leeko.com