How hard is a hard cap?

In the last two months four private equity funds have blown through their hard caps, which, Helix Associates’ Ian Simpson says, demonstrates general partners’ growing weakness to the smell of money.

A fund’s hard cap used to mean that under no circumstances would an investor exceed the agreed target but now, says Ian Simpson, founder of Helix Associates, as more managers are increasingly willing to ask their investors for more cash, the cap has almost become a redundant figure.

Flush investors are only too willing to hand over their cash

Last month Blackstone increased the size of the world’s biggest private equity fund from an original target of $9 billion (€7 billion) to $20 billion.  In June Blackstone raised the target from $9 billion to $12.5 billion, and set up a main fund with a cap of $11 billion and a side fund, which will raise another $1.5 billion of equity.

However, it is not only the megafunds that are dramatically raising their targets.  The mid-market has recently shown the same behaviour.  This month 3i closed its latest fund, Eurofund V, on $5 billion, beyond the initial target of €3.5 billion, making it the largest fund dedicated to the European mid-market after Cinven’s €6.5 billion European fund.

Yesterday Coller Capital, one of the largest private equity secondaries managers, announced that it is raising the cap on its latest fund Coller International Partners V from $3.75 billion to $4.5 billion to accommodate demand. 

In October GTCR held its final closing of GTCR Fund IX with $2.75 billion in commitments, a quarter more than it had initially targeted.

Why are more managers raising the bar?  Are they being too conservative in their initial estimates of how much capital they will need?  Simpson said: “In a lot of cases it means the general partner is scaling their fund to maximise their management fee income rather than to match their skill set or the investment opportunity.”

Why has this activity been common recently?  Simpson said: “Investors have also had a lot of money back from private equity funds recently, through realisations and re-caps, which they want to put to work.”

Going back and changing the hard cap could mean that the market opportunity has suddenly changed in the short time since cap was set. 

Ian Simpson, founder, Helix Associates

Simpson said it is not smart to go back on the agreed target.  “To me, a hard cap should represent the maximum a general partner reasonably believes it can invest over a three to five year period.  Going back and changing the hard cap could mean that the market opportunity has suddenly changed in the short time since cap was set.  General partners want to invest it with the top performing managers, naturally, and some of them have found the temptation to take the money irresistible.”

He believes that this behaviour is potentially more of a problem in the mid-market than with the mega funds. 

“At the big end, there’s no difference between the way sales processes are run whether a mega fund is bidding for a $5 billion company or a $15 billion company.  In either company, an investment bank will run a highly effective auction process.  In the mid-market, there is a world of difference between the way a €50 million company might be sold by a boutique intermediary and the ruthlessly competitive way the investment banks manage auctions for €500 million businesses.  Stepping up in the mid-market requires the general partners to have a quite different skill-set.”

A large UK investor says it is hard to find fault with the mega funds increasing their capacity. He says: “It is important that they stay competitive. You can have some sympathy with CVC which saw the definition of a mega fund change almost overnight and suddenly they are left behind.”