Friday Letter: Smart moves

It’s the right trend for the times – manager contributions to their private equity funds are growing larger.

Private equity fundraising is no picnic nowadays, regardless of how seasoned the fundraiser. In light of underwhelming performance in the past, many limited partners have tired of existing manager relationships, and they aren’t easily making new friends either. Getting them to commit to your new fund requires large doses of persuasion, persistence – and one other thing: your own cash.

One of the most effective tools fund managers can use to draw others into a fund is their cheque book. Besides acting as a powerful badge of faith in the potential of the fund, it also appeals to a more basic human principle of accountability. If I hurt then you need to hurt too – hence the popular tag offered up by GPs and their advisors to prospective investors of having “skin in the game”. How thick that skin needs to be is an interesting question nowadays. In the past managers lobbed in what in personal wealth terms many regarded as negligible, while others at times opted to leverage up to arrive at an adequate number to commit. Not so today. 

Last year, €28 million, or 7.5 percent, was the manager contribution London-based Stirling Square Capital made to the €375 million buyout fund it raised. Earlier this year, Danish mid-market firm Axcel Partners increased the GP commitment to 6 percent from 1 percent on its fourth fund, expected to close soon on around DKK 3.5 billion (€469 million; $675 million).

In a poll taken at PEI’s Private Equity CFO and COO Forum held this January in New York, 51 percent of the managers present said their commitment to their next fund would exceed 2 percent; 16 percent even predicted they would stump up more than 5 percent.

These amounts are way above the 1 percent manager contribution that used to be the industry norm. Clearly, if you’re hoping to make money in the private equity business, it helps to bring along some start-up capital. But don’t think of it as just a cost; if you do know what you’re doing, it could, in fact should, turn out to be one of the best investments you’ll ever make. You’re in charge, remember? You control totally where the money goes.

Eating their own cooking has been an increasingly important part of a GP's diet for some time now. Not only have they been pointedly filling their plates during primary fundraisings though; they’ve also looked to take advantage of their existing funds’ recovering NAVs in the secondary market, increasing their exposure by buying into listed feeder funds for instance.

Even the debt on their own buyouts has been deemed a target. The head of IR at a large European private equity house told PEI recently of a structure he’d devised to enable the partners to load up on portfolio company loans whose market value has since risen sharply.

“Smartest thing I’ve done in a while,” he said happily. “It’ll be my pension.” And should the value of this pension come under threat at any point, he will be fighting tooth and nail to protect it, which again is precisely what his LPs, who hold the underlying equity, want to see.

Alignment of interest? Yes please. Smart money? Of course.