Pledge drive

While the deal-by-deal fundraising model known as pledge funds is gaining steam, there are some serious weaknesses that managers and investors need to consider, writes Kevin Ley.

In the wreckage of the fundraising environment this year, newer private equity firms have turned to “pledge funds” as a way to navigate the perilous landscape. 

Pledge funds are private equity investment platforms in which, unlike traditional committed funds, investors provide no commitment to fund all the manager’s deals, but only agree to consider providing capital on a deal-by-deal basis.

Recent franchise-imperiling developments at firms such as PAI Partners may make even more well-established funds start to consider the pledge fund model going forward. LPs have been gaining ground in negotiations with PAI over proposals to reduce outstanding commitments by up to 60 percent to the French firm's latest buyout fund. 

One new pledge fund to arise from the smokey remnants of the global markets is Flexis Capital, launched by

Kevin Ley

former Bear Stearns mergers and acquisitions chief Louis Friedman. The amount of money the fund's investors have said they would like to invest would allow Flexis to write equity checks for $25 million to $100 million per deal. The firm is targeting mid-market companies.

A platform offering investors improved control over the choice of investments might prove popular, and if LPs industry-wide continue to have the upper hand in negotiations, it’s likely that pledge funds will gain further ground over traditional private equity funds. But there are several pros and cons for managers who use such vehicles.

One area that will be affected is auctions. The first thing that a seller may ask is ‘how can you commit to this auction process if you haven’t got a committed fund behind you?’. The manager may be forced to either give a separate confirmation or have a confirmation from their LPs that they would be committed to fund the deal if the deal goes ahead.

This may require a private equity manager to obtain more consensus than he would have before, and that may well put him at a disadvantage in a highly competitive, fast-moving situation.

Issues around confidentiality will also arise when the deal is shown to LPs, and that will have an impact on an auction situation where the seller wants to keep a low profile. If the manager is showing it to investors as a condition of funding the deal, it may get out to a wider circle than normal.

Finally, questions remain about how carry is going to work in situations where an LP goes into one deal but not the next. 

Such considerations mean that, for all the flexibility pledge funds offer as compared to fixed fund structures, managers should not go the pledge fund route lightly.