Getting a new private equity firm off the ground is no mean feat. Fundraising can be protracted, and is invariably hard work. An international pandemic has not helped.
“Covid has made fundraising for emerging managers – never an easy assignment – even more difficult,” says Rick Spencer, co-head of Barings’ funds and co-investment platform. “The statistics around the number [of firms raising funds] and amount of capital raised by emerging managers in 2020 was significantly lower than in years past, as investors have been inclined to continue investing with managers they know.
“Meanwhile, the inability to meet managers in person, the needs of the existing portfolio and the general acceleration of the fundraising cycle have made it difficult to get time and attention from investors.”
That is because, traditionally, an emerging manager fundraising would involve some serious clocking up of airmiles. And although the pandemic has lessened the travel burden, LPs still crave as much interaction with new managers as possible.
Close to 40 percent of the respondents in the fifth annual Buyouts Emerging Manager Survey, conducted in partnership with Gen II Fund Services LLC, met with upward of 150 limited partners prior to closing. For the investors that did ultimately make commitments, multiple meetings and – due to the pandemic – conference calls were required.
More than three-quarters of respondents experienced in excess of three separate interrogations with individual LPs. For more than a quarter of respondents, this figure rose to over five.
Fundraising is time-consuming and, even in a virtual environment, time pressure was cited as one of the most significant factors that emerging managers face. “Time was undoubtedly one of the biggest challenges,” one respondent claimed. “Data request fulfilment, time demands and managing internal expectations were the biggest headaches,” said another. A third noted that “juggling LP meetings with running and investing a fund was particularly hard.”
“Covid has made fundraising for emerging managers – never an easy assignment – even more difficult”
And time constraints appear to go both ways. Overstretched LPs also lack the bandwidth to take on the additional work that emerging manager investment entails.
“LPs are currently overwhelmed by a backlog of funds coming to market, including those high-quality VCs that have generated outstanding returns and are taking priority with investors, given their tight timelines,” says Monument Group partner John McCormick. “It takes time to diligence emerging managers and time is something that is currently in short supply.”
Other challenges cited by emerging managers include getting investors comfortable with partial track records and the ability to properly identify and interact with potential LPs during a pandemic. Elsewhere, GP respondents simply cited an engrained bias against emerging managers as the most profound challenge in this segment of the market. “LPs will take a meeting but overcoming the inertia and the predisposition to say no can be hard,” one GP respondent noted.
“Fundraising for emerging managers remains challenging,” agrees Derek Schmidt, director of private equity at Marquette Associates. “There are already so many high-quality funds raising capital, as well as new strategies, that getting in front of institutional investors is difficult. Very few strategies are truly differentiated at this point. It takes an investor to believe in a team, which often requires a personal connection. And that often only comes from an in-person meeting.”
“During covid, some investors were more inclined to support existing relationships versus forming new ones,” adds Alli Wallace Stone, managing principal and consultant at Meketa Investment Group. “Zoom may have increased the number of introductory meetings for some emerging managers, but it is unclear how many of those converted to full diligence and commitments.
“Fundraising timelines elongated for less established managers and some investors were not comfortable conducting virtual due diligence with managers they had not supported previously. Given the long-term nature of private equity funds of 10-15 years, investors want to make sure that they are comfortable with all aspects of the opportunity.”
Indeed, 16 percent of respondents said they had been forced to abandon fundraising as a result of the covid crisis, while another 20 percent said they had been forced to press pause. Only 28 percent claimed that fundraising had been unaffected, bar the need to meet virtually. The largest contingent, at 36 percent, said fundraising had continued, albeit at a slower pace.
Meanwhile, non-institutional investors, such as family offices and wealthy individuals, continue to be the most fruitful for emerging managers raising funds, and by some distance. “Family offices have a willingness and ability to get their heads around managers that don’t necessarily check every single box,” says McCormick. “Many may have been doing direct deals for some time already, so they tend to be more comfortable with newer managers than more rigid programs.”
However, McCormick adds that there are a growing number of endowments and foundations with active emerging manager strategies.
“Selectively, we see these foundations and endowments revamping their programs,” he says. “There are a number of them out there that are willing to spend time on emerging managers as they seek to re-set their portfolio of relationships.”
“We typically find that our public fund and endowment and foundation client base has the greatest appetite for emerging managers,” adds Wallace Stone. “Many of them have explicit goals with respect to supporting emerging and diverse-owned asset managers. In addition, many of them have staff dedicated to these initiatives.”
Meanwhile, Spencer believes the potential pool for investors is wider still.
“Family offices, high-net-worth individuals and insurance companies with an alpha orientation are the most likely to back an emerging manager,” he says. “Private and public pensions also use emerging manager programs as an incubator for future manager additions to their core programs.”
There is no doubt that emerging managers continue to play a key role in the private equity strategies of a range of different investors. And with good reasons.
“The emerging manager space is less penetrated, which offers greater potential for attractive returns,” says Patricia Miller Zollar, head of Northbound Equity Partners, Neuberger Berman’s specialist emerging manager business.
“They can act as feeder relationships for future core positions and may serve as a complement and diversified source of return to a traditional private equity program.
Emerging managers are also more likely to have a niche and specialized investment focus and there can be additional benefits in the form of access to smaller companies, often with more attractive valuations and with less leverage.”