INVESTOR APPETITE FOR private capital proved resilient in 2021, resulting in the strongest global fundraising year on record, with the private equity troupe closing on around $870bn of commitments (see Figure 1). This was propagated by buoyant M&A markets, which supported a flurry of investment activity by GPs. Having deployed faster than ever before, many GPs found that the need to return to the market for more capital had been expedited, compressing their fundraising cycles.
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The average manager has now recommenced fundraising within two years of raising their prior fund, compared to the traditional five-year cycles.1
These structural trends have carried into 2022 and contributed to the busiest fundraising environment in recent memory with an unprecedented number of GPs returning to market. A total of 2,886 funds are in the market in 2022, the largest-ever amount at a given time, collectively targeting nearly 1.6 times the level of capital targeted in 2021 (see Figure 2).
Zero-sum game
Unsurprisingly, spaces for new GP commitments have become highly competitive as LPs choose to focus their attention on re-ups; a number of investors have reported that re-up pipelines alone represent more commitments than annual budgets allow. LPs simply do not have the resources or allocation to process the current volume of opportunities.
The fundraising landscape for many investors is currently a zero-sum game, making a new commitment only possible by declining to re-up with an existing manager. This has naturally raised the bar for all underwriting as it is no longer enough for a fund to be strong in its own right – it needs to be able to unseat an (often long-term) existing relationship.
On the flip side, LPs are also being forced to take a fresh look at their existing managers, meaning re-ups can no longer be considered the sure bet that they once were.
Greater scrutiny
Investor processes are therefore being conducted with greater scrutiny and increasingly thorough due diligence. LPs remain focused on high-quality, consistent track records and long-tenured, stable teams that can demonstrate a direct application of their prior experience to their current strategy. However, this has been amplified in recent years, with more rigorous internal review processes and enhanced referencing as investors are able to be more selective, seeking to exclusively partner with top quartile managers that demonstrate potential for true long-term value creation.
An increasing majority of LPs have also built ESG considerations into their IC processes, operational due diligence and return expectations. This is particularly prevalent in Europe, where adopting the highest ESG standards can be the difference between a commitment and a decline.
“Haves” and “have-nots”
In general, the barriers to an LP commitment are greater than ever, with investors looking for any opportunity to say ‘no’ to a fund. Where commitments are possible, many investors have been forced to keep their ticket sizes flat, or in some cases reduce them, to maximise the number of existing relationships they can maintain or the new ones they can add.
The result is a market of “haves and have-nots”, as the bulk of the capital continues to consolidate around a group of select managers. In Europe in particular, the COVID-19 climate has especially favoured established managers, causing the average fund size to increase steadily year on year (see Figure 3).
This has left many GPs facing somewhat elongated fundraises, in some cases allowing LPs to dip into 2023 allocations. In Q1 2022, the number of global private equity funds reaching their final close was at a decade-low (see Figure 1).
Reasons for optimism
However, despite the number of funds reaching a final close falling, fundraising in Q1 2022 was robust overall, as the aggregate volume of capital raised exceeded the strong levels of fundraising seen in Q3 and Q4 2021 (see Figure 1). Despite high levels of volatility in the public markets, private equity valuations have proven resilient and there has not been a material denominator effect – for the moment, anyway.
Expedited raises remain possible with early communication, careful preparation and well-managed execution. As well as addressing macroeconomic challenges and demonstrating replicability of returns, managers must look to enhance their differentiators in an effort to stand out from the crowd. There is no room for complacency – nor is there reason to panic. ☐
1Private Equity News, a fellow Dow Jones Group title
A full version of this article appeared in PLATFORM 07, Summer 2022