Gen II: Shifting dynamics are impacting fundraising for emerging managers

A combination of macro headwinds and competition from established firms is making capital raising an uphill battle for new managers, says Jeff Gendel, principal at Gen II Fund Services.

This article is sponsored by Gen II Fund Services

Jeff Gendel

At this time last year, emerging managers seemed to have survived the challenges brought on by the pandemic and were finally poised to pick up where they left off before it began. LPs were eager to make commitments to new managers, and the fundraising market was robust. 2022 has brought shifting dynamics for emerging managers in this tentative economic environment, and responses to the 2022 Buyouts Emerging Manager Survey from both LPs and GPs indicate that the landscape for private capital fundraising has clearly changed.

Driven by the declining performance of public equities – triggering the dreaded denominator effect – investors are rejiggering their private capital portfolios and initiating a more conservative approach to capital allocations. With established firms coming back to the well sooner than ever before and raising increasingly larger funds, re-ups are absorbing much of the bandwidth of investors.

This is making it difficult for emerging managers not only to get a slice of the pie, but even getting in front of investors can prove challenging. Investor allocations for 2022 are already stretched thin. LPs report that the percentage of their private equity/venture capital portfolio allocated to emerging managers has been cut by nearly a third in 2022. It has become a buyer’s market, with more managers, both emerging and established, chasing less capital.

Fundraising across the board is becoming more challenging, but this is especially true for emerging managers. While LPs are still deploying capital, fundraising timelines are longer, requiring many more meetings and, ultimately, more time to get to the finish line. In 2021, 31 percent of managers said to get from first introduction to signed commitment typically took one to four months; in 2022, fewer than one in 10 were able to secure commitments within such an abbreviated timeline. Far more common, more than half said it typically takes five to nine months.

The good news is that the majority of investors are confident their allocations for new commitments to emerging managers will increase in the next three years. Indeed, the demand is still there. However, in a crowded market with an uncertain economic backdrop, emerging managers face even more scrutiny from potential investors, and a longer timeline for an expected closing of their first fund.

The bar is set high

LPs are always looking to add new managers and want to invest with newly formed firms with genuine differentiation. Anecdotally, many believe GPs are “hungriest” to perform for funds with Roman numerals one through three. At the same time, they recognize the challenges emerging managers face, to not only source investments and create value but to set up a back and middle office to meet their LPs’ rigorous reporting and compliance demands. So, while there is still space for new players seeking capital, the bar is set high.

Two-thirds of the LPs cited superior returns and portfolio diversification as the primary reasons for their emerging manager programs, and almost 79 percent of LPs indicated they are most likely to invest in an emerging manager formed by a team spun out from a larger firm. At the same time, LPs are putting increased pressure on emerging managers when negotiating terms, including discounted management fees, co-investments, and the ability to opt out of certain investments, a provision that doubled from 15 percent in 2021 to 30 percent in 2022.

Whether this is the right approach to position fledgling fund managers to thrive – because they’re certainly not reducing their reporting demands – it underscores the pressures facing new managers. In this more risk-averse environment, it is even more important that emerging managers partner with the right service providers so they can focus on the mission-critical tasks of raising, investing, and growing capital without taking on the back- and middle-office responsibilities that might otherwise create a distraction.

Increased demand for real-time access to accurate, timely information

Given the significant levels of capital invested in the alternative investment space and a larger addressable market of investors, automation, accuracy and transparency have never been more critical.

In the private markets, implementing technology is a requirement to handle not only the increasing volume of investors but the growing complexity of the fund structures. Increased competition is driving next-generation technology to fill a critical role in the fund administration process for emerging managers.

Not only are LPs in the driver’s seat when it comes to capital raising and negotiating terms, but they are also driving trends in fund operations. This is especially true around new technology, which is fast becoming table stakes to facilitate improved onboarding through electronic subscription documents, bespoke and more frequent reporting, and more depth and transparency around performance and attribution reporting as well as portfolio monitoring.

Technology is changing how GPs onboard investors by digitizing the fund subscription process from a labor-intensive, error-prone paper process to an automated, digitized subscription process that is more accurate, reliable and customizable. Utilizing electronic subscription documents not only improves the LP experience, but it also gives fund managers immediate visibility into investor activity and fundraising analytics. This visibility is critical in an environment where the competition for capital is heightened.

As the asset class matures, there will be a sea change in reporting frequency, particularly to the extent managers welcome high-net-worth and accredited retail investors. Historically, reporting is done on a quarterly basis. However, some LPs are starting to ask for more frequent reporting, seeking the same access to information that they have for their public market investments. The adoption of technology will likely be required to accommodate the acceleration in the timeliness and accuracy of information LPs are requesting.

Private equity sponsors are also embracing technology around portfolio monitoring. They’re leveraging data and analytics for real-time insight into how they’re generating returns and using these capabilities to optimize decision-making. With the growth in private equity as an asset class, we are seeing much more demand for data and precision in analytics as sponsors realize that their data is a potential source of differentiation.

Working with specialist fund administrators like Gen II levels the playing field for emerging managers by enabling them to gather and analyze data faster and make it more consumable. Gen II has the tools that give sponsors “corner office” analytics and insight into their portfolios, and a performance analytics platform that offers both a 30,000-foot view of their enterprise or fund as well as granular details at the investment level. These capabilities through Gen II allow emerging managers to offer best-in-class bespoke reporting for LPs that are increasingly demanding transparency, custom reporting requirements, and real-time access to details of their investments, performance attribution, management/performance fees paid, etc.

At Gen II, we believe that investing in technology and investing in people go hand in hand. We look for a balance and try to invest in technology in areas where we can scale, reduce cycle times and improve quality, but also maintain capabilities to ensure that we can administer and manage these complex structures or even enhance the “operational” alpha embedded within them.

Scalability, performance and experience truly matter

The majority of emerging managers start their life with an administrator relationship. Given the increased complexity of fund structures, escalating stakeholder expectations, and complex regulatory requirements, it is vital that emerging managers team up with a provider that can demonstrate relevant and specialized experience. Equally important considering the long-term nature of these relationships, is a commitment to technology investment, team continuity, and the ability to scale with clients.

Gen II has helped launch more than 100 emerging managers. We have partnered with them to build a strong foundation for success, and help them scale as they add new funds, LP types, geographies, and even alternative strategies – from every flavor of PE to private debt and real assets. The private equity entrepreneurs we work with value the confidence our experience imparts, and they can trust their funds will be well-run.
For the remainder of 2022 and beyond, the survey reflects that while capital raising for emerging managers is temporarily decelerating, it appears poised for continued growth over the long term.

However, lower capital allocations, economic uncertainty and hesitation to take on greater risk are causing LPs to be more selective and take longer to evaluate emerging managers. A highly qualified set of professional service firms – fund administrators, auditors, placement agents, compliance consultants and attorneys – with deep experience supporting first-time funds will continue to be vital to the emerging manager’s success.