Think small

GPs are often instinctively inclined to raise as much money as they possibly can. But more LPs are starting to object to this approach.

This week saw PEI host its annual CFOs & COOs Forum in New York, with almost 400 finance and operating experts braving the Arctic conditions in Manhattan to come and talk about the issues they think will be top of their agenda in 2014. 

As always, one topic that featured prominently was fundraising. Many of the delegates are currently (or have recently been) embroiled in the fundraising process – mostly on the GP side – and there was much discussion of how to expedite that process and avoid the most common stumbling blocks. 

This is bound to be a significant issue in 2014. According to the most recent figures from PEI's Research & Analytics team, there are currently 1,624 funds in market, with a combined target of $616.7 billion. By way of context, that’s more than the total raised in 2008. Last year – the best year since – 599 firms closed funds with total commitments of $385.6 billion. 

Even assuming that a large proportion of the funds currently in market won't get raised, the fact remains that LPs will have an awful lot of PPMs to sift through this year. There's a view in the industry that after all last year's success stories – especially at the larger end of the market – LPs looking to commit big sums might struggle to do so. These numbers suggest they won't be short of options, at any rate (albeit volume is clearly no substitute for quality). 

In light of all this, the practical challenges of getting commitments across the line is clearly a big deal. So it was interesting to hear some of the LPs present at the Forum talk about the things that are most likely to give them pause for thought. And it may surprise some GPs to learn that the issue top of the list for some is not fees, or carry, or clawbacks, or offsets, or LP advisory boards; it's fund size. 

According to one panellist, fund size is something that many GPs don’t spend enough time thinking about or trying to justify. But in fact, it affects almost every aspect of a firm’s business model, from the strategic to the tactical – including headcount decisions, internal organisation, co-investment and borrowing policies, and overall economics. 

The February issue of Private Equity International (which is out at the end of next week) includes an exclusive interview with Nordic Capital, which closed its new fund in December. Nordic first went out to market in 2012 with a target of €4 billion, but after a tough first few months on the road (when the Eurozone crisis was at its height), it decided to cut the target to €3.5 billion. The (not unreasonable) rationale was that it didn’t want to be expending so much time and energy on fundraising when there were so many good deals to be done; but it was inevitably painted in some quarters as something of a climb-down. In the end, Nordic made the lower target easily, closing oversubscribed – but it decided against revising the target back up again, on the grounds that “operationally, it has very little impact”, as one of the managing partners told us. 

Fundraising is clearly an increasingly complex and time-consuming process (as this week’s Forum highlighted). So you can understand why GPs would want to put the next fundraise off for as long as they can, by raising as much as possible this time around. But LPs are increasingly sensitive to fund size; they want to know exactly why the target is what it is, and exactly what consequences that has for a firm’s strategy and resource base. 

Equally, if this does turn out to be a year when there’s plenty of capital available (at least for the better funds), GPs must be wary of going up to a number that does have a significant operational impact. 

Either way, picking a target size on the basis of what’s possible – without a clear rationale – is probably not going to cut it anymore.