The year 2000 in the buyout fund-raising market may have roared in like a lion; however by the end of the year that lion was looking more like a lamb.
As 1999 closed with mild numbers compared with 1998’s ambitious fund raising, general partners used phrases like “the calm before the storm” to describe it. Well, the celebratory millennium year is over, the proper millennium has begun, and the storm seems to have come and gone.
Despite groaning from firms currently in fund raising, buyout fund closes in the year 2000 wrapped up with $60.8 billion, according to Buyouts data, topping last year’s total of $34.1 billion by $26.7 billion – a difference that rivals the jump in capital from 1997 to the record-breaking numbers of 1998.
Interestingly, this year has introduced 20 fewer buyout funds to the market than last year with only 44 funds being launched in 2000 compared to 60 in 1999. The drop in the total number of funds, including special situation funds and mezzanine funds, is even greater with 52 launches in 2000 compared with 79 in 1999. The cumulative capital raised however jumped to $56.31 billion from $43.98 billion.
Of course any limited partner can tell you that despite the fewer number of funds, the demand for capital is alive and well as existing funds are consistently topping each other’s targets. In a sentence, it’s the year of the mega-fund. In 2000, 28 buyout funds reached the $1 billion mark – twice the 14 funds than reached the billion mark in the previous year. Also, 13 funds reached the $2 billion mark in 2000, while only seven funds did so in 1999.
And Then There Were None
Although the year started out with a bang, fund raising quickly tapered off in the third quarter along with the debt markets, the public markets and the number of deals completed. However, by September funds raised in 2000 had already surpassed the total of buyout funds raised in all of 1999.
With so many mega-funds picking up commitments early on and institutional investors feeling the crunch from the stock market in their pools of capital, the fourth quarter proved a trying time for general partners.
LPs, many of which have reached their allocation for alternative investments, mainly stuck to their existing partners, re-upping in the ever-increasing successor funds. Such a situation created a difficult environment for new funds to attract LPs unless they could present a good track record and something that made them unique – whether it be size or focus.
“It’s much harder for new entrants into the marketplace,” says Tim Mayhew, a founder and partner at Palladium Equity Partners. “It’s not impossible but it’s much harder and the reason for that is the large institutional funds that invest in these types of funds are trying to manage their own relationship level. If they’ve got 20 existing relationships they’ve been working with for five or six years and they feel happy with that, why would they take on a new relationship? So you really have to have a compelling story to catch their attention.”
Palladium wrapped its second fund – its first traditional blind pool fund – in the third quarter of 2000 at $300 million. The firm’s focus on fixer-upper middle market companies, and no doubt its ties to Joseph, Littlejohn & Levy, were enough to bring in the targeted amount. The companies that Palladium invests in are not necessarily turnarounds, but ones that need some explaining or need some work, says Mayhew. And in a changing economy, investors find that attractive. “I think some people thought that that’s a good place to be in this type of economy.”
Mayhew says there are definitely LPs looking for funds out of the mega-fund realm, but in any case its not easy fund raising. “From our standpoint I think the fund raising went well,” he says. “I think we also felt very grateful to get it done. It wasn’t lost on us that the market has gotten tougher in 2000, so we hustled a little bit more and were grateful that people liked the story and came in.”
Working Outside the Box
Strength Capital Partners, another fund new to the market in 2000, took a different approach to overcoming strained institutional investors. The firm, which was founded by David McCammon, a former Ford executive, his son Mark McCammon and Michael Bergeron, decided instead to focus on their ties to wealthy individuals. With the goal of raising only $50 million for lower middle market buyouts, the firm has already closed on $25 million, which came almost entirely from corporate executives.
Although the firm likely could not reach this modest target if it were dependent on institutional investors, Strength Capital found 2000 to be as good a year as any to turn to individuals. “[Raising from wealthy individuals has] been good, in contrast to raising money from institutions, which is quite hard right now,” says Mark McCammon. “Individuals are not the same, they’re not cyclical . . . Individuals have not been affected by the funding environment, I don’t think, at all. In fact, it may even be better now because they are not putting as much money in the public markets or in venture capital.”
