A moving hard cap is an oxymoron. A manager decides on an absolute upper limit to its fund size… and then decides to move it upwards as more capital becomes available – leaving LPs less than impressed.
Oversubscription has become a common ‘problem’ in the modern fundraising environment. In 2015, the total capital raised across all private equity funds was $409 billion. The stated target for all those funds combined when they launched was just $340 billion. That’s nearly $70 billion of excess demand reported by happy general partners, and the trend is continuing.
Raising commitments of exactly the right amount is no mean feat. “Landing on the hard-cap is like landing a helicopter on a sixpence; you do what you can to pilot it in the right direction, but there is always a chance that you will be blown slightly off course just before landing,” says Janet Brooks, a partner with placement agent Monument Group.
There has to be some adjustment when it comes to the final close. But if the hard-cap cannot go up, commitments must come down.
Unfortunately, there is no standard way of ‘scaling back’ commitments.
“I don’t think there is a GP out there that has an orderly and structured way of dealing with it,” says a European LP.
The process can range from a pro rata reduction of each limited partner’s allocation – which would seem to be the fairest way – to a fairly arbitrary cull of one or two individual LPs.
One placement agent says the management of an oversubscribed fund is their least favorite scenario, recalling a situation in which the GP identified two LPs that they wanted to cull to remain within the hard-cap. The reason for selecting these LPs was not, to the agent, particularly reasonable, and yet they had to make the call to explain why there was no longer space for them.
A reduced commitment to a fund – or one that is cut in its entirety – can cause professional embarrassment for the individual at the LP, who will have invested time and money on due diligence and pitched it to the investment committee. In what is still a ‘people business,’ it can also cause genuine personal offense.
LPs have their own part to play. Some will try to ‘game’ the process by proposing a commitment of twice the size of the one they intend to make. However, as Billy Gilmore, an LP at Aberdeen Asset Management, notes: “You cannot get away with that for long – if it goes wrong a couple of times you will get found out.”
Landing that helicopter on that hard-cap sixpence is more art than science, say fundraisers. Assessing demand is based on early communication with existing investors, says the head of investor relations for a global private equity firm. “From at least 12 months ahead of time you are trying to establish how much new intent you should be working on versus how much demand there will be from existing investors.”
While an oversubscribed fund is a badge of honor, it is a challenge to manage well. GPs should tread carefully.