When an important deadline is looming, it can feel like time is speeding up. Many GPs are experiencing that sensation right now, as funds that were launched amid the booming private equity deals of 2007 are struggling to meet their targets by the stipulated deadline.
As 2008 nears a close the evidence of a slowdown continues to pile up. Funds tied to Kohlberg Kravis Roberts and Fortress Group reportedly have been on longer than expected road shows, while firms like The Blackstone Group and Madison Dearborn Partners have reportedly encountered delays in raising capital for recent funds.
“Fundraising is slowing down by the month and it's likely to get worse over the coming months,” says Andrew Sealey, managing partner of London-based placement and secondary advisory firm Campbell Lutyens. “Closing money at the moment is very difficult … [investors] are deferring decisions until there is more clarity in the market.”
Most partnership agreements stipulate that the GPs have up to a year from a first closing to hold the final closing. GPs that at one time had little trouble meeting such deadlines – or even closing within only a few months – are scrambling to close on time in today's challenging and competitive market. Funds are now taking an average of 14 months to close, more than twice as long as in 2004, in part due to the fact that many GPs are seeking to extend their fundraising periods by an additional quarter in order to squeeze out a few more precious investment commitments.
“Almost all of the non-institutional sponsors and even some of the institutional sponsors we represent have asked their LPs and discussed with us extending that one-year period, often by three months or four months,” said Roger Singer, a partner in the New York office of law firm Clifford Chance.
So if GPs are seeking to raise a $1 billion fund but only have $300 million or $400 million by the tenth or eleventh month of fundraising, what are their options? According to Kevin Scanlan, managing partner with New York-based international law firm Dechert, the typical route for seeking an extension in the offering period is by either getting approval from a majority of LPs, sometimes two-thirds or even just more than 50 percent, or going through an advisory committee composed of a select few representatives and big investors.
Often GPs will go to their investors for an extension if they have identified a likely investor within a year of the first close, but for whatever reason cannot secure the funds until later. Such difficulties are especially common around this period because of the year-end effect that kicks in around late October or November. During that time many GPs come across investors want to put money in but are already over-allocated and need to keep the fund waiting for another one or two quarters until the next budget period, according to Antoine Drean, founder and chairman of Paris-based placement firm Triago.
In cases where an investment is likely to be made but cannot be secured for another few months, Singer says the LPs will have little problem approving another 90-day period as long as it's just a matter of finishing up the paperwork and signing the necessary documents. However, they will be less understanding, especially in the current market, if a GP wants to continue traveling around the world in the hope that a few extra months will allow him to hit a potential jackpot.
“Clearly some [sponsors] just need a bit more time to convince someone who is on the fence but a good possibility,” Sealey says. “But to go out and try and find new investors now is going to be difficult and conversion rates are going to be very low.”
If GPs have weighed their options and decided that an extension is in the best interest of the fund, the best way to make their case is to stress that the fund isn't large enough to follow the investment strategy, it is too concentrated and undiversified, it won't have enough market clout and it won't have the funds to pay its management team.
Singer says GPs seeking more time are seeing little pushback from investors right now. “Investors don't want to be in a $300 million fund if they thought they were going to be in a $600 million fund,” he says. “They want the fund to be larger and diversified and they understand that this is not about the sponsors trying to game them somehow.”
However, the longer the GPs need to be on the road searching for more funding the more concerns this creates for investors who have already put in their money. One of the biggest problems LPs have regarding long road shows is the cost not only in expenses such as travel, promotion and lawyers fees, but in the time the GP's focus is on matters other than making a profit for the LPs.
“People definitely want the GP's full time and attention after a certain point on the investment strategy and they don't want him marketing forever,” Scanlan says. “Maybe there are great opportunities in the market right now, but he's not going to see them because he's spending so much time on the marketing front.”
Investors who have already committed also don't like the idea of someone being able to monitor the investments that have been made and potentially coming aboard on the fifteenth month and paying some negligible amount of interest on what has turned into a valuable asset.
This slowdown is likely to continue for the foreseeable future, as more funds delay their initial closings until enough money is raised to run the appropriate investment strategy.
Alternatively, GPs may also have to hold first closings smaller than originally targeted if an investor wants to come in immediately. Back in 2007 losing a couple of months wouldn't cost a fund as much, but today both the GPs and LPs might regret such a decision down the road.
While such considerations may be giving more LPs pause, they have little recourse if a GP is fundraising for longer than they think is necessary. Scanlan says that many partnership agreements do not provide for a termination of the commitment period unless there is a key-man event or the GP is shown to have committed a bad act.
In a worst-case scenario a GP could have to deal with requirements that force him to give back any unfunded commitments if he is unable to raise a certain amount of money by the one-year anniversary of the initial close. However, Scanlan says he has yet to witness such a drastic “hardwire shutdown” of a fund.
“That would be a pretty hard pill for the GP to swallow,” he said, adding that such demands could backfire by leading to lower targets and less ambitious investment objectives from sponsors in the future.
In any event, a slightly longer road show is going to be something LPs will have to live with for a while. But Drean says the patience of the LPs may start to wear thin if GPs keep coming back for extensions.
“They should be worried quite quickly,” he said. “In today's market another three months may be reasonable, another three after that is probably less reasonable, and after that it becomes I guess impossible. What [the LPs] don't like is to see their GPs run around looking for money when they should be putting what they have to work.”
That is why even if GPs have a good reason to seek an extension they should take care in how they go about asking for one. While a sponsor doesn't have to go to all the LPs to get an extension approved, putting a decision into the hands of just a few people can alienate the rest of the investors. So even after consulting with an advisory committee, sponsors should ensure that as many investors as possible feel like they've had their concerns addressed.
“ [The GPs] should ask everybody their opinion, let them feel included,” Singer said. “An important aspect of any vote is remembering that it is not only about what you can do legally, but continuing to have good investor relations. Because in lots of funds, although individually you may not care about the small investors, if you lose most $10 million to $20 million investors most funds are going to regret that.”
For his part Drean says that in the near term extending their fundraising drives may not be the right answer for many GPs anyway, as those that stay longer on the road may find themselves spending too much chasing after too little. Instead they should consider closing their current funds as close to their target as possible and waiting for conditions to improve before the next go-round.
“In today's market it is probably better just to close, take the money that is there and try to do something wise with it and not wait for some investors to come in at this point unless they are very close to doing so,” he said. “If it's enough to work with, put the money to work in decent conditions and come back when the market is better for the next fund.”
“In today's market another three months may be reasonable, another three after that is probably less reasonable, and after that it becomes impossible. What the LPs don't like is to see their GPs run around looking for money when they should be putting what they have to work.”