Personal contributions: keeping skin in the game

In July, Elysian Capital reached a final close for its second fund on £250m after just five months on the road. While the rapid raise could well be explained by the performance of Elysian's first vehicle coupled with continued strong demand for UK funds, according to the firm's founder Ken Terry, there was another important reasoning at play; namely, the GP's substantial personal commitments to both of its funds.

Terry's story and the foundation of Elysian is a compelling one. Terry was previously a founding partner at Doughty Hanson but interestingly left the GP in the mid-00s to do a history degree. "As a mature student you have much more free time, and I used that to invest in a few funds myself as an LP," says Terry. However, he soon realised that a better idea would be to invest in himself.

Terry set up Elysian in 2007, to do just that, and began fundraising in 2008; an undeniably challenging time for a first-time fund to go out on the road. "But as we wanted to invest in ourselves, LPs were really open to the idea, which was crucial to that fundraise," says Terry. Indeed, Elysian was the only first-time fund to raise in 2009.

While Terry established the firm on the basis of wanting to invest in himself, during the early stages he was not aware of the powerful message this would carry. It was only after meeting with a US endowment who explained how desperate they were to see meaningful GP contributions that made Terry aware of how unique his fund was.

Terry soon realised that Elysian's personal contribution was creating a good reputation for the firm; it was sending out a clear message that this GP is truly committed to alignment.

Buy-side bonus
While Elysian's beginnings benefited from Terry's philosophy in terms of raising capital, another surprise came when the GP began speaking to management teams. "I didn't realise the importance on the buy-side," he says. "We have won competitive deals against funds that only have 1% commitments. This is because our personal contribution shows that we will fight for our portfolio companies. If there is no personal commitment there is a possibility that fund managers might switch off when times get tough. For us this isn't a possibility; we really want to fight for every investment.

"Entrepreneurs and management teams, who are naturally suspicious of private equity, like the fact that we are investing personally alongside them, as partners rather than just as owners."

Indeed, the ability to create an immediate bond with an entrepreneur or business owner through the common ground of having committed a huge amount to each enterprise, goes beyond giving the GP offering a differentiated approach – it shouts: we are the same.

As Terry rightly points out, the lower-mid-market in which Elysian operates is all about relationships. And for Elysian, the key has been to build those relationships through true partnership. To be able to say; if you fail, I fail too.

Because the "personal" factor is less prevalent in the mid and upper markets, where leaders of companies are far less likely to be the founder, one could argue that achieving strong alignment through personal contributions to the fund is less needed. However, taking this view may create negative feelings among LPs as it would highlight the manager as less concerned by its overall performance – what does it matter if it is someone else's money that is lost?

Unfortunately, however, this kind of thinking is present throughout the industry. At a recent industry event, the topic of GP contributions was raised and one manager labelled it a "non-issue".

Conservative approach
Elysian's performance over the last eight years highlights the hugely positive impact GP contributions have on fundraising and on winning deals. However, some LPs have raised concerns that a heavy personal contribution could lead to a more conservative approach to deal-doing. "I don't think this is the case," says Terry. "While I was at university the second time, I did some personal investments in 2005-2006 and effectively overpaid for them. When investing other people's money, I think I have always used a much higher standard of care and concern regardless of my personal commitment."

Following a second successful fundraise, Elysian now counts an 11% personal contribution across both of its funds; a far cry from the industry standard of 1-2%. Of course, looking at GP contributions in terms of percentages is not a fair way of assessing how meaningful a personal contribution is, as larger funds would require much bigger cheques. For example, an 11% contribution to a £500m fund would require a £55m commitment, which for a small team, especially one that may only be on its second or third vehicle so does not have the benefit of large carry cheques coming out of previous funds, would understandably be a struggle.

And despite Elysian's relatively smaller fund size – its first vehicle raising £130m and its second £250m – Terry agrees that the focus should not be on percentages. "The GP commitment is now 11% across both funds, with more in the first and less in the second because it is difficult to keep that pace up as the fund size increases. But it's not about the percentage, it's about the message."

Furthermore, GP contributions are not reserved to the partners themselves in order to squirrel away the resulting carry cheques. For Elysian, it is the entire workforce who invests in the fund and benefits from the pay-outs. "This approach is humbling," admits Terry. "With all members of the team investing it shows great faith in what you are doing. Internally, it's a hugely positive thing."

Down to Earth
Fortunately, Terry is not alone in championing personal contributions. One firm operating in the heart of the mid-market, Terra Firma, has been vocal on this issue. Speaking to unquote" back in February, Terra Firma's chief investment officer and chairperson Guy Hands asserted that certain groups of LPs are demanding more meaningful alignment. "Endowments and sovereign wealth funds want something different, something special, and personal contributions from the GP's decision-makers."

For those suspicious of Hands' motives – it is no secret that he has amassed substantial wealth through private equity investing, nor that the GP decided to not raise another institutional fund – sceptics will likely dismiss his view on this as simply a way to entice new investors.

But Elysian and Terra Firma are not alone. Endless is an outstanding example of a fund not only subscribing to this philosophy, but clearly proving its merits. For its Endless Fund IV, the Endless team represented the largest single investor in the newly raised vehicle. What is more, this fund took just two months to raise.

After sweeping through unquote" data to check upon recent fundraising efforts, it appears so far this year only one other fund has detailed its GP contribution – Czech GP Genesis Capital's latest fund, which recently launched, will receive a 2.4% commitment from the partners. The only other GP to comment on personal contributions was PAI following the close of its PAI Europe VI fund – it said a GP contribution was included but declined to comment on just how much.

While raising capital in current market conditions has improved greatly, as LPs pile into funds following two years of record distributions, the deal-doing environment has only become more challenging. And as competition for deals continues to heat up, those GPs that can offer target companies a true partnership will undoubtedly be the ones that win out.

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