Raising a fund is getting more expensive – and investors are picking up the cheque.
Establishment cost caps have “increased significantly” in recent years, according to Proskauer’s European Fundraising Terms and Trends 2022 report. This continued into 2021 and 2022 for both mega- and medium-sized funds. A number of mega-funds’ caps now exceed €10 million, while funds in the €750 million to €1 billion range are regularly negotiating caps of €3 million and above.
“It’s not so much [about] what allowed that to happen – it’s what caused it to happen,” says Peter Olds, a partner in Proskauer’s private funds group. Both regulation and LPs’ own processes – through elevated due diligence and negotiation processes – are becoming more sophisticated, resulting in more time-consuming and costly processes.
“Things like cybersecurity and money laundering – all the things that people would have considered just process – are now integral, and [are] actually as time consuming and as costly as what people used to consider the main deal, which was negotiating the LPA [and] negotiating the side letter. All of that side diligence is now enormous.”
Where’s the money going?
“It’s the sheer cost of doing the job of closing a fund that has skyrocketed, rather than GPs’ desire to push back more onto the LPs, or LPs’ desire to create more processes,” Olds adds.
Additional information required via due diligence questionnaires – covering points such as cybersecurity and KYC – takes GPs “an enormous amount of time to answer”, he says. In turn, this adds “an enormous amount of cost, because they need to outsource quite a lot of it”. The expectation of LPs’ regulators can drive higher costs, Olds explains. “So many LPs are themselves regulated now, and so have their own processes, which they’re required to have because of what they are – like a German insurance company or a US state pension or even a sovereign wealth fund… [They] all have quite strict rules about the way they have to do things.”
Proskauer private funds partner Aranpreet Randhawa tells PEI that investors who are new to private equity can also add to costs. It’s not the case in all scenarios, though, and depends on the investor profile.
A family office, for example, may not have complex internal processes or the same volume of due diligence, regulatory and compliance requirements compared with institutional investors, so the process may well be more straightforward. “But, equally, if they’re less familiar with private funds, they may need more help working through the documents and subscription process,” Randhawa explains.
Regardless of investor size or experience, it will be tricky to tier fund establishment costs based on the time and money investors have cost the set-up of the fund, Randhawa says. “We certainly don’t pass it up in the documents or behind the scenes and say, ‘You’ll be allocated more of the set-up costs because you’ve been particularly painful in the negotiation.’ I don’t think that would go down well.”
“If [an investor is less familiar with private funds, they may need more help working through the… process”
Private funds partner,