What LPs really want

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It is no surprise to anyone that this year has been another bumper one for fundraising. The Private Funds CFO Insights Survey 2019 bears this out, with around one-third of our 100-plus respondents currently in market and a further 10 percent expecting to approach investors by year-end. And it does not stop. A further quarter expect to collect capital next year for a new vehicle.

Fund sizes are still rising. A whopping two-thirds of respondents – dominated by mid-market firms with vehicles in the $100 million-$500 million bracket – expect their next vehicle to be larger than their current fund.

Finding new investors to back the fund remains the most significant test, although the proportion of managers reporting that this is “extremely challenging” dropped from 21 percent last year to 15 percent this year. Part of the reason for this drop is the amount of capital looking for a private equity home, particularly from North American investors.

Many more respondents than last year (54 percent compared with 37 percent) expect to see a greater proportion of these in their next fund raise. “The private equity dollars available as a percentage of most [pension] plans has grown more significantly in North America compared to the rest of the world as the equity markets have risen faster and further,” notes Centre Partners’ CFO Bill Tomai.

If there is more cash to collect in North America, then GPs have few reasons to look elsewhere.

“Why increase resource burn (time and money) to raise a fund?” asks John Otterson, partner at Jackson Square Ventures. “I’ve spent years chasing international LPs. It is a less efficient and more difficult sales process that really only works for the most established brands.”

And then there are barriers to collecting capital in other markets. Another CFO notes that in Europe, “AIFMD certainly contributed” to US investors taking a growing share of the investor base. “Funds are likely nervous about Chinese or Russian money too, with the current political climate.”

Due diligence

Bigger funds mean dealing with more investors. At the same time, those investors are seeking more information and demanding greater detail from GPs. More transparency is increasingly important to LPs, according to survey respondents. LPs are “generally asking for more transparency into fund information,” says one CFO. Another elaborates that LPs also want transparency into “track record, reporting quality and safety of electronic data.”

Performance and track record data remain, unsurprisingly, the core requirements for LPs. The pillar performance benchmark used by GPs is the internal rate of return. Less than 1 percent do not use it.

Paramount to LPs are, “one, consistency of returns; two consistency of team, including next generation succession; and three, consistency of strategy and how you execute against that strategy, ie, LPs do not like to see strategy stray,” says one CFO.

“Prior performance is table stakes,” says Otterson. “Team experience and fund strategy need to be consistent and [you need to] present a cogent narrative on how performance can continue. The fund narrative also needs to include compelling elements around sourcing, selection and stewardship.”

“Operational due diligence has increased greatly over the past few years too,” adds a chief compliance officer.

During due diligence, LPs like to interact with the CFO in person. The proportion that always demands to meet the CFO is rising (16 percent), while a solid majority (72 percent) sometimes ask.

Dimitri Korvyakov, the CFO of Sandton Capital Partners, notes that “beyond the returns, LPs are quite interested in seeing in general that the investment manager is prudent with investors’ capital, uses resources optimally, puts efforts into applying the industry’s best practices and remains transparent and forthcoming with the LPs. The topics covered during due diligence meetings are usually geared toward ascertaining this.”

He adds that LPs are asking additional questions around diversity, gender and ethnicity, as well as on environmental, social and governance topics. Around 70 percent of respondents say LPs delve into their use of ESG consultants either always or sometimes.

The factors most important to LPs during due diligence “probably varies a bit by geography and/or type of investor,” says one CFO.

“Scandinavian investors, in particular, are increasingly focused on ESG and this is becoming as important as the potential economic return. One noticeable change during our last fund raising was the focus on operational matters and risk, particularly by US investors.”

Granular

As institutional investors become more sophisticated they are scrutinizing the same functions, but in more granular detail, says Fred Steinberg, SANNE’s managing director for North America.

LPs are asking for more detail on investments, including company data at acquisition and to-date, says one CFO. “Some have requested greater reporting on fees and expenses, and also the use of fund-level credit lines. Many now expect completion of an annual operational due diligence questionnaire, some of which are very comprehensive.”

The survey reveals that the proportion of LPs using a standardized template when requesting track record data has risen (from 21 percent last year) but is still only less than one-third. “Only a few more than in the past are using standardized templates. Rather, they continue to use their own internal templates,” notes one respondent.

“Unfortunately, there’s no sign of standardization on one template yet for portfolio company/investment reporting,” adds another. While templates can be useful, says one CFO, “unless everyone is willing to say a specific template is ‘perfect,’ investment managers will always be completing specific investor/consultant templates. I haven’t seen this change in decades.”