Agents of change

Once upon a time, in the technology-crazed gaga years of the late 1990s, organising a private equity or venture capital fund wasn't particularly difficult.

The market was awash with cash – much of it known as ‘dumb money’ – and even people with limited experience in the business of raising and investing private equity funds had little trouble getting a piece of it. With investors eager to join the limited partner club, many general partners could afford to spend next to no time or effort on fundraising and investor relations related matters, especially in between individual fundraising campaigns.

At that time, private equity fundraising was lucrative business for placement agents too, those well-connected intermediaries specialising in helping capital find its way from investors to general partners. Because their product was so hot, agents were able to make plenty of money relatively quickly and easily, especially if they could persuade the best private equity fund managers to work with them.

Looking back on this period today, some placement advisors joke the roles they played then were more aking to ‘chamber maids’ and ‘travel agents’, implying that there wasn't all that much to do beyond making sure their general partner clients would meet the right customers at the right time and helping them manage the (albeit complicated) logistics of a fundraising effort.

Remy Kawkabani, a London-based managing director at Credit Suisse First Boston's Private Fund Group, says that during the late 1990s into 2000, placement agents had a hard time confirming their value-added to GPs: “General partners would accept or reject advice with impunity. The market was extremely forgiving and LPs would often give a GP the benefit of the doubt.”

With the collapse of the public markets and the end of the private equity boom in 2001, all this changed, almost over night and dramatically so. Some investors learned for the first time that private equity needed to be handled with a degree of care and understanding. Others remembered it.

At the same time, general partners, while struggling to deal with varying degrees of carnage in their investment portfolios, realised that the next fundraising (if indeed there was going to be one), would not just be a formality. Some groups in fact didn't understand that this sea change in attitude was not just general but horribly particular. These firms still launched new funds in a way that seemed casual at best, arrogant at worst, only to find the market would no longer tolerate such attempts. Some of these chastened firms have endeavoured to reconnect with investors, others do not even have that option left.

Meanwhile placement specialists, perfectly positioned to observe the transformation of the behavioural patterns of both LPs and GPs from close range, recognised too that the future of their business would involve a lot more heavy lifting than it did in the past.

Now the dark days of private equity are officially over, and institutional interest in the asset class has bounced back. Rising public equity markets have taken some of the pressure off investing institutions that prior to the recovery found themselves over-allocated to private equity by dint of massively depreciated public equity holdings. Over the past six months, existing LPs have also been at the receiving end of very significant cash distributions from large buyout firms such as Kohlberg Kravis Roberts, Clayton Dubilier & Rice and The Carlyle Group in the US and Candover and Industri Kapital in Europe.

These distributions, according to J. Lyons Brewer, a partner at independent placement services group C.P. Eaton headquartered in Rowayton, Connecticut, will “trickle down from the mega-funds to the smaller fund segment” and hence benefit everyone who will be offering new funds to the market going forward. As a result, many practitioners predict that private equity fund marketing activity will increase further over the course of 2004, especially in the second half of the year.

Those who survived the downturn are determined not to repeat the mistakes of the past. Many more limited partners for instance have become notorious for doing much more work and demanding significantly better information and transparency from fundraisers before making commitments to new funds than ever before.

General partners know this. They also, says CSFB's Kawkabani, “understand the importance of being properly funded with limited partners who will be there in the long-term.” Hence fundraising as the recurring make-or-break test of a manager's long-term investor management capabilities is no longer considered a peripheral part of what private equity firms do. Instead, it has come to be seen as mission-critical: a manager without a fund doesn't have a business, so their IR and fundraising processes had better be up to scratch.

One consequence of the downturn is that many private equity and venture firms, especially the larger, longerestablished houses, are devoting more resources to the investor relations process than they ever did. “There appears to be an increasing need for experienced, in-house investor relations professionals across both private equity and hedge funds,” notes Alexandra Hess, who is responsible for IR at multi-billion private equity and securities specialist Oak Hill Capital Management in New York and Menlo Park, California.

But it also means that placement agents tend to be more closely involved in their clients' dealings with the buy side than they were in the past. As the private equity fundraising process becomes more sophisticated, relationships between GPs and placement consultants are becoming much more intimate – and much more long-term.

To be sure, some private equity investor relations and fundraising trailblazers such as Carlyle (see profile on page 50), Permira, BC Partners and others have perfected their methods of communicating with, and securing commitments from, limited partners to such an extent that procuring additional expertise or manpower from external placement groups is considered unnecessary.

Selecting fundable managers is half the battle

Andrew Sealey

But despite the fact that some of the best-selling firms will not do business with placement agents as a matter of principle, few providers of placement services actually complain about a lack of mandates that are worth pursuing – even though competition for these mandates is probably greater than ever.

