Taking a lever to Europe

Nigel Doughty alarmed some of his loyal institutional investors this year when he tried to buy Nottingham Forest football club. They thought the chief executive of Europe’s prime venture-capital partnership, Doughty Hanson, had finally flipped – not because Forest, twice European champions, were recently relegated from England’s top football division, but because they feared Doughty had lost his hunger for business. Soccer clubs are seen as the toys that increasingly distract the UK’s new rich from their day jobs.

“To be fair to Nigel, he would never treat Forest like a rich man’s toy,” says one person who knows him. “After all, he’s supported them since he was in short trousers.”

But there were good reasons to wonder whether, following a series of successful deals, Nigel Doughty and Richard Hanson might wish to quit while ahead. Over the past six or seven years, well funded and well organized financial investors such as Doughty Hanson could simply buy cheap in the private market, acquiring companies on multiples of six, seven or eight times annual earnings before interest, tax, depreciation and amortization (EBITDA), and sell at higher prices by later floating companies on booming public stock markets at multiples of 14 times EBITDA or more.

“People like Doughty Hanson need a greater fool, and the greater fool has been the public stock market investor,” says the chairman of a more conservatively run private equity fund. But as more such funds seek investments in continental Europe, initial acquisitions will often be made at ever higher multiples of 10,12 or 14 times EBITDA. It’s questionable whether they will be able to exit, through initial public offerings (IPOs), at 18 or 20 times EBITDA or above.

Last month, those questioning the drive of Doughty Hanson got their answer. It unveiled a new $2.5 billion fund, by far the largest ever dedicated to acquiring European companies through leveraged buy-outs.

Some consider Doughty Hanson to be Europe’s answer to Kohlberg Kravis Roberts (KKR) in the US, the firm behind the infamous $26 billion leveraged buy-out of tobacco and food company RJR Nabisco. The English firm matches KKR’s aggressive approach to private-equity investing: its willingness to use innovative financing, including junk bonds, to enable it to bid high prices for investments; the speed with which it has flipped some companies back to the public stock markets at very high prices; the huge profits that must have made its founding partners extremely wealthy. “Hanson would probably say KKR is America’s answer to Doughty Hanson,” jokes a banker who knows the European firm well.

In the past year or two Doughty Hanson has risen, apparently from nowhere, to dominate the European buy-out market. Its founders – Nigel Doughty and Richard Hanson – avoid the press, believing secrecy adds to the firm’s mystique and enhances its reputation for hard-driving professionalism. But the firm has achieved a high profile because of a string of spectacular acquisitions and divestments in recent months.

Doughty is the smoother of the press-shy double act: “Pukka, public school” is how one banker describes him, immediately qualifying this with “well educated and well spoken but not at all in a stuffy old-Etonian way”. He is pleasant – even charming. His particular skill is presenting the firm to clients and investors, rather than detailed due diligence. Doughty knows that part of the firm’s function is to be a catalyst for corporate restructuring in Europe at a time when the old social market is collapsing. Companies can no longer be protected from international competition and so have less security for long-term planning. Restructuring often means job cuts. But Doughty prefers to talk in terms of changing firms’ culture, breaking the internal log-jams and making them outward-focused not inward-focused.

He doesn’t aim to sound like a US management consultant, or as a cold-blooded cost-cutter or asset-stripper. He is keen for the firm to be seen less as a source of equity capital demanding a high return and more as a source of responsible capital, and as a responsible, ethical owner. In private talks, he will point out that most of the firm’s partners are fairly young, with young children. Doughty and Hanson themselves are only just into their 40s – others at the firm are in their 30s, their youth sometimes making it hard for them to deal with older European board members. They are also concerned about issues such as the environment. Doughty Hanson often insists on onerous environmental audits of companies it is buying.

Political skills

Is this just window-dressing for the real business of making money? Perhaps. “Nigel is an extremely good politician,” says one former colleague. “And he can wangle his way into a presentation to a company when it might seem to everyone else that Doughty Hanson would be the last group that the company would want to see.”

