Fundraising certainly has had a wild ride over the past five years. After violent surges of activity and sudden breaks, the capital raising process appears to be experiencing fundamental shifts that could take years to reverse.
Where is private equity fundraising heading? It’s a question we pose as we celebrate the top fundraisers in the game, as shown on our Buyouts 100 list. Based on the fundraising tallies over the most recent five-year period, Blackstone Group earns the top slot, having raised about $125.6 billion, toppling KKR, which fell back to No 2.
One of the most aggressive climbers was Advent International, which vaulted its way from the 21st position in 2022 to the sixth slot this year with a five-year fundraising tally of about $52.9 billion (see our Q&A with Advent’s John Maldonado).
Most of the top five – Blackstone, KKR, Thoma Bravo, Carlyle Group and TPG – are in the market now (or will be this year) with their flagship funds. Most of them, to varying degrees, are stuck below their targets (with the exception of Thoma Bravo, which is just gearing up for its next fundraising cycle). Several of them have alerted their public shareholders that they will likely be closing flagships below expected goals.
“As a pension fund investor, you have to be careful with your liquidity and stick to your vetting process. You can’t continue to give money to GPs just because they come banging on your door”Jim Pittman, British Columbia Investment Management Corporation
A few years ago this would have been unthinkable for the bluest of private equity’s blue chips, but times have changed. Private equity is facing a new fundraising reality, one that may be with us for a while. This new epoch is characterized in real-time by longer stretches on the road, smaller fund sizes, stricter terms on LPAs and more demanding LPs.
If the best and brightest in PE can’t hit their targets, where does that leave everyone else? Some sources have compared mid-market fundraising to a wasteland, where firms that lack reputation are being left behind as LPs stick with managers they know best (even if they are only committing half of what they committed to the prior fund).
Yet others see opportunity. For those mid-market firms built to last – with strong teams, economics that seem fair, a strong bench of next-generation leadership, great past performance, no style drift – the challenging fundraising market could prove to be a boon. Liquidity, so tight at the upper end of the market, will likely flow smoother through the mid-levels. Mid-market firms have more robust exit options – simply by selling to larger shops – and have less reliance on heavy levels of expensive debt.
The failure of the biggest players to reach their ambitious goals provides an opportunity for those well below to strive a little higher, and perhaps attract a bit more attention.
Some firms will thrive, others will begin to fade out. Private equity firms are notoriously hard to kill, but those emerging from this current market – marked by higher interest rates, expensive debt, slower exit activity, longer fundraising processes – are expected to come out much stronger. Our 100 fundraisers list, so dominated by the largest firms in the business for many years, may see more shifts in coming years.
A gradual shift
Back in 2018, who would have guessed that fundraising would essentially shut down for six months as a global health crisis raged, only to rebound explosively when markets got over the initial shock of the pandemic?
That rebound led to what may well be a high watermark for private equity capital raising last year, when 1,064 funds raised around $585.6 billion, according to Buyouts’ data (many of those funds launched in 2021 and held final closes in 2022).
Even with last year’s glorious tally, the market was doing something different with newly launched funds. They were becoming harder to raise, they were taking longer, and limited partners were no longer so eager to pile into the top names in the market just to get their little slice of allocation.
“We feel that we have more time to be selective and take our time to conduct proper due diligence. We are able to get better terms with the GPs, as they are able to provide more concessions. LPs are able to push back more on non-standard market terms”
Public pension LP
The shadow of the Fed loomed over the private equity landscape. As interest rates rose, debt became more expensive, and M&A started to slow, including exit activity. With fewer exits, distributions slowed, and LPs found themselves with less capital coming back to commit to new funds.
The natural cycle of private equity fundraising – commitments, investments, harvests, distributions, recommitments – was being disrupted. Add to this, many LP institutions became overallocated to the asset class. GPs have been reluctant to take mark-downs on their assets, and private equity’s performance overall has held fairly strong compared with public markets. As the total value of investment funds fell because of floundering public markets, the value of private equity held up, increasing as a percentage of the total fund. In many cases, pensions and other LP organizations breached their exposure caps to private equity, forcing them to find ways to rebalance.
These two drivers – overallocation and slowing distributions – forced LPs to rethink their PE programs. Many have simply slowed their pacing and cut their commitment sizes – if a pension committed $300 million to the prior fund, expect $150 million this time.
“As a pension fund investor, you have to be careful with your liquidity and stick to your vetting process,” says Jim Pittman, executive vice-president and global head of private equity at British Columbia Investment Management Corporation. “You can’t continue to give money to GPs just because they come banging on your door.”
At the very least, until exit activity begins opening back up, it’s unlikely this LP slowdown will reverse, sources said. Along with this, LPs are being even more detailed in their assessments of potential new commitments.
“We feel that we have more time to be selective and take our time to conduct proper due diligence,” says a public pension LP who wishes to remain anonymous. “We are able to get better terms with the GPs, as they are able to provide more concessions. LPs are able to push back more on non-standard market terms. LPs are able to ask more questions and speak to the relevant deal leads. Terms are more negotiable, especially if the terms have changed from fund over fund.”
“The true test is when you hit some bumps in the road and perhaps carry is delayed, or fundraising is challenged, or finger-pointing with some portfolio company losses”Scott Ramsower, Teacher Retirement System of Texas
The Teacher Retirement System of Texas is doing several different things these days with manager diligence, according to Scott Ramsower, head of private equity funds at the pension system. The system is spending more time evaluating valuation marks on a firm’s underlying assets; it’s “de-emphasizing historic track record” and scrutinizing the potential for future value creation, Ramsower says.
