According to figures from PEI’s Research & Analytics team, private equity managers collected about $420 billion in commitments last year. That’s almost 40 percent up on the 2012 total, and represents the highest annual figure since the good old days of 2008.
But market sources say fundraising is still far more challenging relative to the industry’s golden years. Of course there are a few well-known reasons for this: investors have become more sophisticated negotiators; regulators are placing more scrutiny on the marketing process and the fundraising trail has simply gotten more crowded.
But a lesser known factor may be that GPs are losing commitments by not properly understanding LPs’ investment processes, say placement agents, LPs, funds lawyers and other various market sources.
The common scenario is for the GP – often represented by the investor relations team – to have a great introductory meeting with a potential investor and leave thinking that a commitment is all but sealed. Often times the LP is nowhere near ready to commit just yet, but the message sent back to headquarters is that the bank or pension plan is ready to pull the trigger on a $50 million pledge.
Sources point to two complementary forces that are shaping this trend. One, some GPs are doing whatever they can to leave LP meetings on friendly terms, even if that means tough conversations around certain fund terms are left for later.
“This is absolutely prevalent in the market, simply because you have GPs who for the most part are just incredibly keen to get a positive answer or sign, any sign, that the LPs are interested,” says Warren Hibbert, a founder of placement agent Asante.
And two, picky investors want as long as possible before they have to provide someone a firm answer on the fund opportunity. Taken together, initial meetings then are ending on warm fuzzy feelings that leave the door open for a fund manager to believe a commitment is in reach as long as some careful negotiation work is completed later.
“Some GPs ask the difficult questions, others don’t,” says one US-based fund of funds manager. “And GPs hoping to raise subsequent funds will not want to push too hard in case of being turned down – not just for this fund, but in wanting to keep relationships alive for other successor funds.”
One strategy to avoid this scenario is to gain a detailed understanding of an LP’s investment process. For many LPs, the commitment process entails a preliminary review, a preliminary approval, a final review and a final approval. “Always know what the next stage is before a commitment is finalized,” says one US placement agent. “Maybe that’s an onsite visit with the GP, or another conference call to discuss what terms the LP considers must-have items.”
Expanding on that approach, Probitas Partners managing director Kelly DePonte says GPs should also know who an investor’s key decision-makers are. “They’ll know when you can anticipate receiving a formal approval. And if a formal approval is received, whether or not there will be any further negotiation or documentation.”
Of course different institutional investors will have different commitment processes, adds DePonte. For instance family offices tend to have the ability to make ad-hoc decisions fairly quickly. In comparison some public pension plans may only have the ability to write checks during a monthly or even quarterly meeting.
PEOPLE POWER
Another fundraising challenge is that LPs are constantly chopping and changing their investment staff. “There is a lot of LP turnover and it is easy for a GP to get lost in where exactly they are in the process,” observes a second US-based placement agent.
Moreover a change in who the key contact is at the LP, or a prominent member of the investment committee, means their replacement may want to do things differently. Things like level of due diligence, which fund terms are considered acceptable and how the operation is run are all susceptible to change when new leadership or key personnel is put in place. In the end, that may create the need for more relationship building.
“When you have someone that’s been with the LP for a long time (i.e., they know its internal processes, how things work and has a long-standing and straightforward relationship with the GP), they can be honest about a fund’s chances of receiving a commitment and when it might happen,” the second US placement agent said. “But a new LP who is still finding his or her feet may not know that the committee stage is no longer a rubber-stamp and so tells the GP it’s a formality – but in reality the commitment may be far from complete.”
PAST THE POST
Indeed more commitments reaching the final stages of approval are being rejected now – something that was relatively rare prior to the crisis.
“This is in part because LPs have been more demanding about governance and other legal terms,” says Roger Singer, a fund formation partner at Clifford Chance.
Issues around regulation, tax, environmental, social and governance (ESG) factors that people didn’t think about before are becoming important parts of the investor’s process; and those things can cause commitments not to happen, adds Adam Turtle, founding partner of placement agent Rede Partners.
“If I think of a fund we have just raised, we had to do ten operational due diligence questionnaires and ten ESG questionnaires, neither of which existed before. Maybe they asked a question or two but not at this level,” he says. “LPs are trying to get their heads around this and still figuring out what the need from managers, as it is all new.”
But with a private fund manager’s business being as much about raising capital as investing it, paying attention to the details when negotiating with investors is sure to pay dividends.
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