Albion Venture Capital VCT Blog number 2

Albion want to change the performance fee from the current arrangement (1.9% management fee, plus 8% of returns over a hurdle rate of 5% per annum with a high-water mark) to 20% of returns above a hurdle of RPI +2%p.a., from a new starting point of NAV at 1 April 2019.

ShareSoc recommends shareholders vote against this proposal and other resolutions at the AGM on 21 August. 1.9% plus 20% is egregious, particularly when:

1. it represents an increase from historically agreed arrangements and
2. it is accompanied by the rebasing of the current high-water mark to current NAV (effectively a forgiveness of historical under-performance, in favour of the manager).

For previous comments and blogs see https://www.sharesoc.org/blog/vcts/albion-yet-another-vct-problem-case/

Background

ShareSoc VCT investor group member Tim Grattan and Cliff Weight met with Albion Capital Group Chairman Patrick Reeve and Albion Managing Partner Will Fraser-Allen, at their request. Albion Capital wanted to present their point of view. We met them on the 30^th July in their new office (smart, looks efficient but not unduly expensive) at 1 Benjamin Street. We had a very pleasant meeting, with each of us listening carefully to others’ points of view, even though we did not agree on every point.

Albion Capital have a desire to harmonise the management and performance fees in the six VCTs which are in their stable. These include:

Albion Venture Capital,

Kings Arms Yard,

Albion Technology and General,

Albion Development,

Albion Enterprise and

Crown Place.

They also manage Albion Community Power and Albion Care Communities and, an investment management subsidiary called OLIM investment managers. Patrick explained the desire to move to a common approach of 20% performance fee sharing above a threshold of RPI +2%. In fairly recent times (2013), Kings Arms Yard shareholders approved a performance fee of 15% share above a threshold of RPI +2%. Kings Arms has a 2% management fee and the AIC ongoing charge was 2.43%, and 3.37% if the performance fee is included, according to be AIC site, for the year end 31 December 2018 see https://www.theaic.co.uk/companydata/60074/gearing.

Albion Development changed their fee earlier this year, it was already a 20% share, but they lowered the hurdle and the annual escalator, but at least there was a some sort of quid pro quo with the cap being lowered to below the historical running cost. Even so, 13% of shareholders voted against.

The VCT legislation has changed, requiring VCTs to have more early-stage investments and higher risk ones. Albion Capital Group has decided to focus on technology. So, as the various VCTs exit existing investments they will be reinvested in technology investments. They expect all funds to transition over time to a focus on technology type investments. Some funds are more advanced in this than others, e.g. Albion Tech and General and, Albion Enterprise.

However, Albion Venture Capital has more mature investments and less cash inflows from selling investments,  so has fewer funds to invest than some of the others and so will be slower to transition, as it was the only one of the 6 that was 100% asset backed when the rules changed. Nevertheless, Albion want to introduce a performance fee which is likely to payout. The current arrangement of 8% above a threshold of 5% is being proposed to be changed to 20% above the threshold of RPI +2% (which at the current levels of RPI will be a threshold of about 4.6%, i.e. less than 5%).

The current hurdle is way underwater and unlikely to be hit for many years if ever. Hence rebasing the hurdle and setting it at a lower level will generate significantly more fees for Albion Capital over the coming years. The shareholders’ circular fails to point this out.

Albion Capital are also hoping to bring together all of the VCTs’ performance fees to be linked to RPI +2% and not a fixed figure nor, as it some cases at present, to base rate plus X percent.

Patrick made the point that all funds have the same investment strategy, although they invest differently depending on their available cash.

It is expected with the new investment strategy that investments will become higher risk, but this will be less so with Albion Venture Capital in its transition phase and we can expect a steady but not exceptional performance. It is noted that performance since 1996 was on average 6.5%p.a., and only 5.3%p.a. since 2009. It is unlikely that the new performance fee will generate large amounts of fees. This is very different to for example the Persimmon type plan which started from a very low base, see https://www.sharesoc.org/blog/remuneration/persimmon-2018-agm-voting-recommendations/. It was stressed that Albion Venture Capital’s net asset values are independently valued and because of the nature of investments highly unlikely to generate significant increases in the short-term.

