Have You Run Out of Capital?
Even the best private equity firms sometimes find that they are temporarily out of capital and are unable to consummate new transactions. The interim stage between fundraises can be stressful for GPs as they continue to charge ahead at investment opportunities but have to deal with the uncertainty of temporarily being without a capital source. In these situations, many GPs that I have talked to find that temporarily warehousing transactions with a counterparty is a viable option to continue chasing attractive deals.
Counterintuitively, this issue has actually grown more acute in today’s frothy market conditions. Given that GPs face growing pressure to deploy their funds faster and faster, many GPs are forced to put their subsequent fundraise on hold to wait for their prior fund to mature. LPs are usually unwilling to commit to a first close for your next fund while your prior fund is largely unrealized and on the come. Thus, GPs find themselves caught in no-man’s land – out of capital in their prior fund but unable to reach a first close on their next fund due to LPs forcing them to wait.
A common misconception in the market is that GPs assume that they would have to give up the proverbial pound of flesh in order to have a financial institution agree to warehouse their transaction. The reality is that if carefully selected, your warehousing counterparty can actually be additive to your process. I typically think of warehousing counterparties as falling into three distinct buckets: transactional counterparties, opportunistic counterparties and long-term partners.
- Transactional counterparties: These are financial institutions such as banks that are primarily focused on providing warehouse lines for portfolio investments. They are market makers for this kind of financing and are becoming increasingly creative in how they structure their financing even without a full new fund to secure their commitment. This is typically the cheapest type of warehousing you can get and I’m happy to share some examples. However, they don’t provide any additional value add beyond the financing and so competitive pressures keep the cost of capital lower than for other counterparties.
- Opportunistic counterparties: This includes a broad swathe of LPs such as secondary funds, family offices, hedge funds, specialty finance funds, wealth advisors and others who are eager to access unique deal flow. They can typically provide 6-8% cost of capital and in some cases may even pay the GP in the ballpark of 1-10% management fee/carry with step-ups based on performance that can ride as high as 25-30% carry. Moreover, these warehousing counterparties will typically allow you to buy back half or more of the investment to put it back in your fund, once raised.
- Long-term partner: These are usually traditional LPs that are able to move quickly to co-invest into your deal while providing stapled primary capital for your next fund. These LPs are truly value-add – warehousing your deal while also helping you reach your first close more quickly. Such LPs are typically open to being flexible in their timing, fees and commitment in order to better position themselves for a sizable stapled allocation in your next fund.
There are a number of scenarios in which warehouse lines may be relevant to your firm. Don’t overlook this form of financing for fear of egregious terms – it is absolutely possible to find warehousing counterparties that will be additive to your fundraise at attractive economics. The questions and notes are very much appreciated and I look forward to speaking more. Have a great weekend!
Sixpoint Partners, LLC, is a registered broker/dealer, member FINRA (http://www.finra.org) and SIPC (http://www.sipc.org). Sixpoint Partners Asia Limited is licensed by the Securities and Futures Commission (http://www.sfc.hk).