European PE fundraising forges ahead amidst macro uncertainty

The uncertain macroeconomic start to 2022 follows a record fundraising year in 2021. European private equity managers raised EUR 208.7bn across 130 final closes for buyout, co-investment, fund-of-funds and generalist strategies last year. With EUR 55.3bn raised across 27 final closes in 2022 to date, according to Unquote Data, 2022 is on track to see GPs raise record amounts once again.

However, some market sources who spoke to Unquote remain sceptical about record fundraising predictions for 2022, pointing to the worst of the macroeconomic impact being likely to penetrate the market in H2 2022.

The market is indeed starting to show some negative signs for fundraising for the first time in around two years. Antoine Drean, founder and chairman of placement agent Triago, sets the current scene. “The war in Ukraine and increasing inflation have disorganised a lot of the LP market,” he says. “And even before this, we had the tech bubble, with many LPs trying to work out which VCs were doing well, which were the stars of tomorrow. So, there are reasons for people to take a slight pause. LP commitments are not frozen, nor is fundraising or the secondaries market, but people are being more cautious.”

Ongoing market bifurcation bolstered 2021’s fundraising figures, with top managers steadily increasing their fund size from vintage to vintage. Huge fundraises by GPs originating in the US who also invest in Europe drove up the average fund size, as reported. These included Hellman and Friedman Capital Partners X and Silver Lake Partners VI.

This market bifurcation is set to accelerate in 2022. Hamilton Lane’s latest market report stated that the firm expects 15 managers to each raise USD 15bn globally, taking up a significant chunk of available private equity commitments. GPs including EQT, Apollo Global and Blackstone are all planning to raise huge amounts of capital for their next vintages in the form of EUR 20bn-plus funds, according to Unquote Data.

“In an environment where capital is scarce, LPs have to decide how they will build their portfolio,” says Moose Gounir, founder and CEO at placement agent MVision. “In Europe, there is usually around EUR 120bn available in the market for commitments every year. Back in 2007, the “megafunds” were EUR 3bn - EUR 4bn in size, but today, they are EUR 20bn - EUR 30bn. In Europe, the 'mega-pan European' and 'mega-local' GPs dominate. When an investor who is already tight on money looks at geographical allocations, they will see large funds in the market. Typically they would have a mix of large and mid-sized funds in their portfolio – but if the very large funds come out, that money for those others is gone.”

Many GPs will be breathing a sigh of relief that they managed to close their latest flagship funds at the end of 2021 or early in 2022. However, the fundraising landscape was not completely plain sailing even before this, with many LPs having already filled up their 2022 allocations at the start of the year.

“The market is very busy and the level of fatigue is high at both LP and GP level,” says MVision’s Guen. “We’re in a macro environment that is completely unknown. But there are other dynamics at play – in the US in particular, there has been an incredible acceleration in fundraising, with three or four years’ worth of PE firms coming out at the same time, but there is only so much primary capital available in a physical year. Within that, investors want fewer relationships but want them to be more substantial, so that they can take advantage of co-investments.”

Refining relationships
The current situation has given LPs cause to assess their options, says Richard Hope, managing director and head of EMEA at Hamilton Lane. “LPs see rising inflation all around them in Europe and the US and question the possible actions, and therefore outcomes, of central banks in rising interest rates,” he says. “With such a backdrop, LPs are trying to understand the role of private equity in their portfolios and how to participate in a market which has never had more opportunities. In times like these, LPs need to sift through the choices and understand what experience may be round the table to navigate them through more volatile times.”

The pressure is on for GPs to make their strategies stand out. “When things get tougher, there will always be a flight to quality,” says Triago’s Drean. “For some people, it will be as easy or easier than before to raise a fund, for others it will be tough or even impossible.”

Over the course of the coronavirus pandemic, the market saw the trend towards LPs seeking closer relationships with fewer GPs become increasingly cemented, with many intending to deploy larger tickets with a smaller number of managers. However, capacity and re-up constraints amidst a flood of GPs returning to the market looks set to complicate this trend. “Many larger investors we speak to are constrained with their budgets – a lot of GPs are back, and they can’t re-up with them all,” says Rolf Dreiseidler, managing partner at placement agent Polaris Investment advisory. “We are increasingly seeing investors cutting their ticket sizes by half to keep these relationships, whereas previously they would have committed more and more per fund. Even the brand name GPs could struggle to get to their targets, or it could take much longer.”