His political skills were needed in one of Doughty Hanson’s largest and most complex deals to date. Earlier this year, funds it controlled acquired a 55% stake in a newly formed joint venture, Impress Metal, which combines the metal-packaging divisions of Pechiney of France and Schmalbach-Lubeca of Germany. Pechiney and Schmalbach-Lubeca each retain 20% of the new company and management owns 5%. Doughty Hanson put Dm149.1 million ($84 million) into the equity of the new company, which has a capital structure comprising Dm260 million of equity and Dm1.09 billion of debt. The net purchase price of the underlying assets was Dm1.05 billion and some debt was also acquired and new financing raised for a gross consideration of Dm1.24 billion. The new company will own large businesses in Germany, the Netherlands, Italy, the UK and smaller operations in eastern Europe, Spain and Japan. The combined company would have annual sales for 1996 of just over Dm2 billion and earnings before EBITDA of Dm173 million.

The French and German companies had each been contemplating disposing of their food-canning divisions, considering them non-core businesses. But they had also realized that by combining them they could create the second-largest metal packager in Europe. The only question was who should run it. Both realized they needed an outside investor to take the helm at any new company, as managing it would be a low priority for the former parents. It also needed a neutral partner that would not favour one side over the other.

After reviewing offers from several prospective financial investors, they agreed to work with Doughty Hanson, which offered the highest price. But offering a higher price was not the end of Doughty Hanson’s involvement in making this complex deal work. One source at Schmalbach-Lubeca recalls how competition and rivalry between the two industrial companies, which had prevented any 50-50 joint venture from working previously, also threatened the new deal. “As you can imagine, negotiations between a French and a German company were very complex and the whole thing was on the brink of collapse several times. At those moments it was Nigel Doughty who joined the negotiations and helped us through our difficulties.”

Impress Metal was a landmark deal for Doughty Hanson, the kind it hopes to do more of with its huge new fund. Though it has always targeted larger European buy-outs, it has done more than its fair share of takeovers of family-run firms and smaller divisions sold by large companies. Its other two big acquisitions earlier this year were German machinery group Winkler & Dünnebier, with annual sales of Dm275 million, which Doughty Hanson bought from family owners for around Dm250 million, and Swiss sanitary systems maker Geberit, which it bought for Swfr8 billion ($1.2 billion), again from family shareholders, contributing Swfr440 million in equity and subordinated debt.

Those, Geberit in particular, were big buy-outs, but Impress Metal was in a higher league. It not only created a new European-scale company, it also profoundly affected the whole European market for food cans. This is dominated by CarnaudMetalbox with a 40% market share. Previously, the divisions of Pechiney and Schmalbach-Lubeca had 12% each. Putting them together reconfigures the market into more of a duopoly. No other competitor has more than 5%. Doughty Hanson is keen to do more such deals, making big acquisitions from the largest companies in Europe and getting itself right to the heart of wholesale restructuring there. It wants to create European businesses rather than national champions. “Europe is crying out for those kinds of problem-solving deals,” says a source close to the firm. “Doughty Hanson wants to be doing big deals with the biggest companies, the likes of Daimler and Siemens”.

Richard Hanson is almost exactly opposite to Doughty. “I mean this in a nice way, because I like him” says a former colleague, “but Dick is a thug. He’s a bish-bosh kind of guy, who just wants to get his hands on the deal and really doesn’t care about any of the politics.” Just as Doughty’s diplomacy serves his firm well, so Hanson’s tougher, no-nonsense approach earns respect from European company directors who no doubt see him as personifying the hard-nosed approach of Anglo-Saxon capitalism. “Ah, Dick Hanson,” recalls an executive from Pechiney in what sounds like an indulgent tone, “the man whose tie was never done up at any meeting or dinner we had in six whole months and whose collar was always unbuttoned.”

If European corporate executives are near bowled over by Doughty Hanson, banks are in awe of it. As a potential source of huge fees to investment bankers through advisory work, raising acquisition finance and IPOs – its favoured method of exiting investments – it is held in awe by many in the City of London. “We cover them like we would cover the treasury of a European sovereign with a large number of privatization mandates to hand out,” says a banker. “If I was quoted talking about them, I could lose my job.”

Even before closing its new fund, Doughty Hanson, which has offices in London, Stockholm and Frankfurt, is already Europe’s largest independent private-equity fund manager. It manages a Dm1 billion fund, now nearly fully invested in market-leading international companies in northern Europe. Investors in its existing fund include pension funds, insurers, banks and state funds worldwide.

