GPs Launching Funds Earlier
Greetings from Los Angeles this week where I’m writing today’s issue. I want to give a shout out to the LA private equity community. There is a prominent and growing base of high quality GPs here and I’ve enjoyed my various discussions with many of you. I can say with confidence that LPs are increasingly focused on what you’re doing. With the idea of “growth” in mind…a common refrain I hear from LPs today is the number of expected re-ups for 2019 and how fast their allocation for 2019 has already filled up. Note: It’s only March! In today’s fast-paced market, many LPs are finding that their existing fund relationships are coming back to market sooner than ever – and sometimes less than three years since closing the prior fund. I think it is a worthwhile discussion for us to have: what is causing the acceleration of the fundraising timeline and how can you adjust your fundraising strategy for success in these conditions?
The abundance of LP demand for private equity investments is itself driving favorable fundraising conditions for GPs who want to grow their AUM and deploy capital. This is a self-fulfilling pattern, as an easy fundraising market drives up fund sizes, which drives up market valuations, causing GPs to run out of capital faster and return to market sooner. Furthermore, concerns around the medium-term macro future of the fundraising markets has led GPs to come back to market quicker than they otherwise would have for fear of missing the “market window.”
These dynamics have given rise to a number of changes in the way LPs evaluate funds. Most notably, they have become less comfortable with GPs coming back to market with unrealized portfolios in their prior funds. Only two years ago I saw GPs raising unrealized portfolios with ease. Today — while it can be done — other mitigants are required (like exits in your prior funds, stronger legacy returns and traditional catalysts like co-invests.) Not only are distributions king again, as it relates to the market’s impression of a private equity firm, LPs have become less forgiving and more skeptical about marks. LPs want a better demonstration of the value creation bridge and won’t give you credit if your returns are dragged down by the new investments made right before launch — especially if the number of new investments is outsized from a pacing perspective. GPs that face this dynamic should prepare a detailed gap analysis for each unrealized portfolio company, highlighting achievements to-date, basis of the valuation, value creation initiatives underway (and the expected financial impact), as well as a timeline for exit. The same GPs should also consider timing their raise around at least one exit — even if that exit process begins before the first close but doesn’t close until later.
GPs should also expect tough questions around deployment pacing on a forward looking basis and the need for more capital. This is easier if your prior fund is simply out of capital – although LPs may still press on this issue – but more important if you have not closed out the prior fund. LPs will want to see an actionable forward pipeline with a clear path to closing out the prior fund – some LPs will even make a commitment conditional on this point. Furthermore, if you are increasing your fund size, you will need to provide a rationale for why you think you need more capital and whether it will affect your strategy in any way. LPs will want to ensure that the fund size doesn’t grow too dramatically and that they can still expect the same performance from you with a larger fund.
Times of plenty in private equity result in the mad dash for capital that we are seeing today. And for the time being, it certainly makes sense to capitalize on the opportunity to grow your firm and accelerate your fundraising strategy. The difference between raising your fund in H1 2019 and H2 2019 can be dramatic and timing of launch matters. GPs who anticipate that they will be fundraising in the near future should make sure that they have an ear out to the market and are tactically sound in executing their fundraise.