There’s been plenty of talk over recent years about how branding can help fund managers with deal origination, fund raising and staff retention. But what about LPs? Now that access to the best funds is becoming an issue in Europe, should investors be building their reputations among GPs? Vicky Meek asks.
What a difference a few months makes in private equity. A year or so ago, fund raising figures remained pretty depressed and most general partners had to fight to get any attention from prospective investors. These days, for buyouts at least (European venture being quite a different story), it seems as though the pendulum has swung right back in the other direction. Barclays Private Equity recently closed a €1.65bn fund in a matter of a few weeks. CVC Capital Partners, BC Partners and Bridgepoint are all expected to make final close announcements over the coming weeks; and all of them are believed to be seriously oversubscribed.
All of these are brand name firms that many LPs have been waiting to commit to for some time. But their experience points to a phenomenon not seen in Europe before. “It used to be that access was really only a problem for LPs if they wanted to commit to, say, a Sequoia Capital fund,” says Hanspeter Bader, managing director of Swiss fund-of-funds Unigestion. “But it has now become an issue across the private equity spectrum. You’re now seeing buyout funds that are two or three times oversubscribed.” Bernd Kreuter, director of private equity at German fund-of-funds Feri, agrees. “Access has really become a key issue over the last six months,” he says. “Of course, it follows a period in which nothing really moved and so you might expect there to be something of a swing in the opposite direction, but this is quite extreme. And I think this situation will continue to a certain extent for some time to come.”
For fund-of-funds, the ability to invest in invitation-only funds is a key selling point to their own investors and so it’s no surprise that many have been conducting analysis on the state of the market. Pantheon Ventures is one. “Pantheon has examined its previous fund-of-funds to determine how many of the managers it backed had restricted access,” explains Helen Steers, partner at Pantheon. “In the past, between one half and two thirds of the managers backed by Pantheon were difficult to access for various reasons, but going forward we estimate that at least 80% of our managers will be restricted access.”
Of course, that 80% relates to Pantheon’s future portfolio and not to the private equity industry as a whole, but it illustrates just how competitive the market has become for investors hoping to commit to what they perceive to be the best funds. In an environment in which a fair proportion of GPs are able to pick and choose which investors they want in their funds, LPs increasingly have to work hard to get the allocations they want. But they are also having to pay ever more attention as to how they are perceived by the GPs they want to invest with. We’re all very familiar these days with the concept of GP branding. But are we moving to a stage where LPs will have to devote time and effort into establishing and building their own brands?
If the experience of US state pension fund CalPERS is anything to go by, and as the world’s second largest private equity investor it should be, the answer is a resounding yes. “CalPERS commissioned a study to see how we could improve our brand as we wanted to be considered as an intelligent investor and not just one with the ability to write large cheques,” JonCarlo Mark, a member of the CalPERS private equity investment team, said recently at a conference. “The access problem is not just restricted to the venture capital groups, it is now happening in buyouts and we want to make sure we are making the right calls and being a value-added LP.”
Of course, one of the reasons CalPERS has for being concerned about its reputation in the GP community is its disclosure of fund information under the state’s Freedom of Information Act. Yet the fact Mark mentions CalPERS’ desire to be perceived as an intelligent investor able to bring more to the table than large amounts of money is quite telling about its motivations for commissioning the study. Plus, it’s not just CalPERS that believes branding has become an important element of being a successful private equity investor. “Just as we have seen a flight to quality amongst LPs for the best funds, it’s also working the other way around,” says Steers. “For those funds in which access is an issue, we’re seeing a flight to quality LPs among GPs. Fund managers are picking investors that have a long-term view and with whom they have built good relationships, so they know exactly where they stand. As a result, brand is becoming important for fund investors.”
As a demonstration of how important LP reputation has become, one mid-market firm, which recently closed an over-subscribed fund, put together a seven-point checklist against which it measured the attractiveness of potential LPs. The points included the obvious one of how much capital investors had to invest, but others were based on the firm’s perception of particular LPs: Did they have a long-term commitment to the asset class? What kind of reputation did they have (i.e., were they difficult investors, did they seek to make a whole raft of changes to limited partnership agreements)? And how able were they to make decisions quickly and efficiently?
It’s easy for a fund manager to assess these points for existing investors, for whom they will have a preference anyway. For newer investors and those that are seeking to invest with a particular manager for the first time, the issue of reputation is clearly an important one these days.