Overwhelming interest

So spectacular has been the performance of that existing fund, and so eye-catching have been Doughty Hanson’s deals, including realized investments in Swiss watchmaker Tag Heuer, German flooring maker Tarkett International, car park operator Apcoa that when it went back to institutional investors this year to raise a new $1.75 billion-equivalent fund, it was massively oversubscribed.

Hard performance numbers are difficult to confirm in the secretive private-equity game, but Doughty Hanson’s existing Dm1 billion fund, and an earlier fund it managed as CWB Capital Partners, will have provided internal rates of return (IRR) to investors of roughly 40%, 10 to 15 percentage points above returns from the raging bull market in public equity. Institutions, especially in the US, are dedicating higher proportions of their own growing funds to private equity in pursuit of such exceptional performance. US state pension funds that three years ago put 3% of their assets into private equity might today want 10% in that asset class. Some large US endowments like Yale and Harvard might have more than 20% of investments in private equity.

Americans are used to the workings of private-equity investments in the US and are keen to find similar opportunities in Europe. There, Doughty Hanson has been something of a pioneer, targeting large buy-outs and bringing US-style financial sophistication, including high-yield corporate bonds, to enhance returns on its equity investments. US investors are big contributors to its new fund.

The new fund, flooded with offers of US money, was capped at $2.5 billion, roughly Dm4 billion, dwarfing even other large European buy-out funds recently raised and being marketed by the likes of Charterhouse with an £800 million ($1.3 billion) fund, Schroders with a $1 billion fund and CVC with a $840 million equivalent fund. The size of the new fund, more than twice as large as any other dedicated to European buy-outs, may be a knock-out blow to its competitors in Europe, providing Doughty Hanson with the basis to pursue more and larger acquisitions.

It also confirms the firm’s elevation way above its humble beginnings when the two partners initially struggled in 1990 and 1991 to raise a £166 million European venture-capital fund at Chartered WestLB, the merchant bank joint venture between Standard Chartered and WestLB. In those days the UK venture-capital business was still under the cloud of large failed buy-outs such as that of supermarket group Isoceles and kitchen-maker Magnet. The latter was a deal on which the two partners had worked when they were employed in acquisition finance at Standard Chartered.

The years since 1991 have brought a string of successes for the two. They went solo in 1994 when, with Standard Chartered pulling out of buy-outs and refocusing on mainstream corporate finance, the Chartered WestLB joint venture unwound. By then the first CWB Capital Partners Fund was already fully invested and the two men formed Doughty Hanson and raised their new fund. From 1990, the two men had identified new opportunities in private-equity investing and followed them up with determination. They chose to concentrate their search in German-speaking northern Europe and to look for large deals where they could invest large amounts in one go. This was a time when many UK-based venture capitalists were still focused in the UK. Those that did look at continental Europe tended to seek smaller and medium-sized companies to invest in, focusing on the theme of the succession crisis at many family-owned companies.

Doughty and Hanson, sensing the growing acceptance of Anglo-Saxon notions of shareholder value among large companies in northern Europe and the beginnings of corporate restructuring throughout the continent, set their sights higher. They also changed their tactics: “They were among the first to realize the importance of having people on the ground in Europe and also among the first to recognize the limitations of courting accountancy firms to get in with management teams hoping to do buy-outs. Instead they would talk directly to large European companies, letting them know that if they ever wanted to dispose of certain assets, Doughty Hanson would bid for them,” says one banker.

The firm’s small number of junior partners typically spend huge amounts of time reading reports and accounts of Scandinavian and Germany companies. They try to spot the peripheral, neglected division that might benefit from a strategic refocusing and then arrange meetings with the parent company’s chief executive or chief financial officer to talk about a sale. “Partly out of the pure ego of the principals, the firm prefers to originate its own deals rather than to go to any outside source,” says a banker. Outsiders who do bring them deals are more likely to be M&A departments of the largest commercial and investment banks

A mini investment bank

Doughty Hanson operates like a mini investment bank, but one geared only to principal investments. The work load is intense, even by the standards of investment banking. In Europe, the firm has attracted staff from various backgrounds, bright MBA graduates, employees of other private-equity investors, investment banks and corporations. The rewards can be huge but the price is a 20-hour working day.

