When Kian Capital Partners was raising its third fund earlier this year, it got some bad news. One of the LPs from its previous fund could not commit. Not because of poor past performance. Not because of a lack of faith in the fund’s investment strategy. Quite simply, the LP had lost its mandate from a state pension, so there was no capital to invest.
Such a scenario is common with private equity fundraising today. Raising a fund has become much harder, even for behemoths like Apollo.
In the end, Kian closed its third fund oversubscribed at $400 million. But many GPs are having trouble navigating the fundraising trail today. Due to macroeconomic factors and the denominator effect, there are a lot of general partners fighting for less and less LP dollars.
“Placement agents are inundated with work right now,” says David Lippin, a managing director and head of investment relations with One Equity Partners. “GPs who have never had to work with an agent before, are now going out and hiring help because they’re concerned they’ll need an insurance policy or they won’t able to successfully raise in this environment.”
As a result, much of the leverage in the relationship between the two parties has tipped towards the limited partners. According to the Barnes & Thornburg 2023 Investment Funds Outlook report, which polled 125 limited partners, sponsors, and service providers, 75 percent expect changes in fund terms that will benefit LPs.
“We’re seeing LPs being aware that they have or may have the upper hand,” says Kerry Potter McCormick, a partner with Barnes & Thornburg, an Indianapolis-based law firm. “In a sense, instead of begging for a bigger allocation from a fund manager, the manager is coming to them and asking for a bigger commitment or for them to maintain commitment size fund to fund. Even though they may have fewer dollars to commit overall, we’re absolutely seeing sophisticated investors who understand that they can ask for better economics and better transparency. Those are the biggest themes right now.”
Beyond the traditional diligence of management teams, track records and investment strategies, LPs today are looking for increased transparency and preferable deal terms before making a commitment.
According to the B&T report, 58 percent of limited partners believe fundraising is the most pressing issue facing GPs. Furthermore, 38 percent of LPs say transparency is the most pressing issue facing themselves while 23 percent believe favorable economic terms are the most pressing.
“I have not seen LPs walking away solely on the basis of transparency concerns,” says McCormick. “But I have seen them really make a big deal out of it in the negotiation process. And I’ve seen GPs give on it more than they have in the past.
“I think the constraint of LP capital may be driving that because you know the IR people, the front office people, everyone at an asset manager, you can see what’s happening, and if you have a transparency request from an existing LP that writes big checks or a prospect that’s going to be a good partner for you to have going forward, I think all of those constituents are going to come together and say how can we make this level of transparency work for us and work for the LP,” she says.
Limited partners are looking to get visibility into the deals other investors are getting. Whether that is economics, co-investment opportunities, heightened LP-favorable protections, fee breaks, or reporting visibility, limited partners want to check that they are getting the best deal.
“Limited partners like to feel as though they’re kind of being brought into the fold early on discussions,” says Laura Leyland, a managing director with placement agent Asante Capital. “I think it is really important for those LPs to feel as if they’ve got your ear, to be able to call. I think particularly with GPs that are fundraising, acknowledging the LPs as people, and understand that they are being absolutely flooded with information, with emails, and are super overworked. So, the GP just acknowledging that and being grateful for the time that they’re spending with them on the raise and grateful for their advice, grateful for their capital and just really making it feel like a true partnership is important today.”
How GPs are Responding
Given the supply of capital remains below demand, what are GPs doing to adapt? “I think a lot of GPs are realizing they don’t know how to handle lack of LP participation,” says Lippin. “A lot of them are retooling their IR departments. They need to upgrade talent, add to their teams, and figure out how to get out there and win new LP dollars. It’s not twice as hard, it’s 10 times as hard to try and win new LP dollars versus trying to win additional money from an existing investor.”
Lippin says a lot of general partners have never had to deal with this before in their history as they have had a confined set of LPs. As those LPs grew, their allocations would increase and they would naturally expand. However, “It’s a new world for many GPs who don’t have best-in-class fundraising functions and IR functions in place.” Kevin McCarthy and Rick Cravey, co-founders and partners of Kian Capital, attribute their success through these times to the work they did months before the firm was fundraising for its third fund.
“If you’re reacting to losing that LP unexpectedly then you’re probably already behind the eight ball and it’s going to be very difficult to fill that hole,” Cravey says. “If you’re doing the spade work before you’re actually raising money and you have good fund performance and so forth, then hopefully you have enough of a surplus for that unexpected LP departure.”
The million-dollar question of quantity versus quality when it comes to the limited partner Rolodex will differ with each manager you ask. However, Kian chooses to split the difference.
“I’d like to cherry-pick the best of the two hypotheses and say that we want to have a broad and diverse set of LPs,” says McCarthy. “We want to do our very best to have deep connections and relationships with each of them to mitigate the risk of a narrower set of LPs.”
Asante’s Leyland adds that firms are moving beyond traditional sourcing. Firms are geographically branching out to the Middle East and Asia. Sponsors are building relationships with the limited partners in new regions, particularly those that can write larger checks.