Sept. 29 (Bloomberg) -- Dominique Megret, chief executive officer of PAI Partners, France’s biggest private-equity firm, was in his office, a 10-minute walk from Paris’s Louvre museum, on July 21 when there was a knock on the door.

Lionel Zinsou, who joined PAI Partners from Rothschild a year ago, and partners Raffaele Vitale, based in Milan, and Ricardo de Serdio, from Madrid, walked in and said they and three others would resign from the nine-member investment committee unless Megret gave them more power in running the firm, people familiar with the discussions said. The threat infuriated Megret, said the people who declined to be identified because the meeting was private.

“You’re being manipulated,” Megret, 62, said after hearing their grievances, according to the people. The demands are “absurd,” he said.

Ten days later, PAI’s partners named Zinsou CEO, forcing out Megret and his designated successor, Bertrand Meunier, 53, who had been there for 27 years. The pair have since told investors they were victims of a “coup d’etat” by Zinsou and other partners backed by the firm’s biggest investor and former parent, BNP Paribas SA, said people familiar with the matter.

Now Zinsou, 54, a former Groupe Danone SA executive who hasn’t led any private-equity investments, needs to convince PAI’s investors the new management can still run continental Europe’s largest private-equity fund.

Spokesmen for Zinsou, Megret and Meunier all declined to comment for this story. Pascal Henisse, a spokesman for Paris- based BNP Paribas, also declined to comment.

Fewer Transactions

The revolt shows how private-equity executives are feuding over power, money and strategy after the credit crisis shut off the debt financing used to make acquisitions. LBO firms have announced about $50 billion of transactions this year, a 73 percent drop from the same period a year earlier, according to data compiled by Bloomberg.

Megret’s exit follows the departure this month of Jon Moulton from Alchemy Partners LLP, the London-based firm he founded 12 years ago, after a dispute over investment strategy, and Colin Buffin, a senior managing partner who worked at London-based Candover Investments Plc for 24 years.

“We’re going to see a changing of the guard” at LBO firms, Jonny Maxwell, global head of private-equity funds of funds at Munich-based Allianz SE, said on a conference panel in Monte Carlo Sept. 16. “We’ll then have to revisit whether or not the team underneath is the team we want to support going forward.”

Allianz is an investor in PAI’s 5.4 billion-euro ($8 billion) fund raised last year, according to three people familiar with the matter. Maxwell declined to comment on PAI.

Key-Man Clause

The departures of Megret and Meunier, who in their more than two-decade careers at PAI led the takeovers of Yoplait yogurts and United Biscuits, the maker of Jaffa Cakes, triggered a so-called key-man clause, enabling investors to opt out of PAI’s latest fund. Any cut in pledges requires the support of investors owning more than 80 percent of the fund, according to two people familiar with the matter.

Zinsou, who was recruited in July 2008 to become co-CEO with Meunier after Megret’s scheduled retirement in 2013, had to halt new investments for six months and offered the firm’s 150 investors the chance to cut the size of the fund by about 40 percent to win support for the new team.

PAI will meet with investors in Europe, the U.S. and Asia, starting today in Paris, and will ask for a decision on the proposed reduction by the end of November, one investor said.

“It’s in the firm’s best interest to listen to the demands of its investors,” Zinsou said in a Sept. 9 telephone interview. “The leveraged-buyout market has shrunk. It’s going to take more time to deploy capital.”

Funds Reduced

In doing so, PAI would follow London-based rival Permira Advisers LLP and Fort Worth, Texas-based TPG Inc. in decreasing the size of their funds as buyouts dry up. Permira last year reduced its 11.1 billion-euro fund raised in 2006 to about 9.6 billion euros while David Bonderman’s TPG let investors cut commitments by as much as 10 percent.

“These management shakeups reflect how private-equity firms are trying to figure out a way forward in a difficult environment,” Mike Wright, a professor specializing in private equity at the Nottingham University Business School, said in an interview. “Firms need to recalibrate their model. One has not seen the end of the troubles yet.”

Amaury-Daniel de Seze, PAI’s former chairman and CEO who chose Megret to succeed him in 2006, will return as chairman in 2010 to help Zinsou regain investors’ confidence, PAI said in August.