One of Doughty Hanson’s biggest early successes was in buying – along with Goldman Sachs Capital Partners – the German headquartered Tarkett from Swedish conglomerate Stora. “That was a large orphan division that had been under-managed, and which, with properly incentivized management, later produced both strong sales growth and cost cuts,” recalls a banker. The company was floated in 1995, making a hefty profit for Doughty Hanson. From now on it will be able to make such investments on its own, without sharing them with other equity buyers. “They’re not venture capitalists, they are a large industrial holding company,” says another banker.

The two adjectives most often applied to the firm and its partners by rivals and those who have worked with them are “aggressive” and “professional”. One banker who has negotiated with them says: “They are aggressive in a business sense. They know what they want and do whatever they have to do to get it.” As investors, they take a hands-on approach, always appointing a partner of the firm to the boards of the companies they buy into, usually in the position of chairman. Most other private-equity investors appoint an industrialist with relevant business experience as chairman. The Doughty Hanson directors are “very active non-executives”, says a co-investor who has dealt with them. The group often aims for a financial and strategic refocusing of companies it buys, though it leaves day-to-day operations to management. Their approach is in stark contrast to the equity-investing arms of German banks, which usually only take minority stakes in companies, rarely get involved in directing the companies and often don’t even seek much protection for their rights as minority shareholders.

Doughty Hanson also looks sharper-minded than most rivals, even other Anglo-Saxon private-equity investors. It played a key role in developing a European corporate high-yield bond market earlier this year, providing the impetus behind two of the first three issues – the Dm157 million deal for Geberit and the Dm200 million issue for Impress Metal. “They were quite deliberate in making that happen,” says a banker who works closely with the firm. “As a deal sponsor, they were thinking strategically about the development of a financing market. That way of thinking may be second nature in the US, but it is not typically European. Many other deal sponsors in Europe prefer the tried and tested formulae for financing and seem to regard the idea of seeking more appropriate capital structures through developing a new and innovative market as a distraction from their main task of seeking investments.”

Doughty Hanson did not sponsor the creation of a European high-yield bond market out of a spirit of generosity towards the investment banks which will earn sumptuous fees from leading future deals. Partly it helps Doughty Hanson when it is submitting bids. Vendors often dislike high bids being submitted contingent on raising of finance. Doughty Hanson’s skill in raising high-yield long-term debt for companies has allowed it to present letters from their banks and investment banks providing vendors with considerable confidence that it can raise the purchase price, even when that price would seem to be much higher than could normally be provided by equity and senior bank debt. Also Doughty Hanson needed to create such a market to continue generating high returns on its equity investments.

Private-equity investors in Europe today are split into two broad camps: the conservative and the aggressive. Doughty Hanson, needless to say, is in the minority aggressive camp along with Charterhouse, which is more heavily oriented towards UK investments. The conservatives – Electra, Candover, Schroders – say that because prices of acquisitions have been bid up by enhanced competition, and because public stock markets have been pushed up to record highs, it will become harder and harder to generate IRRs of 40%, or even percentages in the high 30s, by simply arbitraging the private and public markets.

Reasons to be wary

The greater fool might wise up, or even worse, disappear, if stock markets crash.

And Doughty Hanson has already provided public stock market investors with good reason to be wary. In September 1996 it sold down its holding in Swiss watchmaker Tag Heuer from 40.2% to 10.1% at the time of Tag’s IPO. The shares were sold to the public at Swfr245, or $19.55 for shares in ADS form. Amid a wave of excitement over the stocks of luxury goods and fashion companies, the deal was 20 times oversubscribed. But in the after-market the price fell away to Swfr211 by the end of last year, in a rising Swiss market.

How such a well subscribed deal could later perform so poorly has been intensely debated. The IPO raised no new funds for Tag Heuer, being merely an exercise in deleveraging and an opportunity for investors like Doughty Hanson to cash out. That may have added to the market’s eventual wariness about the stock. Doughty Hanson did nothing wrong. True, Richard Hanson was chairman of the board of directors, but Doughty Hanson did not sell out its holdings in advance knowledge of any bad news for Tag. Rather, the deal was simply mispriced. Investors soon forgot their initial enthusiasm and concentrated on Tag’s merely decent annual sales and profit growth of 10%. Instead of valuing it in line with the US market’s high rating of luxury goods stocks, with p/e ratios in the 20s, it was priced down to a multiple in the low teens, more in line with a steady European stock.

