2004, The Year Of More: Fundraising Jumps 75% Over 03 –

Private equity pros had predicted that 2004’s fundraising market was bound for dramatic improvement – and they were right. Last year, U.S. buyout, mezzanine and secondary funds raised more than $42 billion in disclosed values, representing an increase of $18 billion, or 75.84%, over 2003’s fundraising total of nearly $24 billion.

The fourth quarter was the second lowest of the year, bringing in $9.34 billion, just passing Q1’s $8.78 billion total. Meanwhile, the number of funds seeking commitments during the year, 159 in all, more than doubled the amount in 2003, when 76 funds were searching for limited partners.

And while market pros agree there’s been more than enough appetite from LPs, most also believe fund raising is moving at the right pace. “We are in a very healthy place right now,” says Alan Austin, a managing director and COO at Silver Lake Partners, which, early last year, wrapped up fundraising on its target-busting $3.6 billion Silver Lake Partners II. “It’s a good fundraising environment, but it’s a deliberate fundraising environment. If you have a track record, there is plenty of capital that can come your way.”

Austin added, “There are a lot of investors that have substantial allocations of capital to invest, but they are extremely careful these days about due diligence and about terms. They’re well advised, by both legal counsel and consultants, and they know exactly what they want.”

Aside from Silver Lake, four other buyout shops raised funds north of $3 billion last year. The largest fund to emerge from 2004 was from Texas Pacific Group, whose TPG Partners IV raised a total $5.3 billion. Next was Providence Equity Partners, which raised $4.25 billion at the drop of a hat for Providence Equity Partners V. The year’s third-largest fund was Silver Lake’s Fund II, leaving Bain Capital and Hellman & Friedman LLC tied with the fourth largest funds of the year, each having raised $3.5 billion for their respective funds, Bain Capital Fund VIII and Hellman & Friedman Fund V.

Conversely, some of the newer funds had a tougher-and longer time-raising capital. “The market is really bifurcated so that the firms that have done reasonably well, even if not in the immediate past, have no trouble raising their funds at all,” says Larry Jordan Rowe, co-head of the Private Equity Group at Ropes & Gray LLP. “But in general there are a lot of people, once again, entering the market with small and new funds, and they tend to have a bit more difficulty than the larger firms with established track records.”

Harbert Management Corp. can attest to that trend. Harbert Private Equity Fund II, which targeted between $150 million and $200 million, began marketing 18 months ago. “We got a lot of pressure from institutional limited partners who were hesitant to invest in a Fund II, and as a result it was a longer process… Most institutions seem keen on funds with roman numerals IV, V and VI,” says Michael Rowland, vice president and director of investments at the firm. Harbert Fund II held its final close with $180 million 13 days ago.

The $100 million-targeted Founders Equity SBIC Fund is an inaugural vehicle that has also traveled down a bumpy path. “When we started raising at the end of 2002, it was a very different fundraising market than it is today,” says Dolores Arton, principal and CFO at Founders Equity Inc. “Limited partners, at the time, were keeping their cash in their mattresses and under their pillows. Even though they had to invest, they were definitely shying away from private equity – everybody was.” The fund had its final close with $135 million in the middle of 2004.

Mezz Gets A Lift, Expects To Go Higher

Raking in roughly $5.2 billion last year, the mezzanine market saw a modest increase in fundraising compared to 2003’s approximate $4.4 billion in fund closes. Twenty-six mezzanine funds were at market last year-five more than in 2003.

The largest final close came from Tennenbaum Capital Partners whose Special Value Opportunities Fund LLC closed on target in the third quarter with $2 billion in commitments. Golub Capital (formerly Golub Associates Inc.) also had a successful fundraising on its latest re-up. With about 90 limited partners, Golub Capital Partners IV LP raised $600 million, doubling the fund’s $300 million cover price.

