Constrained by investors that are still nursing badly burnt fingers from the technology crash, most of the large European buyout firms have gone out this year with funds that are 10% to 20% larger than last time. In the context of longer-term shifts in asset allocation, which are fuelling a very healthy appetite among institutional investors, these figures look modest.
A consensus seems to be emerging among investors within each sector of the market about ideal fund sizes. In the current round of fundraising, the largest funds are being capped at about €6bn, either by the fund manager or by the major limited partners.
“Some groups have a very strict cap written into their fund documentation; others will raise as much as their investors permit them,” said Jonathan de Lance-Holmes, a fund formation partner at Linklaters. “There is still pressure from the bigger investors limiting the size of funds in Europe, this is not a question of formal cap but rather what the LPs see as appropriate.”
Given current market competition, the ability to generate and maintain the impression of fundraising momentum is critical. The distinction between premier top-quartile names and weaker counterparts can be gauged by the amount of time funds spend in the market.
The very best of breed in each segment will have their fundraising completed in a couple of months. Indeed, most of it will be soft-circled before they even hit the market. Recent examples of this include, Barclays Private Equity, which took less than two months to raise its latest €1.65bn vehicle; EQT Partners, which took six months to raise €2.5bn, and BC Partners, which raised over €5.5bn in five months.
Pitching terms and conditions correctly is a major consideration for others looking to join this select club. It is one thing to be confident if you are convinced you are in the top quartile. In the eyes of investors, there is a very fine line between bullishness and arrogance, however. If the manager gets it badly wrong in the initial pitch, the market can be unforgiving when the fund returns with concessions.
The situation was summed up by Jason Glover, a partner at Clifford Chance. “Limited partners are actively marketing to less than 25% of the total funds in the market,” he said. “Since LPs are fighting to get into these funds, there will be very little time lag between launch and final closing. Most of the other vehicles will have to make concessions to get their fundraising programmes completed.”
For some funds, there is a disjoint between how they see their ranking and the view of the market. These are the vehicles that will go to investors with aggressive terms, a very high target and a “take-it-or-leave-it” approach. If investors don’t share this exalted view, the firms are likely to struggle to regain momentum. Industri Kapital, Doughty Hanson and 3i all fared badly in this respect during their previous fundraising efforts.
And this is not the full extent of the story. “The number on the front cover of the PPM only shows 80% of what [funds] are really after; they need to create the impression that demand is exceeding supply,” Glover said.
There seems to be very little debate about the core economic terms of new fundraisings. The carry split remains 80/20, and fund management fees are fluctuating between 1.5% and 2% of total commitments.
“At the moment, the market is driven by multi-generational buyout funds coming back to the market with fund five or six,” said Geoff Kitteridge a partner at US law firm Debevoise & Plimpton. “In these circumstances, terms tend to be stable and LPs find it difficult to rock the boat.”
The debate has thus shifted to more peripheral concerns, the two most pressing of which are succession issues and the impact of Freedom of Information Act legislation in parts of Europe and
Succession planning is reflected in a greater use of key-man and no-fault divorce provisions in newer vehicles. These details have been given real
teeth as they rise to the fore of investors’ concerns.
Glover at Clifford Chance believes that a tightening of key-man provisions benefits both sides. “If the LP is not happy with the team, it wants to know that it can remove the manager,” he said. “For managers, they do not want it used as a tool to renegotiate the core terms in favour of the investors.”
The Freedom of Information Act cases in the US and the potential impact of FOIA suits in the UK mean that confidentiality provisions have also been a greater feature of this fundraising round.
The key clause here is that LPs are unable to release confidential information about fund investments unless expressly required to by law. Fund managers are most concerned about disclosure of information at portfolio company level, which may prove detrimental to the financial performance of the fund.
There is also added emphasis on due diligence, as investors’ fiduciary duties drive them to conduct their own research in support of decisions. Gone are the days when funds could rely on a wave of “me-too” cash after big-name LPs had signed up for the first closing. Investor relations departments have certainly bulked up to square this circle.