Public investors’ losses on the IPO contrast sharply and unfavourably with Doughty Hanson’s astonishing gains. Doughty Hanson had initially purchased a 48% stake in the company for a capital contribution of Swfr16.32 million. It also paid Swfr48 million for preference shares, but these were mainly repurchased by the company out of the proceeds it raised from the IPO. Doughty Hanson’s funds raised Swfr252 million from the sale of their shares, which they had acquired less than a year earlier. That is 15 times its capital contribution at the time of Tag Heuer’s leveraged recapitalization only 10 months earlier in December 1995.

The partners of the firm will have taken a big share of this huge profit as a result of the way private-equity funds operate. Typically, the fund manager – in this case the Doughty Hanson partnership – is paid 2% in management fees by outside investors on all the funds they commit. After that the fund manager will often take a share, say 20%, of the capital gains on invested funds above a certain hurdle rate, often around 10%. This is the manager’s so-called carry. Those earnings will go to Doughty Hanson, which has nine partners. Finally, and unusually to Doughty Hanson, all the partners co-invest some of their personal wealth through the firm’s own investment in each single deal, perhaps 1% or so of the total equity of each acquisition. Doughty Hanson’s partners will have shared tens of millions of dollars from the Tag Heuer deal alone, with the lion’s share split by the two named principals. So this would have been a great deal for Doughty Hanson and investors in its fund, but a lousy one for buyers of the IPO. “I wouldn’t buy shares in one of their floats, now,” sniffs a fund manager at a rival private-equity fund.

It remains to be seen whether or not other public-market investors will indeed harbour a grudge. In all probability, if they think they can make money by buying the next IPO of a Doughty Hanson company, they will snap it up. They have made money on many of its other deals. Shares in Apcoa doubled in the first year after it was floated in 1995 and shares in UK biotech company Powderject are over 5% ahead within three months of its flotation earlier this year. But the company may have to be more cautious over the speed with which it realizes its investments. Quick IPOs boost internal rates of return for private-equity buyers, but holding a company for only 10 months, as it did Tag Heuer, smacks of the private-equity equivalent of stagging a new issue or flipping a public stock.

Even assuming it suffers no reaction to the Tag Heuer affair, Doughty Hanson still faces challenges. There may be less competition for the large deals it seeks – only four other firms were seriously interested in Impress Metal – but in any case such large divisions often command fuller valuations when they are sold and Doughty Hanson will have to win on price. Schroders, which has a $1 billion fund, is seeking more deals in continental Europe. Charterhouse is another bank with a large fund seeking aggressive returns, and the private-equity investing arms of the big US investment banks are a force to be reckoned with. Doughty and Hanson see their stiffest competition in the future coming not from the established local rivals which also include CVC and BC Partners, but from the Americans. Goldman Sachs Capital Partners, with which Doughty Hanson had good relations from the time of the Tarkett deal, was one rumoured to be close to winning Impress Metal. It remains to be seen whether the giant independent American leveraged buy-out firms like KKR will now make real efforts in Europe.

Enter the junk bonds

This is where the junk bonds come in. If Doughty Hanson can put in a thinner layer of equity into financing each acquisition and fund more of the purchase price through debt which the target company will have to service, that might be a way to continue producing 40% returns on the equity it invests. Meanwhile other more cautious private-equity investors are putting in more equity and telling their outside investors to be happy with 20% returns.

But this is a somewhat risky strategy and one that may depend for its success on continuing economic recovery in Europe and stable interest rates. Swiftly rising rates will make servicing large debt burdensome for companies, even if some of the floating-rate debt is hedged, and may threaten their general business prospects. Furthermore, because Doughty Hanson makes a small number of large investments, it is under greater pressure to make each one count than a firm like 3i, which has a portfolio of 60 or more private-equity investments in small and medium companies spread across Europe. And though Doughty Hanson is well established now, investors may wonder whether timing has helped its track record. Coming out of a debt background, Nigel Doughty and Richard Hanson had no success record in 1990 and 1991. But they were able to start investing at a time of recession, paying historically low multiples for companies producing historically low earnings. Since then, markets have flourished, providing easy exits. Their funds have been a leveraged bet on European recovery and booming stock markets.

