Soft on hard-caps

How do the lucky few GPs who beat their targets persuade LPs that they can spend a bigger fund without damaging returns?

For the vast majority of general partners, the current fundraising market remains incredibly challenging; some can expect to spend months or years on the fundraising trail only to wind up with below-target funds. However, a select group of GPs continue to close oversubscribed funds after lightning-quick processes.

In April, lower mid-market focused Arsenal Capital Partners closed its Fund III on $875 million, beating both its $750 million target and its $825 million hard-cap. RLH Equity Partners, another lower mid-market firm, recently collected $380 million for its third fund, above its $250 million target and $350 million hard-cap. 

Both firms had to get permission from limited partners to increase the size of their funds. And while LPs frequently approve GP requests to collect more than a fund’s stated hard-cap, expanding fund sizes can at times create a rift between investor and manager.

“LPs are always worried that the GP is going to get too much money, [i.e.] much more than he can justify with his strategy, and that too much money is going to drive down returns,” says Kelly DePonte, partner at Probitas Partners.“If you have a $500 million target and you’ve got a ton of interest and you want to raise it to $750 million, that’s going to cause a number of LPs heartburn.”

LPs are always worried that the GP is going to get too much money, [i.e.] much more than he can justify with his strategy, and that too much money is going to drive down returns.

Kelly DePonte

The idea of capping a fund’s size has become commonplace in the past decade. “In the late 1990s, a lot of funds didn’t have hard-caps,” DePonte says. “As LPs began to be a little bit concerned about fund sizes, more and more GPs began to put it in.”

However, some firms still don’t include hard-caps in their fund marketing material. For instance, Marlin Equity Partners’ fourth fund, which is targeting $1 billion, does not have a hard-cap, according to a potential limited partner. As such, the firm is likely to raise significantly more than $1 billion, since the fund appears to be well oversubscribed, according to three sources who have seen the fund offering.  “Expect them to raise more than $1 billion and perhaps something close to $2 billion,” said the LP.

In April, Marlin filed documents with the US Securities and Exchange Commission that listed the fund’s target as $1.6 billion.

A few LPs say they are curious to see how Marlin will fare adjusting its investment pace to the much larger pool of capital. The firm will have increased its firepower from $300 million to potentially more than $1 billion in about five years, which several LPs have characterised as being very fast.

But raising substantially more capital does not necessarily require a change in strategy or an increase in resource.
Although Arsenal Capital Partners’ $875 million Fund III is much larger than its $500 million Fund II, the firm has has no intention of targeting larger deals or hiring additional investment professionals, according to partner Terrence Mullen.

“We really stretched [Fund II] very significantly. For each dollar we invested, 65 cents of co-investment capital came from LPs. So we had been operating with a fund that was in this $800 million range when you include the LP capital.”

Ultimately, LPs realise this segment of the market is a broad church, he says. “There’s variability when you play in the lower mid-market, and [our] investors understood that.”