How GPs Can Attract More LP Capital: A Look in the Mirror
It is well-documented that today’s private equity fundraising market is crowded with activity. With record amounts of capital being closed for funds, as well as GPs hastening their fund launch calendars, LPs are facing a plethora of high-quality fund offerings to pick and choose from. One misconception about the market, however, is that this pressure and competition only goes one way. The reality is that despite – or perhaps because of – the high volume of activity in the fundraising markets, LPs are also facing intense pressure to secure an allocation of appropriate size in their preferred fund. Here, we will discuss what is giving rise to that dynamic and how it will affect GPs looking to raise their next fund.
If you aren’t in the top decile of your peer group, soliciting an LP investment can be a time-consuming process. The LP has most of the leverage in such a situation, as theoretically the LP has many more potential investment opportunities to fall back on should your engagement fail. Thus, GPs are typically “price takers” instead of “price makers” as it relates to fund terms and allocation. To a certain extent, this dynamic cannot be avoided – even in today’s “fast market”, LPs enjoy more leverage than GPs given that they are the capital providers in the equation. However, we are certainly seeing the tide shift in the favor of GPs as LPs begin to see themselves getting crowded out of attractive funds – unable to secure an allocation into a fund due to the high level of demand.
This change in the fundamental dynamic between an LP and GP is having profound ripples throughout the entire fundraising process. The first change is that GPs are able to be much more strategic about who they target than before. Given the large number of LPs competing in the market, GPs have found that they can now divide up the LP universe into tiers of preferred partners and solicit capital strategically rather than blanketing the market. LPs are much more likely to react favorably on an “early-look” fund offering, given the high degree of competition in other sourcing channels. This can be effectuated through a privileged relationship with the GP if they are an existing LP, or with the advisor/placement agent if they are not an existing LP. Given the high velocity of the market, GPs are also able to push an aggressive timeline and get an expedited response from the LP.
The other major impact of this changing relationship is that LPs have become much more focused on maintaining optionality as they manage their forward pipeline. Thus, GPs have to recalibrate how they interpret different milestones in the lifecycle of a potential engagement. In the past, getting to the onsite stage with an LP was a good indicator that they would more likely than not end up committing to the fund. Save for a major negative revelation at the onsite, GPs could previously rely on a ~90% certainty that the LP would commit to the fund post-onsite. In today’s market, however, we are seeing LPs move to onsite much quicker than they otherwise would have. As a result, the pass rate on funds post-onsite is startlingly high compared to previous years. As LPs get comfortable with moving to onsite with lower conviction, GPs should expect that their post-onsite close rate will decrease accordingly.
The heightened activity in the fundraising markets comes with pros and cons for both GPs and LPs. If these dynamics are managed properly, GPs that are raising capital now or in the near future can use the changing market environment to close their fund quicker and more efficiently than before.