LPs will therefore be holding their GPs to even higher standards, according to Sergey Sheshuryak, partner at Adams Street. “Everyone will be raising the bar this year, figuring our which relationships are strategic, and which to put on the backburner and reconsider,” he says. “Returns and whether GPs could be overwhelmed with problems in their portfolio are important. And we need to work out if a scaling of the fund size makes sense for each – whether they will they remain competitive in their segment is really relevant, but just raising a bigger fund doesn’t mean it will be a better fund.”

Slow and steady
Many GPs delayed their fundraising plans at the outset of the coronavirus pandemic. Although GPs will not be holding off on raising funds when they need to in the current market, fundraising processes are likely to take longer or remain open for longer.

“The big nuance for 2022 is that investors have technically accounted for their capital already, MVision’s Guen notes. “My view is that GPs will need to work to a number and then put away their watch. If it takes a while longer to raise the fund, it ultimately isn’t important – although there is of course competition in that GPs want to raise faster than others. GP behaviour will come down to what fund size they’re seeking and what their re-up rate is. If they can position their fund correctly, they will go for it, and they don’t have a choice if they are out of money. They will want to have substantial first closes, with 70%-80% of PPN covered.”

This view is echoed by LPs. “We’re not expecting to see any change in fundraising in H1 2022 – GPs will pretty much be sticking to their plans,” says Sheshuryak. “But a lot of GPs who wanted to come to market in H2 2022 with a quick close might need to keep their funds open longer - it will be interesting to see if GPs with significant scaling in their fundraising will have a longer tail, with the last 20%-30% taking longer to close, and maybe hitting their target but not their hard-cap. Not seeing it really slowing down or a struggle, but the last mile becoming a bit longer.”

GPs including Access Capital Partners have told Unquote that they intend to close their funds in 2023 in order to allow LPs to use their 2023 allocations to commit to their funds. Whether this will lead to another similar spent re-ups situation in 2023 remains to be seen, but for now, GPs remain focused on raising capital in the most pragmatic way possible.

Pros and cons of outperformance
Regardless of the challenges that might lie ahead for fundraising, what still seems clear is that private equity has performed consistently over the coronavirus pandemic and it is expected to continue to do so.

“Private markets have come through Covid and have outperformed public markets,” says Ross Morrison, partner at Adams Street Partners. “Within those top performing funds, the questions is which ones will outperform, even if everyone else has performed. The need to reduce relationships won’t be down to underperformance.”

However, this situation presents both advantages and disadvantages, as many LPs know all too well. “Irrespective of the horrifying situation in Ukraine, the strong performance of private markets has caused some issues for investors, not due the denominator effect but to the numerator effect,” says Hamilton Lane’s Hope. “Private markets performance has put NAV way ahead of where it was expected to be, so if the board of an LP allocates by NAV, there will be an issue. We have seen some LPs addressing this via secondaries, but it’s not a big wave yet. LPs are reviewing where their exposure is and where they should commit capital in order to keep up with the record distributions and fundraising environment.”

As the market looks ahead to the remainder of 2022, GPs are adapting to the developing situation. “Folks are recognising that they can’t just snap their fingers and raise funds, regardless of who you are. It’s still a flight to quality in terms of new investors,” says Morrison. “But it’s amazing how quick our GPs have been to react and I expect them to adapt accordingly. People are already putting plans into place for a different environment going forward.”

With LPs having the option to address the balance of their portfolios via secondaries, and GPs keen to foster existing and new relationships, macroeconomic uncertainty seems unlikely to slow fundraising or the appetite for private markets. With the stage set for tight re-up constraints and market bifurcation to carry over into 2023, no GP is likely to be afforded an easy ride when it comes to raising their next fund – but nor would they expect it in a highly competitive environment and an ever-growing, ever-maturing PE industry.

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