Thomas Franco is a veteran of the private equity industry. Having advised CD&R for 15 years, he officially joined the firm in 2006, where he has worked on five flagship fundraises and numerous co-investment vehicles, amassing around $30 billion in capital commitments.
The firm’s latest fund, Clayton, Dubilier & Rice X, closed on its hard-cap last year just shy of $10 billion, having garnered more than $20 billion in demand.
It is no wonder, then, that Franco was named among the industry’s best fundraisers by his peers in April in Private Equity International’s Rainmaker 50 list.
We sat down with Franco to talk industry evolution, managing oversubscription, and pressure on returns.
What’s the most important part of the investor relations function?
To me it’s representing the views of our limited partners to the partnership, and at the same time representing the views of the partnership to the limited partners. In many ways it’s a bridge to understanding. That’s the most important aspect of the job. It’s not about asset aggregation, it’s about transparency and mutual trust and ensuring that, at least from the perspective of the investors, they understand what we’re doing and why, and the GP understands what concerns the LPs might have.
Can that ever put you in a tricky position within the firm?
I think by definition yes, because in a certain sense, if you’re doing the job in the right way, there may be occasions where you have to represent viewpoints and perspectives which may not be entirely intuitive to members of the firm.
You’ve worked on five CD&R fundraises over 12 years. How has your function as a fundraiser changed?
The investor community and its needs are rapidly changing, and therefore they are looking for more from the GPs they commit to. It goes beyond co-invest, beyond sitting on an advisory board; they want to have a broad and multifaceted relationship. That requires people in the function to be more relational in their thinking and anticipate what those needs might be, understand the institutions they are interacting with, and try to be a resource. It’s not simply inflicting your fund on the investment community, it’s about taking the ‘limited’ out of limited partnership and focusing on ways to be a good partner.
As investors have become more knowledgeable and sophisticated, they are far more detail-oriented about the portfolio and individual portfolio company performance. There’s been a massive increase in the number of data enquiries.
LPs are also starting to think about innovation holistically. They expect their managers to develop comprehensive approaches to technology – from due diligence and investment committee processes to driving, monitoring, and reporting portfolio company innovation, not to mention the operational backbones of the GPs themselves.
They’re also much more experienced in the ins and outs of the limited partnership agreement. They understand the nuances of various provisions and are equal to the task when they are negotiating the LPAs.
Private equity’s long-term success has not gone unnoticed, so you have many new entrants into the asset class, such as family offices from Latin America. They require some advice and counsel about how to think about private market deployment and what the dynamics of investing with a private equity firm are.
Another trend is an increased level of staffing volatility within the asset-owning community. Managing that turnover requires almost an ongoing reinvention of the relationship. That has changed quite dramatically in the last decade.
“We want to be able to renew and refresh the LP base selectively, both by segment and geography. We think that is strategically advantageous. And we believe our existing LPs also recognise that this is important.”
Do you spend a lot of time on side letters?
We have tried to keep our terms middle of the road. We haven’t felt that leveraging our position is necessarily a good long-term strategy. We try to be fair even if we may have a demand advantage. The pendulum swings.
You had more than $20bn of demand for your last fund, which closed on nearly $10bn. How do you manage that?
My partners would tell me it’s a good problem to have. Yes, it’s a good problem, but it is a problem nevertheless. The key point is to manage expectations very, very carefully. We were honest and transparent about the demand dynamic and tried to accommodate as many investors as we possibly could, recognising that the size that would have been preferable to some, we were not able to meet. I think people understood what the dynamic was, and they appreciated we were transparent about it.
Is it important to welcome new LPs each fundraise?
Yes, we want to be able to renew and refresh the LP base selectively, both by segment and geography. We think that is strategically advantageous. And we believe our existing LPs also recognise that this is important.
“The traditional model seems to have had good durability and has worked, so I wouldn’t be surprised to see changes at the margin, but the prevailing philosophy is probably not to fix something that’s, clearly, not broken.”
Will there be more pressure on the ‘two-and-20’ fee model in coming years?
Private equity is a highly adaptive asset class. There’s a lot of innovative thinking. New structures are always being tested, and that’s probably a good thing. That said, the traditional model seems to have had good durability and has worked, so I wouldn’t be surprised to see changes at the margin, but the prevailing philosophy is probably not to fix something that’s, clearly, not broken.
Will returns come down?
There are always concerns about returns lowering. And of course, past performance is no assurance of future results. The level of concern depends on what you’re trying to accomplish and what you underwrite to. Some firms will continue to focus on generating very high absolute returns, and others will emphasise higher relative returns.
There is always the risk that as PE grows, what happened to hedge funds could happen to PE, meaning there was a time when hedge funds had very differentiated views, saw things that other people did not see in the market. Then the hedge fund market became very crowded, and firms that used to be highly differentiated looked very similar to their neighbours.
You do see some elements of crowd behaviour in PE. The implication is that if you’re in the business of generating outsized returns, it’s imperative to look for investment situations where the process may be less transparent, where the value creation opportunity is less obvious, and have the courage of conviction to avoid herd behaviour. The PE firms that do that should continue to significantly outperform.
Thomas Franco leads fundraising, and manages investor and external relations, strategy initiatives and activities related to portfolio companies at Clayton, Dubilier & Rice.