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Two years of winter:/
That’s what awaits those who did/
Not bury their nuts
We all know that times are tough for GPs out fundraising at the moment. But ask anyone on the sell-side and they’ll tell you the same thing:
2009 was horrible, but we expect things to pick up by the end of the year
A quick poll conducted by IE Consulting last month, however, suggests that times will remain tough for those PE houses out scavenging for LP commitments. Of course, the very best funds will come out and raise money. By the way, “very best funds” does not mean “top quartile” (anyone ever marketed a fund that wasn’t top quartile?). “Very best funds” means just that: those private equity and venture capital funds that have consistently delivered performance that outpaces its peers and other funds in other asset classes.
It’s simply no longer enough to be delivering better returns than other European buyout funds or other US venture funds. Limited Partners are taking a hard look at the dollars they are investing in private equity and VC funds and how the returns stack up against their other investment strategies: Commentators should not be surprised to see even committed investors into the asset class “taking stock” for a good while longer than even the most pessimistic might have expected.
So what does this mean for those in the market now, trying to raise a fund?
- Get out early. You could be in the market for 18 months or more
- Be flexible. Respect the fact that the balance of power now rests with your LPs: They have alternatives.
- Show how you are different. A longer fundraising timetable means more “competing” funds on the road at the same time. Why should LPs invest in your fund?
- Don’t forget to make the case for private equity: Is your strategy preferable to investing in the public market? How?
I remember a conversation I had in 2008 with the head of investor relations at one of the preeminent large buyout houses. After exchanging niceties and discussing the industry landscape, talk turned to their current fundraising activity. Apparently, the firm was engaged in “philosophical” discussions as to whether it should even include a market commentary section in its PPM. After all:
“everyone knows what we do and why they should be investing in our funds”
Oh, how things have changed…
You can read the full research summary from our LP poll here:
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Earlier this month I had the honour and pleasure to be invited onto a panel at the 6th Annual Private Equity Forum at my alma mater. The panel sought to address how LPs had been affected by the financial crisis and, not being a Limited Partner myself, I thought it prudent to ask some, beforehand. If you were one of the 60 institutional investors into private equity that responded to my questionnaire, many thanks!
In any case, and as my colleagues predicted, there was no real need to call upon the research findings during the event. But some of the findings were so intriguing that I wanted to share them with you. I hope you find them as interesting as I did.
The link below will take you to a summary of the results.
People prefer performance, and that will never change, but we found that many LPs had already ditched managers that they felt had not been communicating with them sufficiently well and some found that misalignment of interests between LP and GP (shock! horror! such DO exist!) had become more apparent during the crisis.
There’s much, much more in the full report, so I hope you will take the time to dive in. If you have any questions or comments, you know where to find me!
In an earlier post, I mentioned the three arguments that I believe are central to any successful fundraising process. If these arguments are sufficiently strong, the fundraising process should run relatively smoothly. A fundraiser must always establish the following:
- This market represents a great opportunity, right now and for a considerable time;
- This strategy is the most suited to exploiting that opportunity;
- This manager is the most able to successfully execute that strategy.
I may have given the impression that I believed that this was all that was necessary to secure an investment, but of course that is not true.
The fund selection process is more sophisticated and the biggest challenge for any fund (but particularly a new fund) is going to be convincing an LP that the time required to properly investigate the fund would be worthwhile.
It is all very well lining up watertight arguments and detailed corroboration, but what good is that if an LP doesn’t get past slide five in your pitch book or doesn’t pick up the PPM?
Not much good at all, of course. Stating the rational case for investment is probably only going to pay dividends once the emotional curiosity of an LP has been awakened.
I think it has a lot to do with awakening fascination, emotional curisosity in the investment opportunity, the investment strategy, or the management team.
You see, as much as the scrutiny of due diligence may reveal about the historical performance of an opportunity, a strategy and a manager, it cannot foretell the future. As everyone in the investment business knows:
Past performance is no guarantee of future results
In order to evaluate the likely future performance of a fund, an LP cannot rely on numbers alone. When an analyst is picking through 50 PPMs, which are the ones that are going to get the most attention and stand an improved chance of being presented to the investment committee? The fascinating ones, of course!
Now, an analyst that values his or her job is not going to present this as a selection criterion. Imagine the response to this statement:
I think we should invest; I’ve always admired Bono and his engagement with imprtant issues. We can trust him with our money,
In all likelihood this fascination with the fund will be rationalised into a more empirical analysis of the benefits of investment. In fact, as the selection process becomes more abstracted from the initial contact with the brand and due diligence begins in earnest, the emotional impact of the brand actually becomes less important.
