How To Know When It’s Time To Launch Your Next Fund
In light of the robust fundraising environment, many sponsors are looking to take advantage of strong LP appetite for middle-market private equity by returning to market early. Others are less certain. In either case, it’s imperative to look before you leap, even in a strong market. Launching your next fund offering at the appropriate time can have a dramatic effect on the amount of time you spend in market, the ultimate fund size you achieve during that timeframe and the quality of the LPs that you secure as partners. Many people believe that the decision-making process rests solely on distributions to paid-in capital (DPI) and what the investment threshold is for raising “other funds” in your current fund’s legal documents. However, there’s a deeper level of analysis required to strategically time your launch beyond solving for the “magic” DPI number or what the acceptable amount of capital you can hold in reserve for fund expenses and follow-on investments. In fact, many other factors apply and therefore there is rarely a clean-cut answer.
For example, it matters whether your strategy is more of a traditional buyout model or buy & build. The latter strategy often requires several additional years to achieve its stated investment objectives, so distributions may be slower to come and the need to reserve more capital for follow-on investments and acquisitions may be greater. Other areas that require careful consideration when assessing what time to launch is historical deployment of capital (i.e. deal pacing) and relevant performance of realized AND unrealized assets. If deployment of capital has been an issue or you’ve refocused your investment strategy due to miscues in certain industries/geographies, then LPs may push back on an early return to market, especially if you’re seeking a significant step-up in fund size.
In the current market environment, exits are not an absolute requirement. It is important to assess all the key drivers for a successful launch that we’ve discussed and determine whether corresponding mitigants are required. Strong marks, momentum in your unrealized portfolio, one exit and a cultivated LP following can all serve to ease the strain of potential pushbacks that may exist. LPs manage their investment calendars a long time in advance (often more than 12 months out), so when you’ve been able to achieve some proven successes in your portfolio, the time to enter preliminary fundraise discussions may be quickly upon you. Sixpoint would encourage a tactical pre-marketing of your fundraise timing and goals to your core LPs to take their temperature approximately nine to twelve months out from officially launching. Too often we find that sponsors are gun-shy about having the direct discussion in an environment that they perceive as too early. The benefit of advanced discussions is that it will help you gauge existing investor support, understand areas of concern and proactively message your story and test its resonance. Some GPs choose their AGM as the time to begin this messaging, but depending on where you are in the cycle, it doesn’t need to start at that one meeting. Also, it’s important to follow-up on these initial conversations and do some listening around when LPs are considering you for allocation and what they’d like to see in advance of running the potential “reup” through their Investment Committee. As we’ve previously mentioned, the critical number to reach on a first close – anchored by existing LP support – is 40%+ of the target if you want to ensure both an efficient and successful fundraise.
It is important to remember that within your existing group of core LPs, there are likely to be leaders and followers. You don’t want the leaders to cause a premature launch or let the followers delay you from taking advantage of momentum in your portfolio. Most importantly, don’t be afraid to push your LPs in a respectful way. Their preference may be a delayed launch but the business case may require the opposite and if handled properly with a groundswell of demand from new and existing supporters, LPs will likely come along even if they display some early resistance. There’s an art to striking a balance between jumping back into market because one LP is ready and supportive and delaying the process because some existing LPs have unrealistic requests regarding liquidity before they can speak to their commitment. When you have critical mass in terms of existing support, the right “fund profile” and you are riding the momentum of the portfolio, then the time to go is now. Sixpoint would be pleased to help you run an assessment of this kind.
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