Fundraising fortunes: prevailing LP preferences persist

Given the unprecedented challenges that befell the private equity industry in 2020, market participants breathed a collective sigh of relief when it became clear that the fundraising momentum seen in the latter part of the 2010s would not be abruptly broken. According to Unquote Data, funds based in Europe collected €141bn across 168 final closes, equating to a 6% increase in capital raised and an 18% drop in number of closings on 2019, when managers raised €133bn across 205 final closes.

While the overall picture is no doubt reassuring, the discrepancy between the smaller number of vehicles crossing the finish line and the fact that they pulled in yet more capital in 2020 highlights how the Covid-19 difficulties deepened the bifurcated nature of the market, with very different outcomes depending on the profile and strategy of the funds on the road.

Established managers performed well and achieved some of the largest closings ever recorded, including CVC Capital Partners VIII, which collected €21.3bn, surpassing its €17.5bn target and becoming the largest European buyout fund ever raised. Other significant fund closes included Nordic Capital X, which collected €6.1bn, exceeding its target of €5bn; Hg Genesis 9, which raised €4.4bn; and IK IX, which held a €2.85bn final close, surpassing its €2.5bn target.

While the appeal of name brands in the large-cap space was arguably strengthened by the events of the past year, it does not fully account for the resilience of the fundraising market. Smaller players were also able to raise impressive amounts quickly, with one undoubtedly winning trend being sector specialisation, and particularly the blooming of vehicles dedicated to technology and healthcare.

Call in the specialists
"The pandemic has accelerated the shift towards sector specialisation across Europe, something that we have already seen in the larger US market," says Marc Wursdorfer, head of UBS's private funds group. "In 2020, we saw generalist funds become much more multi-sector-focused, and other managers that had already embraced the road towards specialisation accelerate and optimise this trend, taking a much deeper focus on certain industries. Numerous players that have historically had a much broader horizon have now started to narrow down their scope, specialising predominantly in areas like technology – particularly software and tech businesses with strong recurring revenues – as well as healthcare and some resilient healthcare-related segments."

In addition to technology and healthcare-focused vehicles, food-dedicated funds have also performed well during the pandemic. Among others, Idea Taste of Italy 2 raised €330m, surpassing its initial target of €250m and €300m hard-cap; Pontifax AgTech closed on $302m; and Cibus Fund collected $66m.

"Sector-specialised funds are the winners of this pandemic, and not only in the tech and health sectors," says Sunaina Sinha, managing partner of Cebile Capital. "Five years ago, when we worked on our first food and agriculture fund, we had to do a lot of investor education on why food and agriculture can successfully be the perfect scope for a standalone sector fund. Since the pandemic started, we have had two oversubscribed food and agriculture funds, and the appetite for this type of sector-specialised vehicle remains very strong. An increasing number of LPs are looking for general partners that are sector specialists able to understand the space, strategy and complexity of intensive investments in a selected number of sectors, as the opportunities across these industries become greater."

Growing trend
Another strategy that has proven successful and has emerged as a winning trend of the pandemic is growth-focused investing. Growth funds are typically smaller vehicles dedicated to minority investments through expansion deals and capital increases. They target profitable companies, with strong revenue generation and high-growth potential. The capital invested does not include any debt packages or significant leverage and is used to fuel the growth and expansion of a promising company, in partnership with its management and possibly with other minority shareholders.

Sinha says: "Pre-pandemic, when we suggested a growth fund to investors, a lot of them were sceptical and uninterested. But today, because of the pandemic, there has been such a resurgence in the idea of growth, and the ability for a manager to develop a growth vehicle able to make expansion deals and successful exits, has become very popular. Growth funds are now a big theme for investors, and I see this trend continuing for the rest of 2021 and further."

Alongside some buyout and growth strategies, and despite a pause in transactions over Q2-Q3 last year, it also seems clear that the appetite for secondaries vehicles has continued unabated. Last year, Ardian closed the world's largest vehicle to date dedicated to the secondaries market, Ardian Secondary Fund VIII, which raised $19bn, exceeding its $18bn target. On a smaller but equally remarkable scale, AlpInvest Secondaries Program VII closed on its hard-cap of $9bn, surpassing its $8bn target, while Dover Street X held a final close on $8.1bn.

Tough going
While it would be easy to look at headline fundraising figures and individual success stories, and assume that the market was broadly unaffected, the smaller number of final closes in recent months offers a first hint that numerous GPs have also struggled to attract new LPs and often had to delay or postpone their fundraising projects.

For emerging GPs and first-time funds, the market has been a far more competitive and hostile environment than a year before. Most of the capital raised last year was collected by GPs with long track records featuring several generations of fundraisings, while only 6% of the final closings recorded were made by first-time funds.

