Friday Letter Smaller funds to the fore

The latest investor survey shows fundraising won’t be getting easier anytime soon.  

Re-ups certainly aren’t a given. The private equity industry was once again reminded of that this week with Coller Capital’s annual survey of private equity investor sentiment. An eye-popping 87 percent of the LPs surveyed said they planned to refuse re-up requests from managers they currently invest with as they continue to pare down relationships and reshape portfolios post-financial crisis. And as a result, investors expect one in five managers to disappear in the next seven years.

That isn’t as radical as it may sound – limited partners were saying broadly the same thing last year, too. And not everyone agrees about an industry shake-out, by the way. As one managing partner at a private equity firm recently put it: “That’s not going to happen. This is such long-baited sticky capital, and markets have no memories.”

Still, it’s clear from the Coller research, which surveyed 110 LPs worldwide, that of the GPs hitting the fundraising trail this year, only those with impressive performance and solid teams sans succession issues will garner commitments. Investors remain focused on active portfolio management and as a result the secondaries market is expected to soar. More than one-third of North American LPs plan to sell stakes in limited partnerships this year; one-quarter of European LPs and as many as 42 percent of Asia-Pacific investors plan to do the same.

This all suggests raising primary capital will remain a challenging proposition – even for industry veterans with well-established track records. Gauging LP appetite and setting a fund target accordingly is a tricky business. Aim too high and your fundraising risks being branded a failure if it comes in under target, or takes too long. Aim too low, and you risk having too little capital available relative to the size of your team, with obvious consequences on the personnel front, and management fee income falls too. 

Many are taking these factors into consideration, of course, along with a changed deal landscape post-crisis, and plan to raise more modest funds going forward. Permira, for example, is almost ready to begin fundraising for its fifth buyout fund with a target of €6.5 billion – a significant amount of capital in any market, bull or bear, but still one-third less than its 2006 vintage fund. Back then, the firm raised €11.1 billion (which it later reduced to €9.6 billion to help capital-constrained LPs).

Permira is not alone. More modest fund sizes appear to be the way forward – no large buyout firm has yet sought to raise a bigger fund than its boom-era equivalent for example. (Here’s something interesting to ponder, by the way: suppose the new fund is pitched at half the size of the old one, the percentage of the management fee is the same and the fund’s expenses  will still be fully covered – what does this say about the fees LPs had to pay on the bigger fund?)

The results of the Coller survey serve as a reminder to managers – even the most successful ones – that they cannot take future fundraising success for granted. In a climate where LPs are proving increasingly selective, lower targets demonstrate that GPs have already come to terms with a very different investment climate. Now the next challenge with those targets is the existential one: hitting them.