Why normality is on hold

Limited partners need to be in full possession of the facts before resuming substantial investment in private equity. Andy Thomson reports

The fifth of March 2009 was a particularly bad day. Recessionary woes, continuing worries over the financial sector, silence from China on much anticipated new stimulus measures and doubts over the viability of giant car maker General Motors combined to drive down the Dow Jones Industrial Average to its lowest level since 1997. “Just when we think we've got to the bottom, the bottom gets re-defined,” one private equity professional recently told PEI.

With each fresh stock market plunge, the challenge facing limited partners in their efforts to keep investing in private equity gets tougher and tougher. The shredding of their public equity portfolios and consequent over-allocation to private equity has been well-documented. But while that's an entirely rational explanation for the lack of capital supply coming from the LP ranks today, there is another dynamic at work that has to do with human emotion – many investors are quite simply spooked. “Some LPs are like deer caught in the headlights,” says Terry Crikelair, managing partner of Connecticut-based placement agent Champlain Advisors. “There is a lot of shock at how far the market has run amuck and people are fretting about whether we're in a recession or a depression.”

Meanwhile, Mounir Guen, chief executive of placement agent MVision, points out that, at the time of writing, many limited partners had not received 2008 numbers from GPs. “A large majority of investors have put commitments on hold until they receive the year-end numbers, but a lot of GPs were not set to produce them until the end of March. Indeed, a number have asked LPs for time extensions, which has resulted in extended delays. The result is that commitments are increasingly on hold and limited activity is taking place.” Guen adds that fundraisings are generally slower, especially for North American generalist funds. “If your existing investors don't re-up for an amount close to their previous commitment, there is not enough money around to make up the difference. In the past you could live with a 60 percent re-up rate. Today, you'll struggle to find that remaining 40 percent from new investors – it could add an extra year to your fundraising.”

Anecdotally, placement agents confide that the third quarter of 2009 is the absolute earliest that many LPs will consider broadening their investment horizons beyond making re-ups to existing core relationships. “My view is that the fundraising market might come back by the end of the year,” says Patrick Petit, managing partner of Paris-based placement agent Global Private Equity. “But it remains to be seen how strongly it comes back.”

Crikelair says that there needs to be more confidence in the macro-economy before things start returning to normal. “You need to start with a general stabilisation and, despite very active government policies, we have yet to see that. Once that happens, LPs would feel they had more of a solid footing and would then be able to project where they want to be and what areas they want to play in.”

If only they had that luxury right now. While it is widely acknowledged that recessions are an optimal time to put private equity capital to work, it's a case of easier said than done. “Historically, investing at a time like this has proved very savvy but these are unprecedented times. LPs don't get paid to take unprecedented risks but to avoid the pot-holes,” says Crikelair. “At the moment there are a lot of minefields out there.”

GPs are finding some newer investors keen to allocate to private equity – after all, they are not constrained by being close to allocation targets and are aware that recessions can provide private equity's best vintage years. However, Clive Norton, managing director at placement agent Helix Associates, points out that they are not in a hurry. “They are able and willing to invest and see the next two to three years as a good time. But they will wait for the best managers to come back to the [fundraising] market – even if that means waiting beyond this year.”

SELECTED RECENT FUNDRAISINGS

Manager Geographic Strategy 1st/2nd/final close Amount Target final
focus raised amount
Atlas Venture Global Venture capital Final $283m $400m
Avigo Capital India Growth capital 1st $i50m $250m
Carlyle Group MENA Buyouts Final $500m $500m-$i.obn
Catalyst Investment Australia, Mid-market Final A$438m A$800m
Managers New Zealand buyouts (plus A$160m
co-investment
facility)
Danske Private Equity Europe, Fund of funds 2nd €600m €600m
North America
Element Partners North America Cleantech Final $486m $400m
Hellman & Friedman North America Buyouts 1st $6.obn $io.obn
Index Ventures Europe Venture capital Final €350m €350m
NextStage France Growth capital 1st €6im €i20m
Odyssey Investment Partners North America Mid-market buyouts Final $i.5bn $i.obn
Pinova Capital German-speaking Lower mid-market 1st €50m €i50m
Risk Capital Partners UK Growth capital Final £75m n/a
Siemens Venture Capital North America, Venture capital 1st $ioom $200m
Europe, Israel, Asia fund of funds
Vision Capital Global Secondaries Final €680m n/a
Z Capital Partners Global Special situations 1st $ioom $500m

REFUGE IN ASIA
Not all private equity markets around the world have been affected by the crisis to the same degree. As geographic allocations come under close scrutiny, Asia is one part of the world where investors are keen to maintain or increase exposure (see chart below left). “Emerging Asia is a bit of a bright spot,” says Andrew Ostrognai, Hong Kong-based head of the Asian private equity practice at law firm Debevoise & Plimpton. “People have got to put their money somewhere and we still have a growth story in this part of the world. China's growth may end up at a bit less than eight percent this year, which is a problem for China, but it's still pretty robust growth.”

This is not to say, however, that Asia is immune from the fundraising malaise. “People are scaling back targets and it's taking longer to raise capital,” says Ostrognai. He says experience is a vital determining factor in a fund's likely success and mentions that his own firm is currently advising a sixth fund and two fourth funds. Even the veterans have to be patient, however: “In the past, a very experienced GP could raise the money in three to six months. Now it's six to nine months, or maybe as much as a year.”

Ostrognai also makes the point that Asia is not a homogenous market and that different parts of the region have very contrasting prospects. “Countries like Australia and Japan resemble the US and Europe a lot more than countries like China and Thailand. Japan appears to be in terrible trouble and, in Australia, distressed debt is now the story.”

One thing is for sure: for all GPs, regardless of geographic focus or strategy, the onus has to be on keeping existing LPs happy – and that means that good investor relations are very much centre-stage. “The relationship with your investors is more important than ever,” says Petit. “Quality reporting, investor follow-up and transparency are all crucial. When you're transparent, you can be forgiven some missteps.”