With LPs avoiding mega funds that depend on high levels of leverage, there is more demand for mid-market groups with a good track record, says Andrew Bentley, a partner at independent advisory firm Campbell Lutyens. He says: “There may be more opportunities for more conservative houses that perhaps didn’t shine in the bull market but have good defensive holdings and a successful portfolio construction.”
He adds that if a GP can demonstrate the strength in-depth of its team and a good track record over a cycle or two, it should be able to form part of LPs’ core investment strategy. Bentley says: “LPs are saying that they are protecting their capital for that part of their portfolio that is likely to be more successful. This core group is probably about 50% of LPs’ private equity investments.”
A good example of a mid-market house that has succeeded in fund raising in today’s tough conditions is ECI Partners. In December it announced the first and final close of its new fund, ECI 9, just three months after its launch. The fund was closed above the £400m target, at £430m. Its previous fund closed at £255m in 2005. The PE house said it felt it had succeeded because of its track record, investment model and knowledge of investing through multiple cycles.
More than 90% of ECI’s investment was raised from existing investors. The firm specialises in buyouts, buyins and development capital deals of £10m to £150m and has been operating for around 30 years. It seeks to invest in niche, growth markets.
“ECI stands out because it ran its fund raising absolutely to time and raised exactly what it said it needed, in probably the most difficult quarter anyone can imagine,” says Bentley. He adds that the fund was attractive to LPs because the firm’s portfolios have been well balanced, not dominated by consumer-facing businesses and not highly geared. “They offer a well-constructed portfolio and have not taken undue risks,” he says.
Armando D’Amico, managing partner at Acanthus Advisers, says: “If you’re a GP offering a perfect and compelling fund then, just like any other product, there will be people who want to buy.” What this means, he says, is having a good track record, reliable management team and being able to demonstrate experience in tackling issues faced by portfolio companies.
But if LPs have any doubts about a fund, they are unlikely to commit to it in the current market, says D’Amico: “If there’s something that people aren’t sure about, in today’s market that might be enough to spoil a fund raising. It could be something like the management team not having worked for long with each other or the fund having a relatively short track record. A couple of years ago investors would have been more likely to take such things in their stride but now there’s much more caution.”
While much of the fund raising action has moved to non-primary buyout funds, such as secondaries, infrastructure and mezzanine, Bentley says that primary issuance will return as a substantial market and that there is still scope for successful primary fund raising. “The ECI fund raising proves that there is money available for attractive funds, but GPs will have to differentiate themselves even more in demonstrating that they offer high-quality funds. We’re seeing a flight to quality among LPs and that means there will be fewer successful GPs than before. In turn, this poses a major challenge for placement agents because it reinforces the importance of good manager selection.”
Antoine Drean, founder of private equity placement agent Triago, says a third of the money he raises comes from billionaires and wealthy families around the world. In 2005 and 2006 these investors began to pull back from investing in buyout funds because they felt the market was becoming over leveraged and over-hyped. “Now these guys are interested in buyout funds again,” says Drean: “They can see that, with company valuations falling, it’s going to be a good time to invest.”
In attracting such LPs, however, it is very important that the placement agent has the right kind of buyout fund to offer them, says Drean. He notes that there are two types of buyout house. The first includes those that have focused on financial engineering and who didn’t care what they were investing in as long as they thought they could sell it on at a big profit, often after a recap. “For this group of funds it’s going to be a tough market to fund raise in,” says Drean.
The second group, however, will be more attractive and is made up of value-creation funds, led by people who thoroughly understand what they are buying, how to get the business operating more efficiently and profitably, and who use appropriate levels of leverage in their transactions. “Placement agents are keen to work with these kinds of funds because they are what many LPs are looking for,” he says.