“I’ve been surprised by the level of interest we’ve received from some exceptionally accomplished CEOs investing in their individual capacities. Golub Capital has 35 of them as investors. Even though this level of commitment by experienced CEOs has been seen on the private equity side, this model is new for subordinated debt and mezzanine firms,” says Lawrence Golub, the firm’s founder and president.

And with demand for mezzanine financing expected to grow in 2005 and into 2006 due to the market’s overcapitalization and high purchase price multiples, a firm that had a rough go-around raising its mezzanine fund last year has a bright outlook for its next effort for LP dollars.

Smith Whiley & Co. began raising its fund two years ago with a target of $400 million. As of the close of Q4 2004, S.W. Pelham Fund II LP had closed on a total of $115 million. “But even though fundraising is a little bit slow, the firm expects that, due to the burgeoning mezzanine market, the investment cycle for Fund II may take less than a year and that by this time next year, a Fund III might be in the works,” says Colette Nakhoul, senior managing director at Smith Whiley. She added that Fund II’s target will likely be rolled back to $250 million as it is nearing the end of its marketing cycle.

LPs Put One Foot In Tomorrow

While 2004 witnessed some funds struggling to grow with institutional dollars, it also bore witness to hefty funds with high roman numerals that held final closes faster than some GPs could say private placement memorandum. The crowding of the mega funds has given some LPs the incentive to seek out emerging managers and find funds that allow some stretching room.

“Because everyone’s doing their due diligence, because everyone’s getting more sophisticated and because everyone’s identifying the same mega funds that they want to get into, the result is that those funds are getting oversubscribed without giving the LP too much negotiating room,” says Rowe. “I would say that the truly sophisticated investors are the ones looking at the new funds with good stories. They’re the ones that are trying to get in at the ground floor.”

One emerging manager with high expectations is Menlo Park, Calif.-based Elevation Partners, which has set a $2 billion target on its inaugural, media-focused fund and held a first close in September with $211.2 million. Mark Bodnick and Roger McNamee, founding principal and general partner at Silver Lake, respectively – teamed up with Fred Anderson, former CFO of Apple Computer; John Riccitiello, former president of video game maker Electronic Arts; Bret Pearlman, former senior managing director of The Blackstone Group; and Bono, front man for the rock band U2, whose legal name is Paul Hewson – acting as Elevation’s managing directors, the firm could be a textbook case of an effective story.

“It’s almost just a different name that these funds are using while everything else remains the same. And they’re doing fine because the savvy investors are always looking for good, new first-time funds to make sure they get a large or, sizable, allocation in the successful predecessors,” says Rowe. “But, that said, the LPs are very carefully examining the first-time funds. They can easily look at 100 new funds and end up choosing only two of them to invest in.”

Indeed, the current culture of LP diligence is certainly keeping emerging managers on their feet. “I’ve met with more than 70 investors and have been to Europe twice for introductions to institutional LPs,” says one managing partner whose firm started raising its first institutional vehicle last year.

“[But] the truth is, if you’re a large investor and you’ve got a lot of money that needs to be deployed by deadline, it’s a lot easier to invest in the Apollos and Blackstones of the world than it is to take the time to seek out the smaller firms, conduct your diligence and throw them a few million dollars,” the managing partner adds.

The Next Trip Around The Sun

The fundraising wave that began in late 2003 and swept across 2004 is not expected to crash any time soon. Many private equity pros expect that 2005 will be an even better year to raise capital than the last one for two reasons: One, there are still a number of high-quality firms that will likely have offerings in 2005; and two, the money being returned to limited partners has increased dramatically, meaning that they have more money to re-deploy in the next round of funds.

And with rumors that Warburg Pincus is planning to raise an $8 billion dual-track fund, along with reports that the The Carlyle Group will likely raise the target on Carlyle Partners IV from $5 billion to $6.5 billion, the new year is already off to a fast start. But still, the lessons of the past loom.

“I would not be surprised if 2005 was even a bigger year than 2004 for fundraising. But given LPs’ measure as a result of having been burned in the past, I don’t think [2005] will be anything as dramatic as what we saw four, five and six years back,” Rowe says.