“It turned out that hurling cash at people who got a lot of press was not a good idea,” a mid-market private equity professional reminds PEI. A reference to the perils of investing through the dotcom boom and bust, the opinion is nonetheless expressed within the context of a conversation about today's clamour to invest in mega-LBO funds. Implied in the remark is a conviction that investors haven't stopped believing hype; all that's changed is that the hype surrounds a different type of private equity fund.
The same professional continues: “It's fair to say that higher brand awareness gets you an audience [with potential investors]. People are keen to know what the Blackstones of this world are all about. It's another question whether they actually merit the attention, but they'll get a foot in the door because they're in the newspapers every day.”
A barely concealed sense of frustration informs this view, emanating perhaps from the conviction that fundraising is an easier task these days if you're raising a vast pool of capital than if your fund size aspirations are more modest. Of course, it should be conceded at the outset that such a sentiment is also a generalisation: numerous are the examples of brand-name mid-market funds whose biggest headache is catering for an oversubscribed level of demand rather than an inability to hit target. Private equity is a popular asset class these days, and the best of breed in the mid-market space are not failing to gather up their share of the spoils.
Nonetheless, some compelling statistics serve to underline the extraordinary pulling power of the larger funds. According to the PEI 50 survey in our May 2007 issue, the world's largest 50 private equity firms have raised a colossal $551 billion since 2002, accounting for 69 percent of all funds raised globally. According to Prequin, of the $204 billion raised by buyout funds in 2006, $96 billion was accounted for by just ten mega-funds greater than $5 billion in size.
Some of the reasons behind this gravitation of capital to the larger end are of a practical nature. Resources at many limited partner groups are stretched, and the ability to conduct meaningful due diligence on the plethora of funds in the market at any one time therefore limited. The likes of Californian pension giant CalPERS and Canada's Public Service Pension Plan are cited by market sources as examples of influential investors focused as much on managing the number of their GP relationships as identifying superior fund managers.
A consideration for investors such as these is whether a commitment to a smaller fund can be meaningful enough to move the needle of a portfolio when it is normally stipulated that one investor should not account for more than typically 10-15 percent of a fund's total capital.
Another factor relevant here is the accelerated speed of distributions from GPs back to LPs enabled by a benign exit environment and, in particular, a preponderance of re-financings. Erin Sarret, director of marketing at Paris-based fund of funds manager Access Capital Partners: “Many investors have been getting their money back far quicker than they expected. But because they have a long-term commitment to the asset class, they want to get that money back out the door as fast as they can.” This need for speed predisposes investors toward established relationships – and larger funds.
Mid-market GPs can arguably do little about this state of affairs: they can't influence the rate of distributions by LBO funds any more than they can dictate the level of resource at a limited partner group. They in effect serve to distract attention away from the mid-market rather than implying anything fundamentally unattractive about the space. But that's not to say LPs don't have reservations about it.
Robert Coke, senior investment officer at UK charity The Wellcome Trust, says there are still plenty of larger investors keen on investing smaller amounts in smaller funds. But: “If the fund is much below €200 million I would say it does become a struggle to attract their attention. At this size there is also a question as to whether the fee income is too small to attract high quality individuals.” Coke also observes that the stellar returns delivered by the larger funds recently mean “it just hasn't paid to be at the smaller end”.
In addition, there is a view that the mid-market has become saturated with ‘me-too’ investors. Kelly DePonte, a partner at San Francisco-based placement agent Probitas Partners: “The number of middle market buyout funds out raising is huge. A number of investors, when looking at this crowded field, consider many of them JAMMBOGs [Just Another Mid-Market Buyout Group].”
The ability to differentiate from the competition is therefore a vital quality for mid-market funds; and one that this article shall return to in more depth later.