“You would have had to be an idiot not to make money in the past five years,” says a senior figure at another private-equity investor. It may not be so easy in future unless the acquirer can really grow the earnings at each company and therefore still make a profit by selling at an earnings multiple not much higher than that at which it first buys.

“Doughty Hanson will drop the odd catch like anyone else, but they probably cannot afford to drop more than one catch,” says a source close to the firm. It’s a sobering thought for outside investors in the new fund, which will be being invested as the tenth anniversary of the Magnet deal in the UK approaches. The obvious large hole it might have in its portfolio is the £50 million it pumped into start-up UK phone company Ionica. What little business the firm has done in the UK to date has been in high-tech sectors. Ionica uses fixed-wireless technology supplied by Nortel and aims to compete directly with BT for residential and business customers. It aims to undercut BT on price and offers cheaper and easier installation than UK cable companies. The company made great play of the fact that its build-out costs are more closely correlated to the signing-up of paying customers than are those of the cable companies. Nevertheless, its future prospects are tough to gauge.

Ionica was floated this summer and immediately reported a £30 million first-quarter loss because of high start-up costs. This time, Doughty Hanson didn’t get any of its cash out at the IPO. In fact it was diluted down from 11.1% to 8.4% (assuming exercise of certain warrants), as all the shares sold were new equity with proceeds going to Ionica for investment in spreading its service in the UK. The share price fell from £3.92 at the float in July to £3.71 a month later. “I take my hat off to SBC Warburg that they even got it floated at all, but I think Ionica will go down from here,” says a banker. “Doughty Hanson may well be sitting on a loss with Ionica.”

But Doughty Hanson has much going for it. It has done a lot of the spadework in Europe, where other private-equity investors are only now struggling to follow its lead. Ten years ago, its partners were virtually thrown out of some meetings with boards of directors for spreading their heretical notions of shareholder value. Now, boards tend to listen, and they are a favoured potential buyer for many leading corporates thinking about disposing of divisions. They have adapted their tactics cleverly to accommodate the social market in Europe. For example, in February 1996 they took over several poorly performing peripheral divisions of Daimler-Benz for a nominal sum. These mechanical-engineering and electric-motor makers, grouped together as Elexis, were virtually bankrupt and for three months Doughty Hanson’s chief challenge was to work out just how much they were losing. Within a year, under a strong new management, they were showing a modest profit. The price was job losses.

But instead of simply laying workers off, Doughty Hanson set up retraining centres and offered to pay former workers through college courses for two or three years. It was a smart move. Redundancy costs were spread over two or three years, rather than being concentrated in immediate lump-sum pay-offs, and, crucially, the policy assuaged the powerful German unions which were able to retain the workers as members. It also helped Doughty Hanson present itself as an enlightened, socially responsible company. In continental Europe, corporates selling divisions tend to worry more about how new owners will treat the companies than do vendors in Anglo-Saxon countries. When Doughty Hanson floats Elexis, probably next year, it may well employ more people than when it first acquired it. What is more, German politicians are queuing up to take credit for the turnround. This must cause some private amusement at a firm that has taken its share of flak in the past from European politicians attacking it as an Anglo-Saxon predator.

Success stories like this, as well as successful turnrounds for companies like Tarkett, Apcoa and large Swedish company Arjo, produce not only financial rewards but make Doughty Hanson a favoured buyer. Success breeds success. Many of the largest banks and institutional investors in countries where Doughty Hanson operates are also investors in its funds. These local financial giants can become a source of introductions, new referrals and deals. European banks are simply too weak and unprofitable to keep propping up local companies with loans at sub-market rates, as they have in years past. A galvanizing new equity investor is not a threat to the local financial establishment: it’s very welcome.

