European buyout firms, generally, are having a good time in the fund raising market of late. This is evidenced not just by a healthy investor appetite to commit, but the record time, as little as three, four and five months have been stated, that many of these funds appear to have been raised in. But is this race to the finishing post a reality or illusion? The answer is, probably a bit of both.
Two things have changed in the market in recent years, the first being the impact of the near closure of the private equity fund raising market post the 1999/2000 bubble, and the second being the emergence of the dedicated investor relations professional within private equity firms. Each has had an important impact on the way firms go into the market to raise funds.
The result of the near closure of the private equity fund raising market in 2002/2003 was that a great many firms’ fund raisings, either in reality or in the planning stage, lapsed into a semi-comatose state. Those that had ventured into the market were often offered soft-circled commitments that LPs promised to firm up near to closing, but with everyone waiting for someone else to go boldly many private equity firms got stuck in the chicken/egg situation and ultimately had to retract from the market. Understandably LPs didn’t want to commit extensive due diligence time and run up a fund raising that might never go anywhere.
The end result, now the fund raising market has come back, for buyout funds at least, is that everyone is perhaps over-sensitive about how long it takes them to fund raise and out of that it appears speedy fund raisings have gained kudos. And so, the quicker you reach completion, the higher the kudos.
“If a fund [raising] is around for more than six months, people start to think there’s an issue. Whereas in the 1990s it was typical to take 12 months to get to the first close, and then have another 12 months between the first and final closings,” says Janet Brooks, who leads the investor relations’ function at ECI Partners.
“I think that years ago people used to go out there with a fund raising and the first people heard about the fund raising was the day that you effectively launched,” says Jonathan de Lance-Holmes, fund structuring partner at Linklaters. So fund raising was triggered by the arrival of the private placement memorandum (PPM) on the desks of investors.
“Once you’ve written the PPM it’s undeniable that you’re in fund raising mode. The bad fund raising market of a couple of years ago made people not want to be out there failing and so a lot of people find out whether they are going to be okay or not under the radar screen,” says Christiian Marriott, investors relations Mezzanine Management.
Philip Bassett, partner in charge of investor relations at Permira, concurs: “The fund raising is off when you send the PPM out, until you have a written proposal you’re not really fund raising.” There is talk in the market that this has resulted in the process being back-ended whereby everything to appear in the PPM is agreed and signed off on in advance of the PPM actually being written.
If firms merely posted a PPM to their investors today, one would wonder what the individual responsible for the investor relations’ function did all day. The investor relations function is expected to keep investors informed about the performance of their current commitment(s) to the firm, and to, if-you-will, warm them up for the next fund raising.
Fund raising in the private market is a highly imperfect process and although investors are becoming increasingly sophisticated, as are the private equity firms in response to this, it’s more of an art than a science and as such always requires a lot of painstaking work that’s not guaranteed to pay off. Philip Bassett, partner in charge of investor relations at Permira, paints the picture: “We had a number of conversations with our advisory committee members, there were two weeks to a month of talking to them and covering the parameters [of the fund]. Then we send everybody a letter to warn them [the fund raising] is coming, and we send them out an information memorandum two weeks later, then they get a pack of due diligence material, then a few weeks later the draft LPA.” Permira held a record closing of its third European fund in 2003.
Warming investors up with a flood of information prior to the launch of the fund is widely termed as pre-marketing. Earlier this year, ECI Partners also closed a speedy fund raising of its eight fund. Janet Brooks, who leads the investor relations’ function at ECI Partners, says: “Pre-marketing involves spending time with both existing and new investors. Initially we spend time with new investors getting us on their list. We would aim to meet them several times over say two years before the official launch, enabling them to respond quickly, which will be key. About six to nine months prior to launch we will really start talking to our existing investors about the new fund, the timetable and any strategy changes to ensure we have their support before we start work on the PPM. So we’re starting the whole process up to two years before the launch.”
One reason to get things under way so early is the sheer task of the job at hand. “A new investor reads the partnership agreement from beginning to end. It takes time and effort to get a new investor up a learning curve. With existing investors there tends to be three or four points up for discussion, but a new investor can come in with 20 pages of lawyers notes,” says de Lance-Holmes.
“However easy it is to raise money, and I don’t think it is, it’s still a hell of a process. In the old days the IR guy and the managing partner would go around meeting people. Now investors meet the whole team, representatives from different levels of the organisation to find out the depth of the organisation,” says Philip Bassett.
So it makes sense to get new investors on side early so they don’t hold up the fund raising process. But that’s only part of the battle, once the fund raising is launched there needs to be a sense of urgency for both existing and new investors to sign up.
In Permira’s case, for its third European fund, the sense of urgency had the classic carrot and stick approach. Rather than it simply being a case of commit early or you miss out, the enviable position largely reserved for a club of Silicon-Valley-based VC funds, the firm was looking at a large transaction that it could not complete out of its second European fund and that was large enough for the first closing to have to be substantial or the fund would not have been sufficiently diversified. Bassett notes that the sense of urgency was in fact very real, with many of the firm’s investment professionals continually knocking on his office door to find out how the fund raising was doing.
Apart from the apparent kudos of an early fund raising, there are other advantages of setting a tight timetable (even though many report that not all LPs take kindly to tight deadlines.) “It saves money for everyone because establishment costs of the fund generally exceed the cap on establishment costs of funds. Generally speaking it costs more to do a job slowly. Momentum does save money, but not hugely material amounts,” says de Lance-Holmes.
Most large buyouts firms, and many others, have a dedicated in-house investor relations function now and smaller firms are reportedly making greater use of placement agents in order to do a lot of his hard graft with investors. Whichever route a firm goes, there is still a lot of partner and investment professional time swallowed up by the fund raising process so a speedy close is good for all the firm in the sense of not detracting from its core business. It’s difficult to see how firms without a dedicated investor relations function will continue to keep up with the pace set by the larger firms, however, given that in these firms the fund raising process really never does stop.
Once a fund raising completes, rather than kicking up their heels, the investor relations individual(s), has their sights firmly on the next fund. “ECI 8 closed in April and we’re already mooting potential investors in ECI 9, although a formal launch is three years away,” says Janet Brooks.
Basset was similarly engaged after closing Permira’s second European fund when it was decided the firm need to considerably up its number of investors. Bassett identified potential future partners and worked on building a relationship with them, the net result being that when the firm closed its third European fund in 2003 it had come close to doubling the number of investors, although the new group only accounted for 19%, by value, of the fund. Being a sought-after offering, Permira Europe III had to look after its existing investors, many of who came into the first closing so new investors were scaled back to keep the fund within its cap.