Although the disclosures say that the investment manager is entitled to up to a 2% fee, of the value of a new investment, this fee this is not achieved in practice. Increasingly, the marketplace is becoming more competitive and such charges are less easy to levy. It is therefore important to note that, because of this, the amount of fees which will be received by Albion will decrease (because fees for new investments will decrease), unless the performance fees are paid out.

A central element of the change from the perspective of the company is the rebasing of the current high water mark: the base level for the performance fee is being reset. This is in reality no different to executives resetting the strike price on stock options due to underperformance. We strongly object when directors reload in that way, and we do so here also. This element is only obliquely mentioned in the circular, and in our view this is misleading and intransparent drafting by the company.

A simple model of the potential payments at different levels of performance would illustrate the impact on returns to shareholders and we suggested (and this was accepted by Albion) that their communications would have been better had this type of disclosure had been included. However, they did indicate, that with the FCA having to clear all documentation, it is easier to follow a boilerplate approach and it is certainly cheaper to do so. We acknowledged the difficulties that the FCA cause.

The simple model below is illustrative and may not be exactly correct. It assumes the old threshold is not achieved.

With nearly £500 million of venture capital funds under management, with their management fee of about 2%, plus £450 million of OLIM AUM with about 0.5% fees, the total income for Albion is about £12 million p.a. (this is my guess. As Albion is a LLP and not a company, it is not possible to get turnover and profits data from Companies House), plus on top of this there may/will be performance fees.

My benchmark data suggests that

1. the management fees for private equity and venture capital firms should be less than 2% and
2. for the performance fee, the share should be less than 20% and
3. the threshold for payout should be 7% or 8%.

It is also the case that the Board of Kings Arms managed to negotiate a 15% share for their VCT.

Two examples of other well known VCTs in which I invest are:

Baronsmead Second Venture Trust, which has an 8% threshold and 10% share;

Northern Venture Trust, which has a 7% hurdle and 15% share.

The new norm in the hedge fund world is 1.5% plus 15% (with a high water mark) with anything above that available only to stellar managers, and I would expect the same to apply to VCT managers.

Hence, I think the board of Albion Venture Capital should also be able to negotiate a 15% or lower share performance incentive. I would also prefer a higher hurdle and/or lower management fees than the current 1.9 %.

ShareSoc Voting Recommendations

ShareSoc think all shareholders should vote against the Albion Venture Capital directors re-election (resolutions 3 and 4) at the Annual General meeting which will be held immediately before the General Meeting on August 21^st. The reason for this is the Directors have not negotiated a good enough deal with the investment manager.

In addition, shareholders should vote against the resolutions to allow Albion Venture Capital to raise additional capital (resolutions 7 and 8).This will affect the manager, costing them circa £100K /annum for every £5M they would have raised in top up offers in Albion Venture Capital. So, voting against resolutions 7 and 8 will be punitive to the investment manager Albion Capital and strongly indicatethe concerns of shareholders about Albion Capital receiving such a large share of the rewards. We must not forget that any management and performance fees that go to the investment manager could alternatively go to shareholders.

Shareholders should also vote against the changes to the Management Agreement.

The one proviso about this is the need to be able to retain good managers and to attract other good managers in the future. We were told that they have recently made some good new hires, and these new people expect to participate in performance fees. However, the shareholders circular has failed to make a convincing argument of the need for this increase in performance fees to the proposed levels at Albion Venture Capital.

One final point, which is positive, is that Patrick and I agreed it would have been better if Albion had engaged earlier and we would both like to do so in future. Early engagement of potentially contentious points enables a better and more informed decision making process.

Disclosure and Disclaimer

I own shares in Albion Venture Capital VCT and Kings Arms VCT. My and ShareSoc’s views and should not be regarded as advice. Shareholders should either make their personal decision or seek professional advice.

Cliff Weight

Director, ShareSoc