Investors Concerned

Still, some investors, including Canada Pension Plan Investment Board, PAI’s second-biggest backer, are voicing concern about the new management and are seeking better terms such as lower fees, according to people familiar with the matter who declined to be identified because the talks are private. Other PAI backers, including New York-based JPMorgan Chase & Co., simply want their money back, people familiar with the matter said. CPP Investment spokeswoman May Chong and Jane Drew, spokeswoman for JP Morgan Asset Management, declined to comment.

Under Megret’s leadership as Seze’s deputy and then chairman and CEO from 2007, PAI raised $10.6 billion in four funds from 1999 to 2008, more money than any private-equity firm in continental Europe. It also had some of the highest returns.

The firm’s 1.8-billion-euro fund raised in 2001 “should be delivering 40 percent” in annual returns, Megret was quoted as saying in an interview with French business daily Les Echos in June. A 2.7 billion-euro fund raised in 2005 and invested at the peak of the LBO market is still showing a positive return, Megret also said. This compares with an industry average of 25 percent from 2003 to 2008, according to research firm Preqin Ltd.

PAI Expands

Started as a unit of Paribas SA, France’s biggest merchant bank, Paribas Affaires Industrielles led the 610 million-euro buyout of Danone’s pasta and condiment unit in 1997, then the country’s largest leveraged buyout. Zinsou advised PAI on the deal as a Rothschild banker.

After spinning out from BNP Paribas in 2000, PAI expanded, opening offices in Copenhagen and Munich, and completing deals in Germany and Scandinavia. It targeted companies worth more than 500 million euros, and by the height of the LBO boom in 2008 owned stakes in firms such as Cortefiel SA, the Madrid- based clothing chain, and Paris-based computer-services company Atos Origin SA.

Then the leveraged-buyout bubble burst. As the economy slowed, some PAI companies struggled to meet their covenants and interest payments on the debt used to finance their acquisition.

Investment Losses

In July, PAI was forced to cede control of German roof-tile maker Monier Group GmbH to lenders, including BNP Paribas and New York-based Apollo Management LP. The firm wrote down the value of its 256 million-euro investment to zero.

The firm also wrote off its investment in French home developer Kaufman & Broad SA, bought for 1.4 billion euros in 2007 at the top of France’s real-estate boom. And it lost its stake in Italian espresso-machine maker Saeco International group SpA after selling it to Amsterdam-based Royal Philips Electronics NV for 170 million euros to pay down debt.

After Megret’s ouster, PAI’s 20 largest backers gathered on Sept. 10 in the Grand Hotel InterContinental on Place de l’Opera in the heart of the French capital to assess the damage. For six hours, representatives of investors, including CPP Investment Board, New York Life Insurance Co., French insurer AXA SA and BNP Paribas, quizzed Megret and Meunier, then Zinsou and the rest of the partners, according to people at the meeting.

Officials at BNP Paribas, AXA, New York Life and CPP Investment Board declined to comment.

Internal Discord

The Monier debt restructuring emphasized tensions among partners and some of them started complaining about the way the firm was run, investors were told by Megret and Zinsou, according to the people. As dissension built inside PAI, Zinsou distanced himself from the firm’s daily operation and considered leaving, according to people familiar with the matter.

The discovery that Megret and Meunier had created a joint company holding their PAI shares was perceived by some partners as an attempt to secure control of the partnership and acted as another catalyst for the crisis, they told investors. Megret and Meunier, who controlled more than half of PAI’s shares, said the holding company was created for tax reasons only and was unwound in August, according to the people with knowledge of the discussions with investors.

Megret and Meunier agreed to step down after they received indications that BNP Paribas, France’s largest bank and whose headquarters are located about 300 feet away from PAI’s offices, favored the change, the two executives told the other investors, according to the people. They will leave the firm in January.

Shakeups Disruptive

Management shakeups are disruptive and may result in the demise of some firms, Rhonda Ryan, head of the private-equity funds group at AIG Investments, said in a speech during a conference in Monaco this month.

She didn’t specifically refer to PAI and declined to comment for the story. AIG is an investor in PAI’s latest fund and sits on its advisory committee, according to people familiar with the matter.

“Some firms have raised their last fund,” Ryan said in her speech.

To contact the reporter on this story: Anne-Sylvaine Chassany in Paris at achassany@bloomberg.net

Last Updated: September 28, 2009 19:01 EDT