Kelly M. Williams, managing director and global head of the
Delivering a keynote address earlier this month at Buyouts Texas, a conference hosted by this magazine, Williams first expressed that challenge in statistical terms. Of the 5,835 funds reviewed by her group from Jan. 1, 2000, to 2011, she said, just 2,908, or about half, made it past an initial screen to receive either preliminary or comprehensive due diligence. Of those that did, the investment committee approved commitments to just 458, or 8 percent of the original total reviewed.
Compared with your average limited partner, that actually may not sound like such bad odds, especially given the group’s penchant for emerging managers. That the odds are as good as they are stems from Credit Suisse Customized Fund Investment Group’s own success at fundraising: The firm manages more than $27 billion in assets, and over the years has counted as clients such pension funds as
Williams went through the broad outline of both her group’s approach to preliminary due diligence as well as its approach to comprehensive due diligence, peppering her talk with colorful bits of advice, summarized below:
• We want materials before we sit down with you. And figure on having about 60 to 90 minutes for a first meeting.
• We’re going to call the limited partners who aren’t re-upping. “Don’t oversell,” Williams added, “because we’re going to find out.”
• Make sure your experience matches your strategy, and that you have adequate resources to execute.
• Don’t simply list the results of your portfolio companies in alphabetical order or chronological order. “We don’t want to see it that way,” said Williams. “We want to see it on a fund by fund basis.”
• Be wary of who you pick as your legal counsel to negotiate terms. At least one law firm, she remarked, doesn’t treat limited partners that well.
• And, finally, some perhaps more idiosyncratic advice: “If we turn you down, please don’t lecture my staff on what we missed,” “Don’t try to go around the personnel assigned to diligence you,” “Please don’t have [Credit Suisse] investment bankers call me,” and “Don’t name drop.”
Williams discussed some of the red flags that can quickly eliminate a fund from the race during the preliminary due diligence stage. A strategy that’s not tailored to the fund size is one of them. Others include dependence on favorable regulations (subject to change), a track record built on too few successes, gaps in the track record, issues regarding succession and a misalignment of interests between fund manager and investors. For first-time funds, the list of red flags is even more extensive, and includes an inability to attribute the track record to the team promoting it and a dearth of back-office systems to track cash flows and manage the portfolio.
Comprehensive due diligence awaits those that get past this first stage of due diligence. Here Williams spent a good deal of time showing how her firm analyzes track records using “ABC Private Equity Partners” as a case study. Ostensibly the firm, seeking $500 million for a third fund to invest in mid-market buyouts, has an excellent track record since 2003, generating a 2.1x investment multiple and 36.7 percent IRR. Nevertheless, the fund raises several red flags, several of which are summarized below:
• One partner led the majority of the successful investments, while another partner “has no demonstrated successes.”
• The firm wrote off its largest investment.
• ABC Private Equity Partners has not had a successful exit for any investment above $16 million, raising questions about its ability to capably deploy a $500 million fund.
• A big home run in a field the firm is no longer emphasizing accounts for a big part of its track record.
• The second fund has plenty of dry powder left and remains largely unrealized.
No fund is perfect, of course, and I doubt Williams was out to discourage anyone from launching a fund. But in a fundraising market that’s icy, if not quite frozen, it’s best to go into the due diligence process with your eyes wide open.