We select the funds we want to invest in emotionally and assess whether we can invest in them rather more rationally.
I’ve set out how I view this process in a diagram, below:
In essence, the idea is that most investment opportunities progress by awakening an emotional interest that is then rationalised, before being checked against certain other criteria, including competing investment opportunities. The amount of time that passes between the individual steps can vary between simultaneity and years.
- The LP becomes aware of the fund somehow
- The LP has some manner of contact with the fund or a fund representative
- The LP finds one or more elements of the opportunity, strategy or manager sufficiently fascinating to properly engage with the fund, its materials, or representative
- The emotional interest in the fund is rationalised into a more empirical investment case
- The LP conducts Due Diligence on the fund
- The LP evaluates the fund against those that are perceived to be similar
- The LP selects the fund for investment and makes a reccommendation to the board
That’s kind of how I would probably buy a new TV…
- Matt hears about the flatscreen TV
- Matt sees a commercial about the TV
- Matt thinks that the TV would look cool on the living room wall. It’s so shiny!
- Matt decides that buying the TV and fixing it on the wall would mean that he could get rid of the old CRT TV and the ugly TV stand…that would mean space for an extra chair in the living room and a more comfortable time when friends come over – how practical!
- Matt checks out to see if the TV will be easy to mount on the wall and if it has a digital tuner built in
- Matt checks out other, similar TVs
- Matt tells Mrs C-G that family C-G simply must invest in this practical, space-saving, TV
Typically, my investment recommendation will be rejected by the committee (Mrs C-G) at this stage. 😦
A firm should not make or offer to make any payment or other consideration with a view to enducing [sic] a third party to enter into contractual negotiations with a client
– that’s according to the Draft EVCA Placement Agents Supplementary Code of Conduct that was released recently.
Yikes. The thought that this goes on, as it clearly has, ought to be shocking. Well, it is shocking even if I feel naive writing that.
But is banning placement agents the answer? Surely it cannot be. Just because a few fraudsters want to line their pockets dishonestly, doesn’t mean that the role of an intermediary in the private equity fundraising process is unnecessary. Ask any GP running a small fund if he/she would prefer to spend more or less time raising money and the answer is pretty clear. If LPs want their fundmanagers to spend their time investing LP cash rather than trying to raise more of it, they had better accept that the placement agent is their friend or, at least, not their enemy.
Traditionally, the Venture Capital industry has taken its lead from the West. Sure there are fine firms up and down the US and beyond, but think of venture capital and it’s hard not to imagine Google’s garage or a sarcastic VC cutting through some poor entrepreneur’s far-fetched American dream (or, if it’s 1999, funding it).
Now that probes into the services that 3rd party marketing firms and placement agents offer are causing some concern, VCs need to wise-up on the marketing of their own funds. And it’s not going to be easy.
I’ve written before on certain similarities between the actions of some in the fundraising industry and of those in the Wild West. I wasn’t too complimentary, but I wonder what we can learn from the Ol’ West? Here are some quick pointers:
Firstly, if you can, it’s important to show some kind of track history. After all…
It’s better to be a has-been than a never-was.
But track history isn’t everything, of course; it might have been easy raising your last fund in ’06: You delivered 30%+ IRR and most of the LPs were reckoning on funding their commitments with distribution in any case. But, in 2009, if you can’t show how your teams delivered those returns, you’re sure gonna hear this an awful lot:
Timing has a lot to do with the outcome of a rain dance
And honesty really is the best policy; let’s hear it for bad news, told well. The amount of DD LPs are putting in these days means that it is going to be increasingly difficult to exercise that special sort of creativity that some VCs are rumoured to be indulging in with the valuations of some slightly wonky Chinese portfolio companies. Much better to open the books and tell the story of what happened and what was learned.
Good judgment comes from experience, and a lotta that comes from bad judgment.
Of course, one of the most important skills is getting an upfront read on who might be ready to commit and who is still waiting before making new commitments. It’s like they used to say:
Never slap a man who’s chewin’ tobacco.
- Show what you have done
- Show how you did it
- Don’t just tell the good news
- Wait for the right time to tell it
If you get all that licked, you might stand half a chance!
I’ll tail off now..:
Never miss a good chance to shut up.