As well as enjoying good standing with the boards of many large European companies, Doughty Hanson has also shown itself good at dealing with European managers. Unlike in the UK, where management teams are often prepared and eager to do management buy-outs and management buy-ins, there is much less senior management mobility within Europe, much greater security of tenure – with executives often on five year employment contracts – and much less familiarity with the idea of taking equity ownership in companies and equity risk. One of Doughty Hanson’s strengths lies in finding good managers. This was another key to its winning the bid to do Impress Metal. It was essential to bring in a strong outside chief executive with no historical ties to Pechiney or Schmalbach-Lubeca. Doughty Hanson impressed its joint-venture partners by recruiting Dominique Damon, formerly a senior executive at Alusuisse-Lonza and at Rhône-Poulenc to be the new CEO.

In leveraged buy-outs in the UK and US there is often tension between management and financial investors. Managements typically fight for as long as possible for a slice of the equity and for the least onerous performance targets to be written into their employment contracts. Financial investors want the opposite. And later there can be problems. Financial investors often want to exit investments as soon as possible so as to boost IRR performance. Managements may want to delay public flotation for as long as possible to take advantage of so-called ratchet arrangements designed to lift managements’ equity stake with each year of good performance.

Managers in Europe are often unsure of how they should be playing this game. But Doughty Hanson gives the impression that when, after an exhaustive recruitment search, it has found a manager or management team it really wants, it will do whatever it takes to obtain their services. “Doughty Hanson may have an aggressive, US-style can-do approach, but they also showed that they understood, and were sympathetic to, the European culture of management,” says a person who worked on the Impress Metal deal. Although Doughty Hanson is demanding of management, Damon was able to negotiate a good package: “There was little nitpicking over the details,” says one source, and management has 5% of a large company with no huge warranties granted in return. “If Damon infuriated them with her demands, they hid it well,” says the source.

Instead of taking an adversarial approach to discussions with management, Doughty Hanson happily underwrote the management teams’ fees to legal and other advisers and Kevin Connolly, an American who works for Doughty Hanson, helped to coach more than 20 managers from seven countries around Europe through the workings of the deal, at occasionally painful meetings in London. But this doesn’t mean it will be an easy ride: “If anyone underperforms, Damon will have them out before Doughty Hanson even gets close,” says someone used to dealing with her.

Managers of Tag Heuer also negotiated a good deal with a 14.8% management stake prior to the IPO. And management teams tend to like Doughty Hanson’s policy of always seeking an exit from their investments through IPOs. Other venture capitalists tend to exit through a mix of IPOs and trade sales to industrial companies. But existing managements may well be sacked following a trade sale. By contrast, the prospect of becoming the executive director of a publicly quoted company seems much more glamorous. Attracting and keeping good management teams is one of the keys to private-equity investing that Doughty Hanson seems to have mastered. Strong managers tend to produce good results even in cyclical downturns.

Making enemies

No firm could make the splash Doughty Hanson has without making a few enemies. Competitors grumble that it uses its growing influence over investment banks to muscle out other competing private-equity buyers. They say it threatens not to do business with investment banks if they work too hard for the competition. Certainly, Doughty Hanson is a huge source of banks’ business and is able to be quite demanding of them. It has considerable influence, and its bankers and professional advisers are falling over themselves to keep in its good books. “They may only have a dozen or so people in-house, but I bet that at any time there are 150 bankers, accountants and lawyers working for them,” says a source at another private-equity investor.

If it does try to persuade banks to be less helpful to the competition, it still cannot avoid the usual auction system by which European companies dispose of divisions. Again its critics grumble that its usual tactic is to bid high, win the right to deal with the vendor on an exclusive basis and then try to claw back advantages in the detailed negotiations over the sale. In truth, vendors are more respectful than critical, though a source at one European company agrees: “At the start you may feel that you are selling to Doughty Hanson. Then they start making the point that you are selling to funds managed by Doughty Hanson and that can complicate discussions of details of agreements. If you are selling to another industrial company, typically there will be unresolved points. At a final meeting, the two chairmen will eventually sit down and bargain through compromises on these. But Doughty Hanson will say they cannot make certain concessions because these may run contrary to the policy of their funds, which has been mandated to them by outside investors.”

