Friday Letter: Don't ask questions

When you hear that new funds are in effect oversubscribed before they’ve even been officially launched, there can be only one conclusion. Private equity fundraising has hit warp speed.  

This phenomenon used to be the preserve of elite US venture funds. Stories of faxes being sent to limited partners demanding they sign on the dotted line and fax back promptly have passed into industry folklore. Recent years have added certain out-performing mid-market funds as well as the multi-billion dollar/euro vehicles shopped by the LBO ‘brand names’ to the club of ultra-desirable sell-out offerings.

With no immediate sign of this trend relenting, the limited partner community is said by placement agents to be shocked by the new need to respond to ever-more aggressive timescales. No wonder perhaps, when allocations are in some cases only being guaranteed if you commit by the first closing. Which, incidentally, might be a mere two or three weeks away.

From the GP side of the fundraising frontline, PEO is being told that it is “interesting” to note which LPs are handling these pressures efficiently and which are not. It doesn’t take a genius to identify the veiled threat here: the message is “adapt or die”. Or, perhaps a little more prosaically: “Make decisions quicker, or you can forget about getting access to the best funds.”

Now, time to add a little perspective. In today’s private equity fund market, where limited partners take pride in their manager selection, few funds can yet achieve closings by fax-back. Due diligence has not become a relic of a by-gone age. And terms and conditions can still be haggled over: note that even pedigree funds are showing flexibility in such areas as transaction fees, waterfall structures and hurdle rates. It may appear an unorthodox claim in today’s heady fundraising atmosphere, but alignment of interest is still recognised as the fundamental underpinning of the asset class. Even in the best of times (for the best GPs), that has to be respected.

And yet, it’s hard to avoid the conclusion that there has been a fundamental shift in the balance of power – and the word is, that while many investors have recognised this, others haven’t. The average institutional investor’s decision-making (and commitment-making) process has traditionally been slow. In some cases – believe it or not – it still is. 

One leading placement agent told PEO: “Of course people shouldn’t cut corners. That’s why if it’s a brand-name fund, we spend ages thinking up in advance all the questions an LP could possibly think of and ask them on their behalf. But still they find even more questions to ask. More than perhaps they need to when the fund is self-evidently solid, has a great track record and has stuck religiously to its stated strategy.”

So will this recalcitrance permanently bar some limited partners from the best funds? Not necessarily. At the moment, capital is flooding into an asset class that hasn’t yet set its sights as high as it might. Some say the day will come when Fortune 500 companies are regularly on the GP radar: and when they are, the funds targeting them will likely be considerably more substantial even than Blackstone’s $13 billion fund-in-waiting. When the ‘real’ mega-funds come through the pipeline, so the theory goes, the bottleneck of capital will be more easily absorbed: and even slow-moving LPs may once more be able to take their place at the table.

In the meantime, top quartile GPs have a message they would like to pass on to potential supporters: just hand over your cheques. And don’t ask too many questions.