Gen2 Partners, a $500 million alternative house focused on funds of funds, has moved to expand its private equity business via a partnership with China Private Equity Investment (CPE).

Managing partner Barry Lau tells AsianInvestor that while Gen2 has a track record with its own private financing business focused on providing mezzanine capital to small to medium-sized enterprises in China, the tie-up with London-listed CPE opens up the prospect of co-investing in PE opportunities through a future asset injection.

Under a memorandum of understanding signed between the parties, Gen2 will serve as a consultant to CPE advising on investment opportunities in private financing deals.

Gen2 will have a three-year option to buy “over 750,000 shares” in CPE at a 36% discount to its prevailing net asset value at the time of entering into the MoU. Further, it will receive fees for introducing CPE to other business opportunities.

While the option is only equivalent to 1% of CPE’s enlarged share capital, senior management of both parties expect this to increase since CPE – being a listed, open-ended PE fund – is free to issue new shares to Gen2 if they are keen to co-invest in a company.

According to a statement issued by CPE last week: “It is likely that CPE will acquire certain assets from the Gen2 portfolio for a [sum] that could comprise cash and/or ordinary shares in CPE.”

Lau adds: “On a reversed basis, through the partnership we would be able to bring some equity investment opportunities to CPE, as we have always relied on our own asset management and risk-monitoring capabilities on-the-ground in China to identify our targeted investments.”

He was referring to the firm’s private financing business, which provides mezzanine capital to Chinese SMEs in sectors that are often short of bank lending, such as real estate and pharmaceuticals.

Lau, a Gen2 co-founder with Paul Heffner, adds that the firm is raising capital for a second China-focused mezzanine PE fund – Gen2 Capital Partners Fund II (subsequently changed to Greater China Credit Fund) – targeting $200 million in AUM for a seven-year lock-up.

Duncan Chui, CEP chief investment officer, says that it could seek to diversify its source of investor capital by marketing to Gen2’s wider investor base that may want a shorter lockup than a closed-end fund but is seeking a higher risk and return profile through a purely private equity investment.

Typically holders of mezzanine debt would be subordinated to other senior creditors for repayment in the event of a default, but rank above common equity holders.

Chui notes that while both CPE and Gen2 run private equity funds, CPE’s approach is different. Gen2 looks for companies with proven cashflow and track record, while CPE looks more closely at the longer-term growth prospects of targets before investing into that firm’s equity. CPE focuses on financial services and telecoms, media and technology (TMT).

While Gen2 Partners advises firms it has invested in on business strategy and management issues and often its managers sit on their boards, to date it has not taken an equity stake in any Chinese companies it has invested in.