Shifting sands: How the tough market is altering PE fundraising

Private equity fundraising appears to be changing right before our eyes.

The reasons for this shift have been extensively documented in this column and elsewhere: the debilitating denominator effect and slowing distributions leaving LPs with less space and less capital for future commitments, causing them to slow the pace of their programs and cut commitment sizes.

These effects are unlikely to change until the situation improves at a macro level – inflation tames, rates come down and banks open up for robust lending activity, driving the M&A machine, which will ultimately lead to more exits. More exits mean more money back into LPs’ pockets, which will be available to flow back into new funds (presumably).

And, as public markets improve, LPs’ overexposure to PE will ease, putting their portfolios back into balance. These are all best-cases, of course.

For now, the industry is stuck in the muck. Let’s talk about some of those fundraising changes and what they mean.

Perhaps one of the biggest, though not surprising, changes is the time it takes to actually raise a fund. Crack reporter Kirk Falconer discovered using Buyouts data that time on the road in fundraising has stretched to a record average of 13.4 months. That is above annual averages stretching back to the global financial crisis, Kirk found.

Extended timelines help explain the recent sharp drop in North American private equity fund closings. In 2022, 1,064 vehicles were wrapped up, down 28 percent year over year, while in the first quarter, 149 vehicles were closed, down 49 percent.

It’s easy to pick out the funds taking longer than expected; I mean, it’s most of them! Let’s go through a short list: Carlyle Group is the obvious example, having been on the road for at least two years targeting $22 billion. As of March, the firm collected about $14.4 billion for Fund VIII. CFO Curt Buser said during an earnings call earlier this year the firm is planning for “a lower buyout fundraising outlook,” Buyouts reported.

Others taking the long road include Blackstone Group, Apollo Global Management and Vista Equity Partners. Execs from some of the other public firms have listed their fundraising woes on earnings calls, warning shareholders about their PE fundraising outlook.

Some other factors: Firms are backing off on affiliate strategies to put full focus on their flagship pools, to make sure they raise the funds that put them on the map.

TA Associates is the prime example: the firm chose to pause raising its third Select Opportunities fund to put all its energy in raising its 15th flagship fund, which could raise as much as $16 billion.

But even flagship fundraisings are being delayed – Onex Partners told shareholders during an earnings call it’s pausing raising its six flagship fund, targeting about $8 billion, until it can deliver some capital back to limited partners.

“Many institutional investors are overallocated and their inflows and outflows are out of whack versus the norm,” Onex CEO Bobby Le Blanc said during the earnings call. “For us, they want to see the IRRs that we’re telling them we’re earning in OPV to be a bit more tangible before they commit.”

We’ve heard there are other GPs out there who have delayed launching their big funds and others who have outright pulled fundraisings.

Finally, we reported in our June emerging managers cover story about a time-tested fundraising strategy that has become much more popular, especially with newer firms, to try to counter the tough market. That is, a seeded portfolio – meaning a GP does a deal, sourcing it with select investors., and perhaps even warehousing it until it actually launches fundraising. Once the fund is set, the deal goes into the pool, eliminating some of the blind pool risk for subsequent investors.

This gives LPs the chance to actually work with the GP as co-investors, or at the very least, see how the GP works on deals, and how the portfolio is starting to shape up.

The problem, as several LPs explained, is that in some cases, deals were struck at valuations unlikely to hold up, and so they become early drags on a fund. This could be a grievous strike against a new fund trying to prove itself. LPs are scrutinizing these types of funds much closer these days.

As we move through this historically bad fundraising market, we’re likely to see these and other issues play out. We’ll see some firms quietly take a bow, and back off the stage, as it becomes apparent they can attract no more capital. Others will cut targets, and many will have to shrink (at least for a while) as smaller funds, and therefore smaller management fees, force some tough decisions about the size of organizations.

It’s going to shift the look and feel of PE, at least for a little while. What are you seeing? Hit me up with thoughts and tips at cwitkowsky@buyoutsinsider.com or find me on LinkedIn.