As this year draws toward a close, it’s easy to assume that 2005 will be remembered for, among other things, the vast amount of money pouring into private equity funds. But, for the most part, unless you are an existing and established buyout fund, little to none of this fund allocation bonanza will have passed your way. Europe’s venture capital funds, for example, didn’t get much of a look in. The fact that so many new funds, especially those European venture capital funds spawned in the 1999 to 2001 bubble, didn’t deliver value has added to the perception of risk associated with anything new, perhaps helping to explain part of the current appeal of tried and tested European buyout groups to institutional investors.
This is probably why, over time, would-be new LP private equity and venture capital fund managers have tried to tap the sometimes more receptive and forgiving public markets. It was, after all, the public markets that encouraged the creation of so many publicly-listed accelerator funds during 1999 and 2000. Today, the talk of SPACS (specified purpose acquisition companies), coming from the US to London, which enable funds to be raised for investment in companies within a specified sector, so long as those funds are invested within an 18 to 24 months timeframe, could be viewed as just the latest private equity fund raising away from the private institutional market.
It’s undeniable that raising money from institutional investors is difficult if you haven’t done it before even if you are part of a favoured grouping (recently European buyout firms), primarily because ‘new’ and ‘non-mainstream’ are automatically percieved as risky.
But there are some emerging managers who have managed to break through that initial resistance. Interestingly enough, the limited partners we polledd appear to have a fairly liberal stance when it comes to new funds. Specifically most said they would consider several different types of emerging managers including; spinout groups where the main change was independence from a parent institution, a group of individuals spinning out from an existing private equity firm, a fund with an established track record that is breaking into a new geography or subset of the private equity asset class and individuals coming together for the first time formally to launch a new fund. No specific caveats prevented or encouraged investment in specific type(s) of new funds and most had either a policy or programme to invest in new funds.
Of course as any first time fund will tell you, having a theoretically open mind is often the end of the story as well as the beginning. But the hurdle for first time funds is high; every time an institutional investor looks at a new manager the amount of due diligence is going to be higher and therefore both more time consuming and expensive than to give more money to one of its existing fund managers raising a next generation fund.
Despite this, Serge Raicher at fund-of-funds and secondary investor Pantheon Ventures, alludes to the fact that his firm, for one, wouldn’t feel it were doing its job if didn’t engage in this process with new fund managers seriously. “We are very often, in an informal manner, consulted by would-be new managers; this happens across all our offices worldwide. We think that is part of our role, to informally help people. It’s part of securing access [for our LPs] and helping proper credible funds to be formed,” says Raicher. He points to CVC Asia, Golden Gate (in the US) and Altor (Europe), as evidence of new fund raisings Pantheon supported. Raicher goes on to say that had Pantheon passed on those new funds, it’s possible that it would never have gained entry to them, based on their success.
While this sounds rather neat, the reality can be somewhat less so. Raicher says: “We would never suggest to a team that they spin out. If people are considering [it], we would talk to them. We would respect [all parties’] confidentiality; you can break that confidentiality once and you are off the market because people don’t trust you anymore.” Vincenzo Narcisco, who is responsible for Swiss Re’s European venture capital fund commitments, notes that in the last three years he has committed to 18 funds in Europe (and including Israel). The picture has obviously been pretty bleak for European venture capital fund raising during that period, and Narcisco admits that he is seeing the same, limited number of names appearing in these funds alongside Swiss Re, suggesting that while there is appetite for risk, it’s fairly clearly delineated among the institutional investors. This leads to the supposition that if a non-mainstream or new fund fails to impress this limited grouping, then the outlook is pretty bleak.
In fact placement agents report deducing the likely risk appetite of an institutional investor is fairly easy just from looking at the internal resource and analysis employed, as well as capital under management. Plus, if private equity fund performance is the raison d’etre of an institution, such as a fund-of-funds manager, then, as Raicher points out, being intimately aware of the market is part of the value add to investors.
It would seem that if a group of individuals is hawking the idea of a new fund to institutional investors while still part of a fund, things couldn’t get more awkward or conflicted. In fact many institutional investors say it’s unlikely that this would come as a surprise, as they are often already aware of conflicts and issues within a team and that the break away of part of the group can in fact galvanise the existing firm to address the underlying issues, if they need addressing. They can, for example, be something as simple as a move up the deal size scale when some members of the team would rather continue with the status quo. “I can think of situations where we have been constructive in both helping the new fund by investing in them and by having direct conversations with the remainder, if you want to call them that, to help them tackle the relevant issues,” says Raicher.
Given their sensitivity and the fact that the rate of failure to reaching first close on a first-time fund is, and probably should remain, high, the perception of institutional investors’ support and involvement in first-time fund raisings is likely to continue to lag reality.