Wursdorfer says that, while we are still in a very strong market environment for raising private equity funds, not every manager has been able to benefit from it: "For lesser-known managers, emerging GPs and first-time funds, it has been very difficult to build solid relationships and expand their network of contacts with new LPs. Some young funds that had a chance to put their heads down, hold some meetings and present their proposition ahead of the lockdown, have been able, to a certain extent, to navigate through the crisis." Without a very differentiated offering and solid track record, most of them had to put their fundraising on pause or, alternatively, raise capital on a deal-by-deal basis.

Some established GPs were also hit by this tough climate, especially those with an excessive overexposure to specific segments of the consumer market most impacted by the spread of the virus and the lockdown measures imposed by the local governments.

Sinha says: "Even if we are not completely out of the crisis yet, we can clearly see which funds and strategies have recorded the deepest loss and shown the greatest flaws. General partners with a consumer bias – funds excessively or exclusively focused on consumer strategies with a high exposure on travel and leisure – have been the main losers and will have to strive to regain success."

Another factor that will now increasingly influence fundraising success is Covid-19's impact on a GP's portfolio, and how the manager navigated the crisis, Wursdorfer points out. "How to evaluate this and which parameter to use is a much more complex matter," he says. "There is a broad set of approaches to valuations and they can vary based on the situations. An uplift in NAV for one manager may not mean the same for another. What is actually essential is looking at the operational performance, at how managers have reacted operationally to Covid-impacted assets, and at what the trajectory of a portfolio has been. There are managers that still need to demonstrate that they can get the portfolio back on track, and therefore will have slow and lagging fundraisings. There are others that have been badly impacted, but have been able to rapidly implement operational change and regain investors' confidence, ultimately coming out very strong on the other end."

Looking ahead
Judging by the first few months of 2021, the market appears set for more of the same: a number of top-flight funds and standout niche offerings are acting as magnets for large amounts of capital, but fewer vehicles overall are wrapping up their fundraising efforts. The growing backlog of funds on the road is therefore unsurprisingly acting as an added deterrent for less high-profile managers to return to market for their new funds.

Unquote recorded 37 final closes of PE funds managed by European GPs (excluding credit and infrastructure funds) in the first quarter of 2021, gathering aggregate commitments of €29.9bn. This is among the quietest quarters for final closes in recent years, second only to Q2 2020's 30 closes. By comparison, Unquote recorded 45 final closes in Q4 last year, 48 closes in Q1 2020 and 58 closes in Q1 2019.

The aggregate commitments of Q1's closes, at €29.9bn, is much more encouraging. But it also highlights how, as seen in 2020, success is heavily skewed by mega closes: Apax X closed on $11bn in January and Coller International Partners VIII held a final close on $9bn that same month.

But Wursdorfer finds cause for optimism in the fact that investor appetite remains strong and LPs remain less risk-averse than could have been feared given the macro context. "We expect that fundraising volumes will be up this year, after going slightly down last year," he says. "Many LPs already have their pipeline defined and they will execute their allocation strategy, probably more selectively than pre-Covid, but not excessively cautiously, because this capital needs to be put at work."

Hot on the heels of Apax (and more recently EQT with its target-smashing €15.6bn final close), several large funds are inching closer to their finish lines, including BC European Capital XI, which has an £8.5bn target; HIG Middle Market I, with a €2bn target; and NB Renaissance Partners III, which has raised €950m so far and expects to close by the summer of 2021.

Other heavyweights are also preparing the launch of their new vehicles, including Investcorp, which plans to launch its second European buyout fund after the summer, aiming for €1-1.5bn; and Permira, which has registered its second growth opportunities fund, Permira Growth Opportunities II, with a target of $2.5bn.

But in addition to the market's giants, industry observers are also hopeful that smaller vehicles and lower-mid-market specialists will be increasingly able to attract capital in the post-Covid landscape.

"Last year, a lot of investors focused on larger, more established funds, but they have now realised that this large-cap-orientated strategy cannot constitute their entire private equity programme," says Sinha. "They also need some smaller funds specialised in the lower end of the market, in order to target different parts of the market and reap higher returns. Much capital has gone into large funds and large deals, and the danger is that GPs will buy expensively and therefore the returns on the vintage will suffer. That's why investors will pay more and more attention to lower-mid-market buyout funds and growth GPs."

This view is shared by Monument partner Karl Adam, who recently told Unquote that he would expect lower-mid-market managers to be able to find success in the coming months: "If you think of the current environment – with fierce competition for deals and high valuations in most sectors – the intrinsic qualities of funds in this bracket stand out even more. The lower-mid-market offers greater opportunity for a PE firm to acquire companies outside of a competitive process, which should result in more favourable entry valuations. And once invested, the GP's ability to make fundamental operational changes and dramatically grow EBITDA is often higher than in multi-billion-dollar companies. […] So the conditions are there for lower-mid-market fund managers to break through; for most, it's just a matter of being able to find the right path to resonate with investors hungry for new relationships."

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