Look before you leap | Intermediate Capital Group (ICG)
ICG’s first direct lending fund proved so successful, the firm went back to investors to raise its hard cap from €1.5 billion to €1.7 billion.
“We still had a number of clients that were already well progressed in due diligence,” says Max Mitchell, director of credit fund management at ICG. “We wanted to reward people for having done the work and so instead of scaling people back or cherry-picking between them. We chose to extend the hard cap.”
Mitchell is also quick to point out that most of the hard fundraising work was done well in advance of the first close, meaning in part talking to investors about their appetite for a direct lending fund, including questions about what they sees as the pros and cons of the strategy.
In fact, preparation proved key here: a lot of ICG’s time was spent educating investors about private debt vehicles, and even helping some gain internal approvals to commit capital to the space, says Mitchell.
These types of discussions also gave ICG a better idea of where to fundraise. “There was a lot of negative noise around Europe [when we stated fundraising], which put off a lot of North American investors,” says Mitchell, who adds Asian investors didn’t share similar reservations.
ICG also pumped more resources into its marketing team prior to fundraising, mostly in order to have local people in new markets that could speak the same language and share cultural ties with prospective investors. Mitchell says this strategy proved especially fruitful in Korea, for instance, where they added a Seoul-based colleague.
Having someone familiar with a new local market is also a big plus in responding to LPs’ due diligence questions. Mitchell says LPs of different geographical backgrounds tend to have different styles and approaches when vetting fund managers. For instance, a lot of Asian investors rely on extensive questionnaires for the majority of their due diligence while others prefer a meeting format, asking questions live and seeing their raw responses.
When it comes to what matters most in the LP selection process, Mitchell found that fund terms seemed to be less important than team stability. Nonetheless ICG did find it worthwhile to offer ‘early bird’ and ‘big bird’ discounts to investors.
“People who are going out of their way to support our funds and get in on the first close, and people who give us significant amounts of money, especially across multiple funds, get the best economics available,” says Mitchell.
In all, these strategies proved especially useful for a strategy not every LP is intimately familiar with like debt.
Framing the numbers | Ardian (formerly AXA Private Equity)
Track record proved key when Adrian raised $9 billion for its sixth secondaries vehicle in just six months, according to Olivier Decanniere, head of the firm’s London office and a senior managing director in the secondaries team.
The firm, which had a re-up rate of close to 100 percent, attracted major institutional investors including pension funds, government agencies and family offices.
But what’s the best way to present something that can be as complicated as track record? Decanniere says Ardian likes to give LPs sufficient data to analyze its performance on their own, as well as walking them through some specific deals. He says many investors are quite numerical and want to analyze data and run their own risk modelling.
One European fund of funds manager agrees, suggesting that LPs like to take this data dive to see how much the duds in the portfolio have affected returns, even for a fund that generated a strong outcome.
“When you start getting into the 20-30 percent loss ratio – and funds can still perform very well within that – you start to question what the repeatability of the process is.”
Perhaps surprisingly, the fund of funds manager says he’s actually nervous about committing with GPs that never lost a deal. “If you think about it, at some point they always will lose money. So if they haven’t lost money to date, the risk is the fund you invest in will.” Too much success breeds arrogance, is his logic.
Another important factor in Ardian’s ability to raise capital was having a few big name LPs in their corner and a high re-up rate, says Decanniere. In fact having a well-known LP with a strong reputation in your fund can mean other LPs are less brutal in their own due diligence, he continues.
“Not all investors ask to see the support functions. It’s mainly the largest investors deploying large commitments above $100 million that want to have access to the compliance officer or finance department, for instance. We arrange shorter meetings or sessions of 30 minutes to an hour for this.”
However, one thing all LPs seem to want to do is secure access to co-investments, says Deacanniere. In fact, some LPs will strike a GP off their list if it can’t provide large co-investment opportunities on a regular basis, he adds.
As one would expect, Deacanniere also discovered that LPs want to talk a lot about market timing, especially when the fund is pursuing a specialist strategy like secondaries.
“They [LPs] want to understand your view on the market, your deal flow, and ensure that if they give you a commitment you can put cash to work and deploy the money in good conditions,” says Decanniere. On the other hand, it seems that LPs are also concerned about hot sectors that might attract new rivals, meaning GPs need to be able to describe their competitive advantage.
Fresh options | Bain Capital
For years, Bain has been one of the few outliers to the prevailing 2-and-20 model, charging 2-and-30 instead – and with some success, given that it raised five funds this way. This time round, however, to hit a $6 billion target for its first flagship offering post-crisis, and in light of changing fundraising conditions, Bain found it valuable to tweak the terms for its Fund XI, says Michael Ward, Bain Capital’s investor relations head, chief operating officer and chief financial officer.
Specifically, Bain decided to offer LPs three options: a 1.5 percent management fee with 20 percent carry and a 7 percent preferred return, a 1 percent management fee with 30 percent carry and a 7 percent preferred return, or a 0.5 percent management fee with 30 percent carry and no preferred return.
Bain landed on the three “pricing sleeves” after consultation with the firm’s advisory board and other existing investors. The aim was to give LPs the option of investing at what was perceived to be the market standard for a buyout fund of Bain’s size, while also giving them the option of a fee trade-off in order to keep Bain’s historic 30 percent carry.
Did the strategy work? Most of Bain’s LPs selected the option closest to “market terms”, and Ward puts this down to internal pressures on certain LPs.
As such, this type of fee innovation may have limited pull on investors, fund formation lawyers tell pfm. “Investors don’t generally select a fund because it has lower-than-market fees, so GPs don’t generally have anything to gain by lowering [them],” said Ed Hall, a partner at King & Wood Mallesons SJ Berwin, in a recent interview.
So what did work for Bain? Aside from the obvious factors like performance and talent, Ward says allowing existing LPs to act as references to new investors is an advantage. The same holds true for portfolio company executives, and maybe even new hires or recently departed partners, assuming what they have to say is positive.
One placement agent told pfm it’s even becoming more common now for LPs to follow up on at least 30 references provided by a single fund advisor, whereas in the past it was typically only around 10-12.
With nearly a quarter of Bain’s capital coming from new investors in fund XI, Bain also successfully overcame the challenge of more onsite due diligence from curious LPs. Ward says investors now want to see how financial reporting is put together, as well as valuation methodologies, organization structure, what technology is being used, cybersecurity, the compliance department, and many other things. This meant Bain needed to have its chief information officer, general counsel, head of compliance, and Ward available to meet LP demands.
Junior staff are coming into the mix too. Ward says this is a way for LPs to test whether the message from senior management is being heard and followed. “We gave [LPs] time privately to sit down with associates and analysts as well as VPs and principals – and that was helpful,” says Ward.
Some LPs are even using a strategy where they have their own junior-level folk speak to their counterparts at the GP’s organization, mostly as a way of getting the junior private fund professionals to open up more.
“It is probably not appropriate for me to talk to an analyst at a private equity firm. They wouldn’t open up to me…but they might to one of our analysts to find out what is going on at the firm,” says one senior US fund of funds manager.
Considering Bain’s latest fundraising feat, that seems a request they’d be willing to accommodate.