LP appetite for private equity is more voracious than ever. That does not mean, however, that fundraising is easy or simple. Someone who understands this is Lindsey McMurray, founder and managing partner of Pollen Street Capital.
Her team has been investing together since 2005 – originally as part of British bank RBS – and had raised capital from external investors twice. But when they started talking to investors in 2015 about raising Fund III, their first full fund as an independent manager, it was not the straightforward exercise they might have hoped for.
“People saw us as a first-time fund despite the fact we had a fund from before,” McMurray tells Private Equity International.
When it was part of the bank, the group – known as SOF Investments – had raised more than £1 billion in 2007 from the “great and good of secondaries”, part of which was invested in the existing portfolio, built up using bank capital, and the remainder made available to pursue new investments. The firm raised again a year after its 2013 spin-out: a £300 million top-up fund backed by two fund of funds managers.
But Fund III was the first time the team had hit the road to meet prospective investors as an independent, sector-focused manager, Pollen Street Capital, and while the firm reached a first close in relatively short order by March 2016 on £120 million, subsequent progress was slow.
The Pollen Street proposition had a number of idiosyncrasies. McMurray’s team had gone from pursuing a special opportunities strategy at RBS – with a bigger fund and a broader investment remit – to being a sector-focused firm in the European mid-market with a predominantly UK-based track record.
Sector-focused funds are something of a rarity in Europe, McMurray says, as specialism in the region tends to be drawn along geographical lines. In Europe around a quarter of all funds raised by number are sector specialists, compared with 40 percent in the US, according to PEI data. In McMurray’s view, being slightly out of the ordinary made it easier for LPs to dismiss Pollen Street.
The choice of sector added an extra layer of complexity. A lot of investors have “a sensitivity” when they think of private equity investment in financial services, says McMurray. “There have been some high-profile losses across the sector and people extrapolate that to what we are doing.” They are wrong to do so, she adds, as Pollen Street operates in the mid-market with a different strategy and risk profile to the larger deals that she believes have coloured investors’ views of the sector.
The Pollen Street pitch is growth investment. The firm looks for growth businesses with a specialist financial services proposition; any misgivings that investors have about how the financial services sector fares in a wider macroeconomic context are not particularly relevant, says McMurray, because the firm is backing companies set to take market share from the established firms, “a lot of the time because they don’t want that market share anymore”. In other words, the large players in the financial industry are retrenching, which creates opportunity.
“We have a differentiated and focused strategy that we believe will continue to deliver strong returns in a relatively uncrowded market,” says McMurray. Economic headwinds – like the one that will be brought by Brexit, she adds – should not detract from its proposition. “Would it be better to have [GDP] growth of 2 percent as opposed to zero? Yes, but it should not cut across us, as our thesis is about taking market share.”
In terms of risk-return, “if we get it right we aim to get above four [times our invested capital back]. If we get it not quite right we aim not to lose money and we aim to get three overall,” says McMurray. Across its financial services deals, the firm has so far delivered a gross IRR of 29 percent and 2.9x money multiple.
The group left RBS with a small number of loyal investors – “we had a fan club as opposed to an investor base” – and in raising Fund III effectively needed to “start afresh”. But it wasn’t a quick process.
“If you want to go and push down the door of an investor on something, they need to take time to think about because it is new, you are just going to get a ‘no’,” she says. “We had to take the long yards of building the relationship, building the knowledge and trust and belief that this was a strategy, as opposed to a time and place.”
Several LPs looked at the proposition “too quickly”, says Magnus Christensson, the former European fundraising head for TPG who joined Pollen Street to help with the fundraise in 2016. “A lot of LPs didn’t have the time to carry out due diligence on a small fund in financial services. When I came in it was a lot about re-visiting LPs.”
In an era of apparently lightning fast-capital raising, Pollen Street took more than two years to raise Fund III. Frenetic fundraising activity actually hinders firms trying to build new relationships, McMurray notes, due to lack of LP bandwidth.
“As much as there are huge amounts of capital, it almost makes it harder for new funds to get going, because there is so much time and capital spent on re-ups that the LPs have limited time to assess new teams,” she says.
“If you speak to an LP and they are writing 10 tickets,” she continues, “seven are re-ups, two might be strategically for Asia, say, which would leave one left. So while there is a lot of capital, there are few spots; LPs have to be pretty ruthless in their culling, their distillation of those opportunities.”
Pollen Street closed the fund at the end of January on £402 million ($565 million; €460 million), above its original £350 million target. N