“What got them here might not get them there. We’re looking at not only what was good and attractive over the last 10 years, but is that replicable for the next 10,” Ramsower says.
The system also is digging into “capacity analysis.” In the uncertain markets, with more expensive debt putting pressure on portfolio companies, firms will need to spend time not only on finding new deals, but also on tending to existing portfolios.
“There’s a lot more things competing for time and attention. Raising capital now is taking longer, they’re spending more time on the road with LPs, do we think they’ll have the capacity to do all this?” Ramsower says. “Are they building up a team, being thoughtful in how they’re spending time and managing a larger underlying portfolio with [potential] problems?”
The system is also spending time assessing the firm’s culture and team dynamics. Even at the friendliest shops, morale can turn when things start to get tough and carried interest potential begins to shrink. “The true test is when you hit some bumps in the road and perhaps carry is delayed, or fundraising is challenged, or finger-pointing with some portfolio company losses,” Ramsower says. “As the firm hits some bumps, what is the culture of the firm and how sticky is the team?”
New normal
One question is whether the current downturn in fundraising is a blip, the downward swing of a cycle that will eventually end up at a place similar to the fundraising market in, say, 2019 (pre-pandemic).
“Lower interest rates stimulate risk taking and stimulate asset growth. Until there’s a snapback in public markets, the new normal is continued headwinds for fundraising”David Fann, Apogem Capital
To get there, sources say, interest rates have to fall, easing the pressure on portfolio companies and bringing credit pricing down. For that to happen, however, the economy may have to fall into recession, helping to ease prices and ultimately tame inflation.
Once that happens, dealmaking will open back up, including exit activity. With capital flowing out, managers will need to fundraise, and with exits, distributions will flow back to LPs, giving them more room to commit to new products.
“Lower interest rates stimulate risk taking and stimulate asset growth,” says David Fann, senior managing director and vice-chairman of consultancy Apogem Capital. “Until there’s a snapback in public markets, the new normal is continued headwinds for fundraising. The reality is, unless asset allocation models radically change for most mature investors – mature in the private equity sense – they’re not going to be in position to allocate much except for re-ups or the best new ideas in the market that displace an existing manager.”
A return to a stronger fundraising market will likely not happen for a few years, if a like-to-like return is even possible. “The liquidity component is going to take longer, unless banks come back opening the spigot in terms of the quantum of funding on PE deals,” Pittman says.
With rates relatively high compared with prior years, there could be a shift in where the dollars go. “Longer-term private equity fundraising activity could be tempered by sustained higher interest rates, which would create increased favorable risk and return trade-offs in other asset categories,” says a public pension LP. “These other asset categories may displace capital historically allocated towards private equity.”
This could apply within private equity as well. In the more expensive debt environment, mid-market private equity has less of a liquidity burden than the larger market, sources say, which will make smaller funds more attractive. The simple reason is that mid-market GPs have a vast array of larger firms to exit into, meaning liquidity will likely continue to flow.
Ironically, fundraising will likely remain tougher for mid-market managers who are less known to LPs, compared with the larger, more established shops.
“More activity will happen in the mid-market in terms of sales because the bigger funds are able to buy them,” Pittman says. “There’s more liquidity potential in the mid-market, and that will help some of those managers.”
Buyouts 100 spotlight on . . .
Genstar Capital
19
San FranciscoAt a time when fundraising extensions and trimmed ticket sizes are common, Genstar Capital took six months to close an 11th flagship buyout vehicle above target.
Fund XI’s seemingly fluid $12.6 billion closing in April, despite a harsh market environment, is par for the course for Genstar. It has long been a successful capital raiser, recently wrapping up successive flagships at higher targets every two years. Fund X secured $10.2 billion in 2021.
Because of this track record, Genstar has entered the Buyouts 100’s top 20. The firm’s fundraising prowess likely owes much to performance. As of September 2022, it was generating an aggregate net IRR of 34.6 percent across five prior flagship funds, according to Teachers’ Retirement System of Louisiana.
Founded in 1988, the $49 billion Genstar is led by five managing partners: president Ryan Clark, chairman Jean-Pierre Conte, Rob Rutledge, Tony Salewski and Eli Weiss.
Genstar’s strategy is to make control investments in growth-oriented mid-market companies in North America, typically with positive cashflow and at least $25 million of pro-forma EBITDA. Targets, valued at $400 million to $2 billion, are sourced thematically across financial services, healthcare, industrials and software sectors.
KPS Capital Partners
78
New YorkKPS Capital Partners may be in its element in today’s market, shaped as it is by economic uncertainty. That is because of the firm’s long experience with turnarounds and helping quality businesses get past challenging periods of transition and operating or financial difficulties.
Its record on this score is well-documented. KPS won Buyouts’ deal of the year four times and Buyouts’ turnaround deal of the year five times. The most recent award was for the sale of golf equipment maker TaylorMade, which on an equity invested basis earned 19.1x cash-on-cash and on a capital invested basis earned 8.8x cash-on-cash.
KPS is led by co-founders and managing partners Michael Psaros and David Shapiro and managing partner Raquel Palmer.
Its flagship strategy is to make control investments in North American and European manufacturing and industrial companies across a range of industries. Investing $100 million to $1 billion per platform, the firm has a particular knack for highly complex carveouts. A mid-cap strategy takes the same approach with a lower-mid-market focus.
KPS is presently in the market with a sixth flagship fund and a second mid-cap fund, which are reportedly targeting a combined $9.5 billion.
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