Could a threat to Doughty Hanson come from within? One rumour circulating just before the closing of the latest fund was that some of the junior partners might be preparing to split off and set up a new fund. The firm has suffered some turmoil in the past. Notably, in 1994 a group based in Germany, led by Max Römer and Andreas Fendel, quit to set up their own fund, Quadriga, which now operates out of Frankfurt. This German team had been at Citicorp Venture Capital in the 1980s, but left Citicorp amid the disagreements over its European venture-capital strategy which wracked the bank in the early 1990s. They joined up with Doughty and Hanson in 1990 when the future partners were at Chartered/WestLB. The Quadriga team operated as franchisees sourcing and managing deals in Germany, a key market for Doughty and Hanson as they raised and invested their first CWB Capital Partners fund.

At times the relationship worked well, especially over Apcoa, a deal that helped put Doughty and Hanson on the map. That deal originated from London, and the Germans took it over. Fendel became chairman of Apcoa, overseeing its restructuring until its float. But the German team had profound misgivings about the Doughty Hanson strategy. They preferred to look for smaller deals among the German family-owned companies that obsesses many traditional European venture capitalists. They seemed uncomfortable with Doughty Hanson’s grander visions and struggled with the idea of seeking larger deals and paying high prices. Frustrated by this lack of deals coming from a core market, the London-based partners began visiting Germany themselves, invading the Quadriga group’s patch, seeking deals there and marketing, often without telling them.

When the Germans did eventually bring a sizeable deal to their bosses, it turned out to be a kitchen company. For Doughty and Hanson, no doubt still thinking of the Magnet fiasco, this must have seemed like a joke in poor taste. The Germans were merely surprised they did not take it up. When the parting came in 1994 it was far from amicable. The two sides lined up for litigation, though they eventually calmed down.

Could something similar happen again? As the rewards on their spectacular successes are heavily weighted towards Doughty and Hanson themselves, might some other partners not dream of setting up on their own.

Certainly the internal pressures are considerable. Doughty Hanson sometimes seems almost overstretched. Counterparts in their transactions note an enormous reliance on professional advisers, particularly corporate-finance accountants from Price Waterhouse and lawyers from Lovell White Durrant. “Sometimes the advisers seemed to be directing Doughty Hanson, not the other way around,” says a source. This is partly a clever tactic by Doughty Hanson. The partnership has to stump up for drop-dead costs, fees incurred on deals that never materialize because the selling shareholder gets cold feet at the last minute. But the hefty fees on deals that go to completion are met by the acquired companies. So it makes sense to manage these transactions like separate projects, with only a small Doughty Hanson presence at the top. It’s a simple tactic of out-sourcing. Later, Doughty Hanson will encourage the acquired company to hire business experts to help during restructuring, to re-engineer production processes or to resolve stock-control problems. It doesn’t make financial sense to have big in-house teams for all this.

Less graft, more gain

But the burden of work for those inside the firm is considerable. Meanwhile Nigel Doughty, and even Richard Hanson, do much less of the grafting deal work than before. Also the two must be very rich by now. Even just the 2% management fees on the new $2.5 billion fund comes out at $50 million, some of which will be eaten up in the running costs of the partnership, but most of which the partners will share – with a heavy weighting towards Doughty and Hanson. Then there’s the carry on earlier investments. Say they manage to treble the equity invested in the last Dm1 billion fund, that would leave the firm with 20% of Dm2 billion, or the best part of Dm400 million, again with the two main men taking the biggest cut. It’s partly because of such guesstimates about their wealth that they seek a low public profile. “They still want to be able to go to the pub with their mates,” says a source close to the firm.

As to the chances of others leaving, it might be no more than a mischievous rumour. Five of the nine Doughty Hanson partners have been together a dozen years since their time at Standard Chartered financing medium-sized UK management buy-outs. And the unusual manner in which partners’ money is co-invested in the funds along with the contributions of outside investors would tend to tie partners in for the long haul. The long-term strategy is to roll out a series of funds, each with a five-year draw-down and 10-year life. Partners will put some of their money into each and, the theory goes, the firm should develop a culture rather like that of Goldman Sachs, where partners hardly ever leave, but only retire and take their money out slowly.

A substantial part of the wealth the partners gained on deals like Tag Heuer will now be placed in the new fund. And staying around to see that huge new fund invested must be an intriguing prospect.