Many funds hitting the market over the past few months include a provision that is reflective of the tough capital raising environment: limited partner agreements have extended fundraising deadlines out to 18 months or more, sources tell Buyouts.
The provision is the result of private equity GPs facing the reality that fundraising is taking longer than ever. Even if ultimately a fundraising process doesn’t take 18 months, the provision gives GPs a cushion to deal with the tighter market, sources said.
“The fundraising market is brutal now. There’s a lot less shame in a sponsor saying, ‘We need more time to fundraise than in the past’ – sponsors are less self conscious about it,” said Stephanie Srulowitz, a partner in Weil’s US private funds practice.
Fund contracts set deadlines on fundraising to ensure that GPs don’t spend too much time on the road, focused on raising capital and not on investing. After the contractual deadline, LPs usually have the ability to force a GP to stop fundraising, or grant extensions. In the tougher fundraising market, more GPs than ever have been asking for, and been granted, fundraising extensions to try and hit their targets.
The deadlines are set on a time frame running from first close to final close. The market for many years has been 12 months, with the ability for GPs to extend that out further, either with or without LP consent (or a combination of both).
New contracts have extended that out to 18 months or longer, according to numerous sources that include limited partners, fund formation attorneys and GPs. The provisions come in the form of a straight 18 months from first to final close, plus the ability to extend on top of that. Or, contracts have also called for a 12-month deadline with a six-month extension at the GP’s discretion, Srulowitz said.
“It is no doubt a challenging fundraising environment for GPs these days. Fundraising timelines have extended out to 18 months from launch to final close, with some funds even extending out to 24 months. In this type of fundraising market the needs/wants of GPs and LPs diverge,” said John Bradley, senior investment officer with Florida’s state board of administration who is responsible for the system’s private equity program.
The contract provisions come as GPs are taking longer to raise their funds. This year, through June, fundraising timelines lengthened to an average of 16.6 months, from 10.6 months, to close funds, according to Buyouts’ data.
The longer slogs come as private equity fundraising continues to decline. North American private equity funds raised $228 billion in the first half of the year, down 26 percent in the prior year, according to research from Buyouts. Fund closings during the period dropped 45 percent, to 347, Buyouts reported.
Equal footing
Longer fundraising processes can present challenges for GPs to make sure all LPs in a fund remain on equitable footing, according to Kari Harris, chair of the investment funds practice at Mintz.
This issue is becoming more pronounced as more LPs commit later in a fundraising process. Bradley said many LPs are waiting beyond the first close, to see how the fund performs, before making their decision to commit.
“For GPs, the ability to have a meaningful first close is critical to driving demand and creating momentum towards a final close. For LPs, there is no incentive to participate in a first close. If a GP will be in market for 18 months, LPs are correctly deciding to wait for the fundraise to reach a critical mass and taking time to see what the first few deals look like,” Bradley said.
LPs don’t get to hold out on their decision for free, however. Those that commit to a fund later in the process, after the first closing, usually have to make their commitment at cost plus a small interest payment to account for value increases in deals already in the fund.
In a 12-month fundraising, this usually doesn’t present a problem as valuations on early investments are not likely to change very much. However, getting up to 18 months to two years, deal values may have started shifting, Harris said.
“In 18 months, you may have had a quick-flip with a strong portfolio company,” Harris said. “It becomes less equitable the longer fundraising draws out.”
LPAs are starting to include adjustments to deal with this possibility, including potentially excluding later LPs from early deals. “Adjustments are being built in giving GPs more discretion,” Harris said.
A few factors could make the issue significant, according to Srulowitz. One is if a key anchor investor is focused on the issue, then the GP is more likely to feel pressure to address it. Another is whether or not a fund begins investing early in the fund life resulting in an extended hold period for certain assets during the fundraising period, Srulowitz said. Finally, significant valuation movement of an asset early on can create pressure to address this issue, she said.
At least one of the factors has become more common in today’s market. Many funds, especially emerging managers, have been pursuing a fundraising strategy by which they seed a fund portfolio as they fundraise, as a way to demonstrate their strategy to potential LPs who haven’t committed yet. While not a new strategy, it’s one that is much more in use in the tougher fundraising market, Buyouts previously reported.
More GPs may also start offering incentives to get investors into the first close, Bradley said. “Most GPs will need to offer incentives to be successful and shorten time fundraising in this market. Even in good fundraising markets GPs have offered fee discounts to first closers in order to get the ball rolling. In this market those incentives (particularly fee discounts) will need to be meaningful.”
Update: This report was updated with quotes from John Bradley, senior investment officer with Florida SBA.
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