Collective Bargaining: How to Aggregate Commitments for a Big First Close

What would you do for $100 million? It’s not a question that most people spend their time pondering, but in the world of private equity fundraising, it’s an important question to consider. When one considers a fund commitment of nine-figure magnitude, there are many factors to deliberate on; foremost should be whether the investment will likely be more “anchor” than “investor” in the future. Commitments of this size rarely come without strings attached. They have concentration issues, you have concentration issues, governance issues and of course — the other 800-lb gorilla in the room: economics. If the $100 million commitment comes early in the fundraising process, as these investments often do, the economic negotiations take on heightened significance. Unfortunately, many spinout groups or new managers are ill-informed with regard to market terms for these types of investments and they are unsure of their footing within this competitive environment. It is a natural problem for less experienced fundraisers, but they are not alone in dealing with these kinds of issues.

The significance or value of a $100 million investment obviously depends on a myriad of factors, not the least of which is the fund size and the timing of the commitments. What should GPs expect as far as a “give” in these situations? If the commitment represents at least 25% of the fund size, the management fee discount will likely range to 1.50-1.65% and carry of 15%-17.5%. Co-invest rights will also be negotiated. Those are common – and many would argue reasonable – requests for such a meaningful financial infusion to a firm with capital needs. The issue becomes more acute when anchor investors look to exact a steeper price for their involvement. We have seen some well-known groups seek a deeper discount of the fund’s economics and in some cases a minority share in the management company. If the “seeder” is value-add because of what they might be able to provide beyond just capital then the concession may very well be worth it. Otherwise, the market might look unfavorably around such a structure and concerns of misalignment may arise.

The alternative to this whale hunting exercise is a more programmatic and disciplined approach to identifying first mover capital. As with all things in life, preparation for this process is key and an advisor is a necessity. In fact, we recommend a 12-month runway for completing a professional anchor investor identification effort prior to even launching an official fundraise. From our experience, the “go-it-aloners” will approach high quality targets – maybe the only ones that they know – prematurely and will have more questions than answers for the prospective anchor. This is a dynamic that GPs want to avoid because it demonstrates a lack of credibility, or worse, a lack of “investabilty,” which can be very difficult to recover from. Ideally, the GP, with the close counsel of its advisor, will have thought through the value of an anchor commitment in advance of these LP meetings and be in the position to offer a proposal of terms and conditions to the LP that reflect the understanding and seriousness of a group that is worthy of the LP’s financial support. The way to avoid a situation where the terms are too onerous or even detrimental is to approach a group of like-minded first-closer LPs that can each represent “a share” of this “$100 million” anchor investment and manage a collective bargaining arrangement. In this model, no one LP has undue influence over the GP and likewise each participating LP can easily avoid these concentration issues and provide a diversifying benefit. In short, there’s better alignment. Naturally, these early bird LPs want to be compensated for the risks associated with coming in first to a fund, but the preferred economics are less harmful to the GP and its ability to attract incremental capital to the fund. Additionally, the benefit of a diversified group of LPs will ultimately make the firm stronger and less vulnerable to the vagaries of one investment program.

There is a vulnerability that all managers experience when approaching or re-approaching the market, but in that time of uncertainty it is important to not leap into the arms of the first LP with deep pockets. Careful preparation is necessary to make the most of this opportunity to build the foundation of your firm the right way. Over the past few years, Sixpoint has increasingly spent time navigating the “first-closer” market and through these meaningful discussions with LPs has discovered that when approached under the appropriate circumstances – fee proposal in place, team established, fund terms thought through – there is a much wider audience of groups with the capacity and willingness to make their dollars count in a first close than GPs often assume.

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