Playing a long game

Investors are in no rush to commit these days. In fact, LP appetite has made a 180-degree turn from two years ago: the days of queuing up to bang on GPs' doors for access are long gone.

"The first half of 2008 was a period of excess," says Mounir Guen, CEO of placement agent MVision. "Investors spent their 2008 allocations in the first six months of the year and planned to use their 2009 allocations for the second half."

As such, the few closes that have been announced since H1 2008 are anomalies. And they all have something in common: they have long-term, loyal investor bases and they take a flexible approach, particularly on fees. "The changing face of the private equity market could force a change of terms," says Adam Levin, partner at Dechert LLP. "The standard 2 and 20 might go as private equity firms struggle to survive."

TA Associates, for example, just raised $4bn for its latest fund against a target of $3.5bn. More impressive than the sum is the fact it lured back existing investors - 75% re-upped - and TA lowered its carry from 25% to 20%. This is something most GPs have been reticent to do - or even consider -until lately. LGT recently raised $268m for a first close on its latest vehicle, which only charges management fees on completed transactions, and even then just at 1%.

UK mid-market specialist ECI announced at its March 2008 AGM that it was looking to launch its vehicle in September, with a view towards reaching a first close before the year-end. "It was important for a lot of existing LPs that they use their 2008 allocations, so the pre-holiday close was crucial," ECI investor relations director Jeremy Lytle explains. By December, ECI made headlines when it held a first and final close on £437m. The fund was admirably ahead of the previous vehicle's £258m.

But with this glory came guts. The fund had formally launched less than two weeks before Lehman's collapse. "Every week there was fresh bad news," Lytle notes. "The economic backdrop was horrid."

Some LPs who had initially indicated large ticket commitments rang to reduce them, but assured they would still commit. By November, they admitted to having run out of cash completely. "They were high quality LPs we'd had long-term relationships with on a number of funds," Lytle says, adding that one had been on board to be a top-five investor in the fund.

Fundraising virtues

If hitting the fundraising trail now, what do you need? Patience, first and foremost. Placement agents reckon 12 months longer than your last vehicle took, not least because of increasingly stringent due diligence demands from prospective investors. Many LPs have indicated they no longer re-up to any manager; each and every one is re-assessed on its current merits and treated as an entirely new opportunity.

Perhaps more frightening for GPs, even those intentionally avoiding the trail are being re-assessed - and those that fail the LPs' tests may find their next capital call difficult, not just their next vehicle raise.

GPs' fear of drawdowns is said to be as much a factor in 2009 H1's deals dearth as the absence of leverage. In fact the most prolific UK investor so far this year is one without any LPs: LDC, with a staggering dozen transactions under its belt in 2009 alone. As its parent provides it with capital, the investor is able to do the deals it sees worthy of doing, without concern that LPs will raise any brows.

"Investors are in no rush today," says Guen, explaining that it took 40 months after the dotcom bust for UK portfolio valuations to fully reflect the damage of the last stock market collapse, indicating the damage of the current crisis still has way to work through. "Where LPs had favourite fund managers, they don't anymore," he continues. "It's open, with five to eight meetings with prospective investments now the norm."

This is vastly different to 2007, when a single meeting sufficed. Guen even says he's heard about LPs asking GPs to take psychometric tests to assess their risk appetite and ability under duress. "First closes have become incredibly challenging," he adds.

Fortunately, not all share that sentiment. Inflexion has just bucked the trend, raising more than £75m for its Co-Investment Fund. "I was surprised by the LP reaction," says Simon Turner of Inflexion, "it was not that gloomy and I was mildly encouraged by that. LPs seem to want to back the lower mid-market."

He goes on to add that it may be because large endowments, a root of many investor woes, do not dabble much at his end of the industry.

The fund was launched in March and marketed to existing LPs only as a way to co-invest in new deals for the Inflexion 2006 fund, which raised £165m three years ago and was only 50% invested. "This fund replaces discretionary co-investing with non-discretionary so that we don't have to approach LPs each and every time we invest in a deal with an equity requirement beyond our core fund. They were receptive not only because of the familiarity, but because we explained that it was to fill a gap in the capital structure that has opened owing to the lack of leverage. We see this as a huge opportunity to do great deals in the coming year by offering high completion certainty to vendors."

About half of Inflexion's LPs committed to this and Turner's hoping they'll come back for more next year: as the Co-Investment Fund merely replaced the less formalised co-investing strategy already in place, it shouldn't alter the time of the next fundraise. With three deals in the pipeline, two of which are likely to close this year, Inflexion is likely to hit the trail for a fresh vehicle in the middle of 2010.

