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LP profile: Capital Dynamics tunes vetting strategy

Wonder what manner of grilling you’ll receive from potential LPs next time you approach them with cup in hand? Look no further than Capital Dynamics, which has adapted its due diligence strategy to changing market conditions.

In light of the collapse of credit, and a recession that’s stretched on for months, the Zug, Switzerland-based fund-of-funds manager says that it is placing a greater emphasis on the following:

• Relationships that a buyout shop has cultivated with banks;

• Operational and strategic talents of the partners; and

• Quality and diversity of a buyout firm’s limited partner base.

Capital Dynamics, which typically makes commitments of $10 million to $100 million to between 35 to 40 private equity managers a year, believes the leveraged loan markets will stay challenging for some time, according to Managing Director Katharina Lichtner.

And in a leverage-starved environment, the adviser knows that it takes quite a bit more work to get financing packages together.

These days, Lichtner said, fund sponsors must have well-established, long-standing relationships with banks, particularly local banks healthy enough to step up to the plate to finance mid-market transactions.

Capital Dynamics has also stepped up its focus on the operational skills of fund managers. Lichtner, for example, said that she wants to know how many people on an investment team have such experience, and whether they’ve run companies during an economic crisis. She says she’s particularly drawn to firms that have developed a network of outside executives—experienced managers who are on call to join boards or to replace senior management during a crisis. Having such a network gives sponsors the ability to solve problems in their portfolio, while also having the time to continue sourcing investments.

“It takes much more flexibility, creativity and experience to generate value going forward than it took in the last cycle,” Lichtner said.

Capital Dynamics manages more than $20 billion on behalf of institutional investors, largely through separate accounts, and it annually commits $5 billion to $7 billion to private equity funds. About 55% of its commitments go to U.S.-based firms; 40% to European firms; and 5% to firms operating in Asia and elsewhere. About half of the investments target small and mid-market buyout funds worldwide.

The firm raised its sixth-generation fund of funds with $596 million at the end of 2007. —Nancy Gordon