Making contact with a GP at an early stage is a good place to start, as it will demonstrate an interest in the fund and will help with the ability to make fast decisions about whether to invest or not when the time comes. Indeed, this is how newer investors managed to gain access to Barclays Private Equity’s latest fund. “We went into fund raising with the view that we wanted to broaden our investor base,” explains Brian Blakemore, head of investor relations at the firm. “But it quickly became apparent that it was going to be difficult to admit new investors because appetite among our existing investors was so strong.
“In the end, we were able to offer allocations to a small number of new investors. These were ones who had been proactive in keeping in touch with us before we launched the fund raising. They had also been prepared to commit time and resources to doing due diligence, even if there were no guarantees that they would get an allocation, so that they could move quickly when the time came.”
It’s an approach Unigestion understands well. “In the last 12 months, we have gone into two lower mid-market funds that were around four-times oversubscribed,” says Bader. “We had to work hard to ensure we’d get a seat at the table. One was a first-time fund and so we weren’t competing with existing investors. With the other we had to start building a relationship two years in advance of their fund raising.” This approach will also help with another phenomenon we’re witnessing in Europe for the first time; funds so confident of attracting commitments that don’t even produce marketing materials. “Some funds have come so far that they don’t even send out PPMs any more, whereas a year or two ago, no one would have considered raising a fund without one,” says Kreuter.
All this means LPs have to be increasingly proactive if they want to get into the best funds. They need to know who’s coming out when and keep open lines of communication months, if not years, in advance of the fund launch. “LPs need to do their market research these days,” says Blakemore. “They need to have a clear idea about who they think are the top performers, get in touch with them early on and work on persuading the GPs that you are the right partner for them. If you wait until the fund raising process, it’s usually too late.” On the surface, this may not sound much like building a brand. But in many senses, it is. Being proactive and contacting GPs early gives them, and potentially the wider market, the impression that you are a switched-on investor.
Maintaining a good reputation in the market will also rely on having the right resources on board; not having enough experienced people to devote to private equity could be damaging. “Many LPs are capital-rich but staff-constrained,” says Doug Miller of International Private Equity, the placement firm that helped Barclays Private Equity raise its fund. “They are also often the ones that have investment processes set up in such a way that they can’t respond in a reasonable time frame.”
Allied to this is the issue of efficiency. We’ve all heard horror stories of LPs not reading documentation in advance of meetings or taking four meetings with fund managers that specialise in, say, Central and Eastern Europe, who then turn around and say they’re not interested because they only invest in the US and Western Europe! Making seemingly irrelevant information requests is another GP bugbear. As one investor relations professional puts it: “Sometimes you wonder whether investors are in a competition to see who can ask the most obscure question.” This kind of time wasting helps no one, least of all the LP because word gets around quickly in an industry as small as private equity. “In today’s environment, it’s important for LPs to make it clear to the market what they stand for,” says Bader. “Don’t waste GPs’ time. Be upfront about where you invest and about what you like and what you don’t like. It’s not always easy to say what you think, but most GPs will appreciate your honesty.”
But beyond being efficient and proactive, one way in which some LPs have sought to build on their reputation is by positioning themselves as a value-added investor. CalPERS is one such LP and Steers says Pantheon is another. “LPs with experience can add value. We find that, especially with newer groups, we can help them position themselves in the market, help shape certain aspects of the team and give guidance on investment strategy.” LPs can also be a useful source of information about broader market trends that GPs, who tend to work in specific areas, may not know about. And they may be able to provide advice on best practice investor communication.
Some GPs remain sceptical about how exactly an investor can add value, but there are others that believe the potential can occasionally be there. “I’m not sure LPs are able to add value in many circumstances,” says Blakemore. “But we have seen examples where investors have been able to introduce portfolio companies to contacts in their networks and that can be pretty helpful.”
For years, there have been a few “must-have” investors that GPs believe give them kudos and offer some kind of endorsement of their fund. Naming certain existing investors to prospective LPs has helped in their fund raising efforts, for example. But what is new is the importance of an LP’s reputation in its ability to access funds in an increasingly competitive environment. In some cases, private equity fund raising is as much a case of GPs vetting prospective investors as it is the other way round. Some investors even talk now in terms of “marketing” to GPs and of having a “proven track record of investing in private equity”. That’s quite some shift from a few short years ago. And something else has changed, too. “Six or seven years ago, if we’d gone out for dinner with fund managers to discuss how their portfolio was doing, it would have been the GPs picking up the restaurant tab,” says Bader. “These days, it’s us.”