Turner is bullish. "I'm not saying it won't be difficult for us, but I think those in the market struggling now maybe need to consider the backdrop more carefully, or re-consider their terms."

Indeed the Inflexion team was creative with theirs: LPs that came on board for the co-investment fund were able to choose between 20% carry for the whole fund, or 10% carry on a deal-by-deal basis, with no hurdle. "It allowed LPs familiar with co-investing to continue with those terms," Turner explains.

Adaptability

In addition to patience, GPs need adaptability. Alongside the aforementioned terms and conditions, it is also important to react to changes in the market. This means creating products that complement your skillset while acknowledging the current market backdrop.

ICG has struck this balance with The ICG Recovery Fund 2008. The Fund reached a first close of e475m in November 2008 and expects to reach a second close soon. It provides new money to support private equity-backed companies, outside of ICG's existing portfolio, that may benefit from de-leveraging and an increase in the funds available for growth.

"The recovery term reflects our philosophy of wanting to build relationships with private equity firms by supporting their existing investments with fresh capital. This approach is perfectly aligned with our long-term mezzanine strategy. It is very different to distressed investing, which can imply a loan-to-own non-relationship approach to ailing assets," says Steven Clarke at ICG.

The strategy has succeeded in attracting new capital and continues to do so, even in times as tough as these. Clarke explains that the fund has attracted a number of new investors to ICG, including sovereign wealth funds from the Middle East, who have each committed a sizeable sum.

"We had some Middle Eastern investors who were keen to get into mid-market European buyouts They saw our Recovery Fund as a way in," Clarke says. It isn't hard to imagine ICG's brand and track record with its multi-product offering helped convince LPs that ICG's latest endeavour was worth backing.

Some, however, needed more convincing. "Initially some European investors were reticent to acknowledge the need for recovery. US investors thought it was a great story and liked our track record, but initially favoured their large market at home. Now some are coming around, realising that the recovery phase may last longer in Europe than in the US and so it's wise to invest now to take advantage of the opportunities over the next few years," Clarke explains.

He adds that a number of existing ICG LPs are also considering the recovery proposition. Indeed, recovery may become a mainstream medium-term investment area for ICG alongside mezzanine. "Whether we have one, two or three funds called Recovery doesn't matter right now but investors have raised it as a possibility," Clarke says.

Whatever the best way to channel money is - separate funds or not - there's no tearing rush for ICG to hit the trail for a new fund anytime soon. The latest European mezzanine vehicle, which closed on EUR2.25bn in April 2007, is roughly 50% invested, indicating it has sufficient dry powder to last through the current malaise.

Not everyone is set to survive the new market paradigm. One UK mid-market retail specialist is believed to have halved the target of its next vehicle from £700m to £350m, with investors still unconvinced that even that will be achieved.

Another bolt-on specialist recently reached a first close on less than half its target, with some LPs believed to be dragging their feet because that GP had the audacity to raise its management fee, despite current conditions. While some GPs argue that half a percentage point should be little deterrent if a fund is truly great, LPs like to feel valued.

The European Investment Fund is Europe's largest venture investor, and to ensure it has access to tomorrow's stars, it often takes punts on funds today as well as backing blue-chip brands.

"Back in 2006 we did deny a few, however, on the basis of terms and conditions," says EIF investment director John Holloway. "Even the very best funds don't necessarily stay that way for 12 months. We need sufficient investor protection."

So who's on track?

It sounds doom and gloom for all but the best fund managers. So what about new teams?

"Emerging managers and first-time funds will simply not find the capital," says Moose Guen, chief executive of MVision. "Established groups are getting money from loyal investors and even then it's less, so new money will be very hard to find.

"The exception may be mega funds experiencing difficult periods, with a strong bench of junior partners that might not see economics for a while but whom the investors are keen on.

"They could spin out - you'd have quality, strong performance attributes and a space, because the lower cap is very popular right now."

The entire interview with Moose Guen can be viewed on demand online at www.unquote.com.

Competing with yourself?

When raising fresh commitments for a new fund, GPs must compete not only with other houses on the road for capital, but also older funds with more mature stakes for sale.

Formerly an esoteric niche of the market, secondaries have become so mainstream so as to prove true competition for GPs' attention.

There is now concern that many LPs would prefer to allocate their precious capital to these lower-risk, shorter-term and often much cheaper opportunities, than to pump money into higher-risk primaries.

A recent study by Almeida Capital, a specialist fundraising advisory firm, reveals that three quarters of all LPs are looking to buy secondaries in the next 12 months.

A staggering 55% of LPs have already bought a secondary interest and an additional 23% intend to do so.

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