Ask them what differentiates them and some will say “great relationships and great proprietary deal flow” and they will say it in hushed tones like it proves they're one in a million. They don't have any sense that they're reciting the most hackneyed phrase in private equity marketing history
At this point – having considered some negative characteristics – it's important to underline the point that mid-market funds will always have their supporters. However attractive the larger funds may be – particularly when assisted by favourable capital markets tailwinds – limited partners are unlikely to abandon the hunt for diversification. Says John Gripton, Birmingham, UK-based head of investment management at Swiss asset manager Capital Dynamics: “Our goal is always to achieve a balanced portfolio. You have to bear in mind that during the fund's life around ten years, economic cycles may change”
This helps to ensure that sources of capital for midmarket funds are never likely to diminish significantly. Given the tendency mentioned earlier for large pension funds to plough profits back into mega-funds, this might seem counter-intuitive. But in many cases, allocations to mid-market funds don't evaporate – they merely get outsourced. Speaking of the lower mid-market, DePonte says: “Some of these pension fund investors – though by no means all – have hired separate account managers to invest in the sector for them.”
Nonetheless, there is widespread acknowledgment among sources close to recent mid-market fundraisings that they have never had to shout louder to get their voices heard. It's an environment in which attracting new investors is particularly demanding. Ian Simpson, a London-based director at placement agent Helix Associates: “With GPs coming back for money every two to three years rather than three to four, LPs have a lot of reups to do before they will consider adding any new funds.”
CONSOLIDATE TO ACCUMULATE
What this means is that consolidating existing relationships becomes a priority. In May, Stamford, Connecticut-based Olympus Partners closed a new $1.5 billion fund. Prima facie, the fundraising cast its net wide, with firsttime investors accounting for around 25 percent of the investor base. In fact, this figure concealed a rather more conservative approach.
Explains Olympus managing partner Rob Morris: “Of the 27 investors in the latest fund, 20 are existing and seven new. Of those seven, five are headed by people who used to work for one of the 20 existing investors before moving on, and they know us well. Two are genuinely new, but they have spent the last several years getting to know us. We wanted to make sure they had a long-term commitment and that they were comfortable with our style.”
But whether the emphasis of a mid-market GP is on working hard to keep existing investors happy, striving to winkle out new sources of capital – or, more likely, both – one thing is for sure: fundraising professionals find themselves at the heart of the action. And, to return to the point made earlier about the need for differentiation in a market where so many funds are jostling for attention, it could be argued that rarely before has the pressure on them been so great.
There will always be certain standout funds that make the job of raising money look rather easy. But for most, it will never been anything other than a tough slog. Ian Simpson suggests why this is the case: “It's a mature market, there are a lot of experienced people, and the differences between funds are often minimal. Superficially, all hatchback cars look the same because that's the way aerodynamics work; midmarket buyout groups look the same because people know the way mid-market buyouts work. You have to look under the bonnet to find out how they're different.”
So, the million-dollar question: how do you differentiate? Erin Sarret says that, in an environment where “LPs see so many people that they all blend together”, one thing that fundraisers should have at the front of their minds is the need to “boil presentations down to the salient points”.
What's more, these “salient points” need to be genuinely meaningful, not blurs or fudges. George Gaines, a Chicago-based partner at placement agent BerchWood Partners, says some fund managers have an alarming tendency to substitute clarity with cliché when asked to identify their unique selling points: “Ask them what differentiates them and some will say “great relationships and great proprietary deal flow” and they will say it in hushed tones like it proves they're one in a million. They don't have any sense that they're reciting the most hackneyed phrase in private equity marketing history.”
“It just hasn't paid to be at the smaller end.”
TOP HEAVYThe ten largest funds raised globally over the last 18 months.
|GS Capital Partners VI||$20bn|
|(as of May, reopened targeting||$20bn)|
|Texas Pacific Fund V||$15bn|
|Providence Equity VI||$12bn|
|Apollo Investment VI||$12bn|
|Bain Capital IX||$10bn|
|Cinven IV 2007||$8.6bn|
|Hellman & Friedman||$8.4bn|
|Capital VI 2007|
|Terra Firma III||$7.28bn|