Oxygen flows freely to sub-$1 billion funds

Consider that in both 2007 and 2008 U.S. sponsors targeting less than $1 billion ended up raising just 12 percent of the total capital that was raised during those years, overshadowed by mega-firms and large-market shops. By contrast, even as big shops returned to market these last two years, firms targeting less than $1 billion captured a far higher 19 percent of the money raised in both 2012 and 2013. The figure is 18 percent year-to-date.

Here is another way of looking at it. U.S. sponsors targeting less than $1 billion raised $30.6 billion last year. That is exactly the same amount as they raised in 2008. Yet last year U.S. buyout and mezzanine firms raised $185.8 billion overall, far less than the $263.6 billion raised in 2008. 

“We’re definitely seeing an increase in demand for smaller funds,” said Justin M. Garrod, managing partner of placement agency Stonington Capital Advisors, which specializes in raising sub-$1 billion funds for clients. He said the sector is viewed by investors as less competitive and therefore less pricey, and as very accommodating when it comes to offering co-investment opportunities. Also, he added, ”the small funds have outperformed the larger funds,” although the subject remains up for debate.

All told, U.S.-based sponsors of buyout and mezzanine funds took in $95.9 billion in the first half of the year, up from $79.1 billion at this time last year. (By July 4, the year-to-date tally had already crossed the $100 billion market, as shown in our Market-at-a-Glance feature.) The industry is easily on pace to pass the $200 billion mark this year. The last time that happened was the financial crisis year of 2008.

U.S. buyout shops took in the vast majority of that first-half sum, $93.9 billion, versus just $1.9 billion for mezzanine shops. Sub-categories that continue to be popular include energy funds, which captured an estimated $13.9 billion in the first half of the year, and distressed debt/turnaround funds, which captured $13.3 billion.


A lot of the fundraising action in the first half took place at the small end of the market.

Institutional investors like TIAA-CREF and UPS Group Trust continue to add smaller names to balance out portfolios built on a foundation of large-cap and mega-funds. Other LPs with a known appetite for small-cap buyout funds include California State Teachers’ Retirement SystemPublic Employees Retirement Association of New Mexico, and Queensland Investment Corp, while a host of funds-of-funds managers have made this sector a specialty, including Bowside Capital, Muller & Monroe Asset Management, RCP Advisors and Twin Bridge Capital Advisors.

Jon Madorsky, a managing principal at Chicago-based RCP Advisors, said the lower end of the middle market has not felt as susceptible to booms and busts in fundraising as at the top end. It is certainly true for his firm, which has fairly consistently deployed $200 million to $300 million per year in sub-$1 billion buyout funds since 2001. “Our appetite doesn’t ebb and flow like other folks,” Madorsky said.

The firm has held “significant closes” on both its ninth fund of funds, targeting $250 million, and its second co-investment fund, targeting $200 million, Madorsky said. Both are expected to close this fall. The firm also raises dedicated secondary funds.

The Winter 2013-2014 edition of Coller Capital’s Global Private Equity Barometer, based on a survey of 113 institutional investors, found more than 40 percent planning to increase commitments to North American mid-market buyout funds over the next two to three years, and nearly 40 percent planning to increase commitments to North American small buyout funds. Just 10 percent or less planned to reduce their exposure to such funds. By contrast, only about 15 percent said they planned to increase exposure to North American large buyout funds over the next two to three years. Some 40 percent planned to reduce such commitments.

Among significant closes among sub-$1 billion funds in the second quarter, Marlin Equity Partners of Los Angeles followed up the close of its flagship fund at $1.6 billion last year with the close of a $400 million fund aimed at lower mid-market companies. The firm easily beat its $250 million target and said it could have raised as much as $1 billion. The fund is earmarked for companies operating in technology, business services, healthcare, consumer products and manufacturing.

Prophet Equity, a Southlake, Texas-based shop that specializes in improving the performance of underachieving companies, closed its second fund at its hard cap of $345 million. Backing came from Danske Private Equity, Dartmouth CollegeIndustriens Pension and RCP Advisors. CapStreet Group of Houston got approval from LPs to raise the hard cap of its Fund IV to $340 million from $325 million to accommodate a last-minute re-up. The fund is earmarked to buy companies with enterprise values of less than $150 million. River Cities Capital Funds, of Cincinnati and Raleigh, North Carolina, reached its hard cap of $200 million in April on its Fund V, ahead of its $150 million target. Its placement agent was Thomas Capital Group. The growth-equity investor targets such sectors as enterprise software, software-as-a-service, healthcare services, medical devices and business process outsourcing.