The majority of GPs, regardless of how fully fledged their in-house capabilities may be, are still expecting to draw on additional external resource before coming to market. And, crucially, market participants agree that these GPs now tend to award advisory mandates to placement agents way in advance of a new campaign being officially launched. The old “test-the-water-then-decide-ifwe-need-an-agent” days are gone.

This shift in attitude amongst GP groups has significant implications for the placement advisors as well. They are having to make firm commitments to clients early on in the process and dedicate resources to a project many months before they can expect to be rewarded for their efforts. “Selecting fundable managers is half the battle,” says Andrew Sealey, managing director of placement firm Campbell Lutyens, which recently advised on a successful fundraising for UK midmarket investor Sagitta Private Equity.

The opportunity cost of a wrong call can be crippling in an industry whose economics are almost entirely success driven and where cash flows are lumpy even if mandates can be completed quickly. A drawn-out process leaving the GP without a fund and the agent without a fee can be a disaster for all parties involved.

The reason why fundraisers turn to external specialists early on in the fundraising process, according to Mounir Guen, founder of London-headquartered placement consultant MVision, is this: no matter how good an internal investor relations team may be, it still won't be as close to buyers of private equity funds as the placement specialists who are offering diverse product to, and are hence in fuller contact with, the market all the time. “The difference between doing it all in-house and working with an agent is like black-and-white versus colour TV: without an agent, you just won't see the investor community in all its colour and light.”

Coming from a placement professional, this argument may seem somewhat self-serving. But given the complexity of limited partners' needs and motives, the way these change over time and the fact that these institutions are notorious for undergoing personnel changes that can fundamentally alter their objectives and decisionmaking processes, it is clear that proximity to these dynamics is of immense value to fundraisers – and few do get in fact closer to them than the placement professionals. After all: their business depends on it.

It is also worth noting that different GPs are buying fund placement expertise for different reasons. Introducing a client to potential new investors can still be an important part of the proposition. For example, one reason why Close Brothers Private Equity (CBPE), the UK investment manager which recently closed its seventh mid-market fund on £360 million, chose to work with BerchWood Partners in New York on the fundraising was to achieve a broader international investor base, as CBPE's John Snook points out.

But it is no longer just their Rolodex that placement agents refer to nowadays when explaining how they add value to a fundraiser. Instead the emphasis is on ‘advice’ – with regard to timing, strategy and presentation – on helping general partners understand what it is that LPs are saying to them, and on project management expertise.

The last two aspects are anything but trivial. “It's hard for GPs to get straight answers even from existing investors,” says Jake Elmhirst, a New York-based managing director and head of origination at the Private Equity Fund Group at UBS. “LPs tend to give them the sugar-coated version rather than the raw and dirty.”

MVision's Guen makes a similar point: “LPs have become a lot more proactive in visiting general partner offices early on in the process. These are typically very nice meetings. But GPs tend to overestimate investors' enthusiasm, and they underestimate the logistics – significantly.”

Another agent who is currently having to spend a lot more time and energy on a European buyout mandate than he expected also agrees. He says the main mistake made during this particular campaign was to let the GP handle all dealings with the firm's existing investors on their own. “They didn't know these investors as well as they thought, and certainly not as well as we did,” the agent says. As a result, ‘re-ups’ from these LPs weren't nearly as forthcoming as the GP had anticipated.

Failing the get-it-right-the-first-time rule can cause major problems in a sales process where so much depends on generating – and then maintaining – momentum. As anyone who has ever been involved in a private equity fundraising will tell you, resurrecting a campaign that has stalled requires enormous resilience on the part of everyone involved.

As more groups return to the market to replenish their coffers – C.P. Eaton's Brewer estimates that by the end of the year, there will be around 75 “credible” buyout groups alone looking for a total of at least $40 billion in new commitments – there will be less and less margin for error even for the most sought-after managers. Because more managers are going to compete for a finite amount of institutional capital available to private equity, “the immense popularity of some of the recent funds will be harder to emulate going forward,” adds Guen.

For placement agents, this poses both a challenge as well as an opportunity. On the one hand, the ability to partner with the right managers will remain critical: the sooner a project can be turned around the better. So from an advisor perspective, some mandates are clearly more desirable than others.

At the same time, however, if the massive divide between winners and losers on the fundraising trail (without a doubt the defining issue of the 2003 fundraising season), is to become less pronounced this year and beyond, more quality GPs are likely to look harder for a competitive edge when raising their new fund – and turn to placement consultants as a result.

No wonder therefore that these consultants have been aggressively jostling for position. Fund placement isn't a business where participants readily disclose which mandates they are going to be working on going forward, but clearly there has been a regular banging of elbows between agents as they sought to fix who they are going be representing. Most players will hint with only half a glint in their eye that they've already placed most of their bets for 2004 and beyond.

Time will tell who has played their cards wisely. As more GP groups move from unofficial to official fundraising mode, the battle for capital will be an intriguing spectacle to watch.