Arkansas Capital Corp., like Strength Capital Partners also set out with a new fund in 2000 focused on the Midwest, Southeast, and South Central regions of the U.S. The firm’s special situation fund, Diamond State Ventures SBIC, managed to close on $56 million including leverage, by focusing on local institutions and investment banks. “We were a first time fund in a market where there are no funds,” says Joe Hays, a managing partner at Arkansas Capital. “So the fact that we did it at all was a tremendous reward.”
In the Shadow of Giants
The $2.5 billion Francisco Partners LP, the $2.8 billion Providence Equity Partners IV, the $2 billion GTCR Fund VII, the $2.2 billion Hellman & Friedman Capital Partners IV LP and the $4 billion Welsh, Carson, Anderson & Stowe IX LP are just a few of the funds that sported mega-fund targets in 2000. While firms such as these carry the name and relationships required to sustain capital intensive strategies, the effects of their fund raising extends much deeper.
“As the mega-funds get larger they obviously take a lot of the oxygen out of the room for other players,” says Palladium’s Mayhew. “So for someone like us, we have to work hard to differentiate ourselves, and I think we have to work hard to present a really good quality opportunity, and if you do, you can raise money.”
Yet even if a firm puts its best foot forward, many investors are simply over-allocated and unable to make commitments to new firms. “Clearly in today’s environment funds are much larger and not only that, they’re coming back to investors much quicker,” says Francisco Borges, president of Landmark Partners, which is currently raising a $250 million Growth Capital Fund. “So for a lot of investors, they have found that they bind themselves because of the frequency and size of the fund raising from pre-existing [relationships]. With just re-ups, they find themselves at or near allocation.”
The effects of the capital vacuum that began in 2000, are also expected to extend into fund raising in 2001. “I think everybody is more or less wanting to put the money they’ve got out to work now,” says Arkansas Capital’s Hays. “I don’t see that fund raising is going to be as vibrant as it has been for the last two years.”
While the launches of mega-funds never seem to cease, at least some investors don’t expect them to get any bigger for a while. “I think there’s so much money to be put to work that returns should go down a bit for bigger funds,” says Strength Capital’s McCammon. “Whether [that happens] or not I think that some funds are probably raising their biggest funds ever right now and I’d say they might end up raising ones of similar size, but for the most part they won’t get too much bigger.”
Ready, Aim, Lower
Although the 2000 numbers have proven to be the best ever for buyout funds, it was evident that several firms were jilted when fund raising came to a grinding halt toward the end of the year. According to Buyouts data, only two funds missed their marks last year, closing funds before reaching their initial target. This year, however, the number of funds closing shy of the initial target is at least five, while many others remain open as they linger just below target. Some firms seem less willing to put an exact number on the cover, while still others have had to bite the bullet and lower the target. Hicks, Muse, Tate & Furst Private Equity V LP and Conning Capital Partners VI LP are among those funds lowering expected totals. Last month Hicks Muse announced that it was lowering the target for its fund, which was originally targeted at $4.5 billion, to $3 billion (p. 1). Earlier in the year the firm announced that the same fund was dropping its original plan for a stapled technology fund (Buyouts, Nov. 20, 2000). Conning Capital also faced difficulty meeting its intended cover. The firm wrapped its sixth fund last quarter at $276 million, short of its $300 million to $400 million target (Buyouts, Dec. 18, 2000).
Even Kohlberg, Kravis, Roberts & Co., the mega-fund trendsetter of private equity, seems to be setting more modest standards. The KKR Millennium Fund, which was long rumored, though never confirmed, to be targeted at $10 billion is now rumored to be targeted at $6 billion, below even the $8 billion that was first reported last Spring (Buyouts, April 17, 2000, p. 8).
Regardless, leveraged buyout funds continue to be an attractive investment in an economy faced with a downtrend in the public markets and unpredictable outcomes in venture capital. And although morale is sinking among some fund-raisers in the market, the past year was clearly an overall success with numbers that outshine the last decade, particularly for those who got in early and got out quickly.