How emerging managers are defying the downturn

Raising a debut fund is tougher than ever, but market dislocation could cause more managers to set up on their own.

The pandemic was brutal for emerging manager fundraising, but there are indications that the pressure is easing – at least temporarily. The average time taken to raise an emerging manager fund stands at 11 months, according to the sixth annual Buyouts Emerging Manager Survey, conducted in partnership with Gen II Fund Services LLC. This is compared with 19 months a year earlier. 

A spate of US debutantes appears to have taken advantage of this window of opportunity. Former TPG Growth duo John Bailey and Shamik Patel’s new outfit Knox Lane, for example, closed its inaugural buyout offering on $610 million in March 2022. The mid-market consumer and services fund closed above its initial target of $500 million and hard-cap of $600 million, despite having launched the offering in March 2020, which Bailey describes as being “right in the teeth of the pandemic.”

“In a business that is all about relationships and long-dated capital, it is hard not to be able to shake hands,” Bailey says. “But we had high conviction in the team we had assembled.” 

According to GP respondents to the survey, family offices and wealthy individuals are the most prolific investors in emerging manager funds, with institutional capital proving harder to attract. Knox Lane, however, was able to secure commitments from pensions, insurers, foundations and funds of funds, once the fundraising market reopened during 2021, having spent much of 2020 working on its deal pipeline. 

“That helped us put points on board and shine a light on the firm’s strategy,” Bailey says. Mid-market industrials investor GHK, meanwhile, went one step further, completing two investments on a deal-by-deal basis, in order to build a track record independent of founder Gil Klemann’s former shop, Goldman Sachs. 

Those deals included an investment in Hasa, a company that produces chemicals to treat pools, in 2020, and ITS Logistics in 2021. GHK then used its third deal, Auveco, a distributor of fasteners to the automotive body hardware aftermarket, to seed its maiden fund.

Other 2022 emerging manager fundraising success stories include HighPost Capital, founded by consumer veteran David Moross and Mark Bezos, which sealed $535 million for consumer-focused investing, despite spiraling inflation and intense pressure on consumer spending. 

HighPost was able to secure capital from institutions and endowments, but, as with so many emerging managers, family offices and high-net-worth investors were key. Indeed, the firm boasts Amazon founder Jeff Bezos – HighPost’s founder’s brother – among its LPs.

Meanwhile, Patient Square Capital – a firm led by former KKR healthcare specialist Jim Momtazee – is purported to be on track to raise the largest first-time fund in history, with a $4 billion target. That is not to say that emerging manager fundraising is easy, however. GP respondents to the survey report a wide range of challenges, including the persistence of remote fundraising and the difficulty in staying on investors’ radars in a market dominated by re-ups. 

“Emerging managers have always faced the challenge of differentiating themselves,” says Joe Benavides, managing partner and co-founder of OceanSound Partners, which closed its debut this year. “But with the pandemic, you then had the additional challenge of established managers coming back looking for big capital increases with their follow-on funds. It has not been unusual to see firms looking for double what they had raised before. The differentiation you need as an emerging manager is therefore greater than ever.”

“LPs are often so tied up with re-ups that they don’t have the bandwidth to review new relationships,” admits Paul Newsome, private equity partner and head of portfolio management at Unigestion. “The biggest challenge that emerging managers face is cutting through that noise to get in front of potential investors.” 

One way to ensure a firm’s profile is raised in such a congested market is to hire a respected placement agent. Indeed, Benavides says he cannot imagine having embarked on the emerging manager journey without a placement agent in tow. 

“Having a placement agent was monstrously helpful for us,” he explains. “There are so many plates spinning for a first-time manager. You are hiring people; setting up the back office; working on sourcing and execution. You need that added support reaching out to new LP relationships.” 

Perhaps surprisingly, then, less than half of emerging manager respondents to the survey – 42 percent – utilized a placement agent’s services. 

Getting more complicated

In addition to the challenges associated with attracting attention in a market dominated by established firms, Benavides says it is simply more complicated – and expensive – to launch a manager today than it would have been in the past. 

“Diligence requirements have increased materially, including ESG and DE&I issues, and it is harder for young firms to have all the infrastructure and systems they need in place,” he explains. “You typically have to have more people on board from the start.”

The survey found that 44 percent of emerging managers have more than 11 people working for the firm, more than double the 21 percent with the same level of employees two years ago. 

Neither bureaucracy and expense, nor macroeconomic turmoil and fundraising headwinds, are likely to deter other private equity professionals from setting their sights on going it alone, however. Indeed, there is an argument that periods of dislocation lead to a spate of new entrants.

“In more difficult times, such as after the global financial crisis or the dotcom bust, private equity professionals tend to reflect on what the carry payouts from their existing programs are likely to be, and, if they have entrepreneurial ambitions, they may decide it makes sense to set up on their own,” says Carolina Espinal, managing director at HabourVest. “We anticipate seeing an increase in emerging managers in the coming years.”

Scott Reed, co-head of US private equity at abrdn, says: “Logic suggests that a positive economic environment would be a good time for GPs to hang out their own shingle and start something new. 

“But we also see new fund formation during periods of market dislocation when some GPs may feel their existing portfolio is challenged and there are better opportunities to be found starting afresh.”

“At the same time, one of the major attractions of backing younger firms is performance potential. And in periods where returns across the asset class are coming under pressure, investors may be willing to step out on the risk spectrum to get those returns from emerging managers.”