One Rock Capital Partners LLC of New York demonstrated what it took to raise a debut fund, securing $432 million for a fund earmarked for lower mid-market investments in North America. Backing came from strategic investor Mitsubishi Corp, as well as New York State Common Retirement Fund. Greenhill was the placement agent.

Blue Sea Capital, a Palm Beach, Florida-based spin-out from a winding down Brockway Moran & Partners, beat its $270 million target with a $312 million final close. Lazard assisted in the fundraise. Varsity Healthcare Partners, based in Los Angeles and started by former executives of Aurora Capital and Enhanced Equity Funds, closed its debut fund at $240 million.

Turnaround, Energy Funds

Institutional investors also backed plenty of $1 billion-plus funds in the first half, while they continued to show plenty of love toward turnaround and energy funds.

All told, buyout sponsors with fund targets of $1 billion to $4.99 billion secured $50.6 billion in the first half of the year, capturing 56 percent of the total pie. Those targeting $5 billion or more took in $24.0 billion, or 26 percent.

Among titans that added assets under management in the second quarter, The Blackstone Group of New York secured $5.6 billion for its Tactical Opportunities Fund. The pool is earmarked for a range of investment strategies, including private equity, real estate, credit and energy. Boston-based Bain Capital reached a final close of $7.3 billion on Fund XI—a significant sum to be sure, though short of the $10.7 billion raised for its vintage-2008 predecessor. Backing came from Maryland State Retirement and Pension System, Pennsylvania Public School Employees’ Retirement System and Tennessee Consolidated Retirement System. Thoma Bravo of Chicago cruised past its $2.5 billion target to secure $3.65 billion for its Fund IX; the pool is earmarked for software and technology buyouts.

Sycamore Partners, which often invests in distressed companies or underperformers, closed its second fund at $2.5 billion, more than double the size of its $1 billion debut fund. One of the veterans in the turnaround business, Littlejohn & Co, beat its $1.5 billion target with a $2 billion final close of Littlejohn Fund V. Among its backers: Maryland State Retirement and Pension System.

American Securities, based in New York, closed its third turnaround fund at its $1 billion hard cap. Backing came from Los Angeles City Employees’ Retirement System, Louisiana Teachers’ Retirement System and Massachusetts Pension Reserves Investment Management. At press time Z Capital, of Lake Forest, Illinois, said it had closed its latest turnaround fund at $750 million, 50 percent ahead of its $500 million target. New Mexico Educational Retirement Board was a backer.

On the energy front, Energy Capital Partners turned the tap off its latest fundraise at just more than $5 billion, well above its $3.5 billion target. Backing came from, among others, California State Teachers Retirement System, Florida State Board of Administration, Los Angeles City Employees’ Retirement System and the New York State Teachers’ Retirement System. UBS Securities was the placement agent on the fund.

The fundraising outlook for the rest of the year looks bright, and energy funds look poised to play a big role.

Thomas H. Lee Partners of Boston is likely to be raising money, although it is not expected to raise anywhere near the $10 billion secured for its predecessor. Look for a target of $3 billion and a hard cap in the neighborhood of $5 billion, as reported in May by Buyouts.

Among other significant fund launches in the second quarter, Hellman & Friedman, of San Francisco, hit the market seeking just less than $9 billion for its eighth flagship fund; Riverstone Holdings, which closed a $7.7 billion energy fund just last year, has been talking to LPs about a new one with an $8 billion target; Blackstone Group is expected to hit the market later this year to raise a second energy fund; and a branching-out Trilantic Capital Partners, carrying on the torch from Lehman Brothers Merchant Banking, said it plans to raise up to $500 million for its first energy fund.

All told, U.S.-based buyout and mezzanine sponsors have collected $206.5 billion of the $302.8 billion they seek, by our estimates, leaving nearly $100 billion left to raise. Add in firms expected to launch in the second half and the fundraising market has plenty of room to expand. That said, not everyone experiences the fundraising market in the same way.

While describing a generally strengthening fundraising market, Sajan Thomas, founder and president of Thomas Capital Group, sees a crowded field of contenders divided three ways. There are the hot funds with “folks waiting in lines” to re-up, he said; strong but not widely known funds that still take 18 to 24 months to raise, and marginal funds that won’t reach target.

Said Thomas: “I still think there are a lot of funds that are not going to get raised or will raise significantly less than they would like.”