Firms freeze recruitment as fund sizes grow

Despite private equity funds raising more and more cash, the teams to manage that money have remained largely static according to research by Zurich-based advisors SCM.

Last year, funds with a size of greater that US$1bn had an average total of 58 team members – 16 partners and 42 investment professionals. Compare this to the year before, a year of lower fundraising and smaller fund sizes, and the team sizes for the plus US$1bn funds fails to reflect the massive amounts of money being raised by the buyouts world – the average total for 2005 is exactly the same as last year, 58, only this time with an average of 18 partners and 40 professionals (which at least shows that at least two people have recently got promotions).

Dr Stefan Hepp, CEO of SCM, said: “One would expect that the foreseen increase of multi-regional investment activities and the trend towards higher ‘rest-of-the-world’ provisions of regionally focused funds would lead to an increase of investment professionals who possess the necessary local networks as the geographical focus especially of larger funds. Quality and quantity of the management team is an important factor institutional investors should pay attention to.”

Whilst the tradition of the bigger the fund, the lower the management fees as a proportion of fund size remains true today, the US$3bn funds have seen an increase of almost 0.2%, and management fees overall increased in 2006 compared to past years, confirming the power of the GP in a climate of strong investor demand for access to private equity.

SCM’s report also showed up the significant differences between the US and Europe in the distribution of carried interest. In the US, 67% of the funds surveyed paid carry on a deal-by-deal basis, whereas only 9% of European funds use this method. Instead, 72% of European funds forced to return all paid-in capital before they can receive carry. Hepp says: ““Only in the large buyout segment a few European GPs have managed to introduce a deal-by-deal waterfall but generally this concept has not gained much ground outside the US.”

The survey also notes the increased selectiveness of GPs over the types of investors they have in their funds in a similar way to US VC Sequoia Capital’s barring of fund-of-funds from the US$450m fund it raised last year. Hepp says: “GPs also use restrictions on secondary sales of partnership interests such as first right of refusal for existing LPs or the right to approve new investors to manager the composition of their investor base after the closing of their funds.”

SCM interviewed 252 funds in 2006 for this report, the fourth edition of it ‘Terms & Conditions Review’. The study found that, discounting first time funds, 87% of successor funds raised in 2006 were large than their predecessors, and that, once again, fundraising was driven by the larger-end of the buyouts spectrum, with 15% of the funds responsible for almost 70% of the total money raised.