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Covid-19 hits emerging managers hardest

Virtual fundraising not fit-for-purpose when it comes to new firms, say investors.

The economic ramifications of covid-19 are unlikely to dampen LP appetite for private equity significantly. Industry outperformance over the past decade has been striking. Investors have also learnt their lessons about vintage-year diversification, while those that did back away from the asset class in the aftermath of the financial crisis are still kicking themselves for missing out on the buying opportunity of a generation.

Nonetheless, the shock waves covid-19 has sent through the financial markets mean many investors have been forced to prioritize firefighting. “Investors have had to retrench into their portfolios, limiting the capital available for new commitments,” says John McCormick, managing director at placement agent Monument Group.

Meanwhile, should surprisingly buoyant global stock markets take a fresh tumble, the denominator effect will intensify. It is possible, therefore, that LPs will choose to preserve longstanding relationships rather than embark on new ones. Indeed, an overwhelming 89 percent of emerging managers surveyed expect the pandemic to make fundraising at least moderately more difficult in the months ahead.

The survey also suggests, however, that despite these short-term challenges, underlying appetite for emerging managers remains strong. More than 60 percent of investors canvassed say covid-19 will not impact their appetite at all. Rather, it appears it is the impracticality of undertaking the intensive due diligence required for investors to get comfortable with new firms during international lockdown that will really make it hard for younger managers to get funds over the line.

“Covid-19 hasn’t changed our appetite for emerging managers, but it will make the due diligence more complicated,” says Janusz Heath, senior managing director at Capital Dynamics. “Chemistry is critical and so it is vital to see people eyeball to eyeball. If it is a team we know from a previous house or have been talking to for months or years, then that is different. But if it is a team we have really never met before, then a Zoom call just won’t do.”

Dan Tamkin, managing director at lower mid-market house Resurgent Capital Partners, agrees virtual fundraising is untenable for young managers.

“LPs want to form relationships as lines – not dots – and so the inability to meet face to face really stretches out the diligence,” he says. “Ultimately, if someone is going to write your fund a large check, they will want to meet you in person. Zoom doesn’t cut it.”

Meanwhile, Nik Shah, managing partner and co-founder of mid-market firm Cohere Capital, which closed its debut fund in May this year, having built up a great deal of momentum prior to lockdown, adds that while appetite hasn’t waned, the bar has become higher. “There is a greater need for emerging managers to prove their value and differentiation,” he says.

Investors are also demanding greater levels of communication when it comes to existing portfolios, say emerging managers. Reporting on revenues and EBITDA projections has intensified, with 57 percent of managers having received increased information requests in these areas since the onset of the coronavirus. “In our experience, investors have a greater focus on cash planning,” says Tamkin.

LPs also want to be sure that GPs are factoring the covid-19 effect into their strategy and origination processes. Indeed, almost 80 percent of emerging managers surveyed plan to invest in industries deemed essential.

“It is too soon to say what the effect of covid on fundraising will be,” says George Spencer, senior managing director at Chicago-based venture capital firm Seyen Capital, which is currently raising its debut vehicle.

“I would imagine that it will be more difficult to attract new investors without face-to-face meetings. Having said that, the types of business I invest in have been the ones that have kept this economy humming.”