A major trend in the private equity industry over the last couple of years has been limited partners shifting towards direct investing.
Rather than sitting back and losing business, some placement agents have turned this to their advantage.
“We had two decisions: we could either ignore it and say ‘well we’re just going to keep raising just funds and we’re going to lose an increasing segment of our investor universe’, or we could continue to raise our funds but we could also try to bring investments and product ideas to investors that are no longer doing funds,” says Jeff Eaton, partner at Eaton Partners. “We clearly chose the latter.”
Eaton Partners was acquired by wealth management and investment banking firm Stifel Financial in 2016. Part of the attraction for the placement agent was the access to dealflow Stifel could provide.
“We came to the conclusion that we could not generate as good quality dealflow as we needed to on our own,” Eaton says.
The placement agent educates Stifel on what kind of assets might interest its investor base. The larger firm is then alerted to which opportunities to pass on to Eaton Partners to show to their investors. The firm can also leverage Stifel’s underwriting capabilities to bolster its own diligence when analysing Eaton-sourced direct deals.
Recent examples include deals in insurance and structured products in the speciality finance area, and hard assets, such as energy, oil and gas, infrastructure, and real estate.
“LPs are not able to lean on someone else to tell them whether or not it’s a good investment, they have to be able to make those decisions on their own,” Eaton says. “Where we’ve had the most success are assets that are more easily underwritten and evaluated because they’re more tangible, there’s maybe a higher component of cashflow, and less need to evaluate what the value of goodwill might be.”
From a standing start two years ago, around 15 percent of the dollars Eaton Partners raised in 2017 was for direct investments. In April last year the firm launched a five-person team focused on raising capital for direct deals, which includes raising additional co-investment capital for GPs.
It’s not the only firm taking advantage of this new opportunity. The fund placement team at Moelis & Company can also offer individual transactions to limited partners, while Mercury Capital Advisors has rebuilt this capability after its spin-out from Merrill Lynch in 2009. The firm’s direct investment and secondaries activities represent more than a quarter of its revenue.
LPs committing to Mercury’s direct dealflow are typically sovereign wealth funds, insurance companies, family offices, and occasionally pension funds, although that is more often the case with real estate joint ventures, says managing partner Alan Pardee.
Around half of Mercury’s direct investment activity is raising capital for co-investments or fundless sponsors. The remainder is opportunistic dealflow that comes the firm’s way through its relationships.
“There is a synergy from our perspective. Raising capital for a direct deal for somebody who wants to raise a first-time fund, some of those LPs will naturally become fund investors in the first closing,” Pardee says.
“But there are certainly people that we talk to, hedge funds being an obvious example, that aren’t going to do the fund but will do the direct deal.”