The Changing Face of the LP

Private equity firms seek less traditional LPs for new funds

Since the economic downturn of 2008, fundraising has become increasingly difficult for private equity firms, and many firms are not expected to meet their fundraising goals. According to Bain & Company's Global Private Equity Report 2013, about 35 percent of the buyout shops in North America and Europe haven't raised a fund since 2008 and have reached a point when they will need to raise their next fund. Many are already on the fundraising trail and aren't having great success. London-based data company Preqin estimates there are 1,200 private equity zombie funds, or funds where the general partner is managing the fund portfolio without making distributions and hasn't raised a follow-on fund after 2006. Twenty-three percent of PE firms actively raising capital have been in the market trying to raise a fund for two years or more, according to Preqin.

The limited partner (LP) community doesn't have the capacity to accommodate all funds in the market. By mid-2012, two-thirds of the LPs were bumping up against their ceilings for private equity allocations, according to Preqin. Further complicating matters, the LPs' large commitments to the asset class before the downturn and the private equity firms' lack of returns from exiting portfolio companies make investors hesitant to increase their PE allocations.

"Over the past five years it seems the majority of institutions are either holding or decreasing allocations to private equity, and far fewer pension programs are creating or increasing PE allocations," says Terry Mullen, a partner with New York-based Arsenal Capital Partners, which closed its Fund III with $875 million in April. "Other traditional LPs, such as banks and funds of funds, have decreased their allocations to the asset class or have gone away completely because of new regulations, in the case of banks, and a decrease of funding into funds of funds. There's definitely been a material shift in the LPs' base over time, particularly in the last five years."

Making the process harder for PE firms is the fact that traditional, actively investing LPs usually re-invest with firms where they already have relationships. Most LPs-54 percent-expect their primary focus to be evaluating additional investments with current GP relationships, with a limited look at new relationships, according to the annual survey of the LP community, called Investor Appetite for 2013, by Probitas Partners, a San Francisco placement agent.

"LPs have become more selective in choosing private equity managers and many have been paring down the number of GP relationships they have," says Gretchen Perkins (pictured), a partner with Huron Capital Partners, a Detroit firm which closed on Huron Fund IV in January with $400 million. "LPs had been burned in the recent downturn and don't want to make the same mistakes."

The bottom line is there will be less capital committed to private equity firms by traditional sources. However, resourceful private equity firms, such as Arsenal and Huron have been able to complete successful fundraisings by growing their LP base and looking for fresh capital in new places.

Arsenal, for example, added 20 new LPs to its Fund III and made sure its LPs base was diversified. The firm raised its first fund, with $300 million, in 2002 and 90 percent of its limited partners were from the U.S. It raised $500 million for its second fund, in 2006, and took only 50 percent of its capital from U.S. LPs, with the other half coming from Europe.

For its most recent fund, Arsenal sought new investors, both domestically and from overseas. The fund is evenly split between U.S. and foreign investors, including investors from Asia and Europe. The firm had 20 investors in its Fund II and touts 35 LPs in its latest fund, which provides a broader investor base and a lower concentration of risk. "In Fund III we were able to access a material number of new names. We found a meaningful number of European LPs interested in increasing their exposure to non-European markets, and other U.S. private equity firms are benefitting from that trend also," says Mullen.

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Danielle Fugazy