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.

Indeed, according to Probitas' annual survey, 55 percent of European respondents say their primary focus is to access the U.S. middle-market buyout sector, looking to put capital into private equity firms raising between $500 million and $2.5 billion. The percentage is even larger for Asian and Australian respondents, with 65 percent saying that the U.S. middle-market buyout sector is garnering most of their attention these days. Kelly DePonte, a managing director with Probitas Partners, says in recent years international investors have established local U.S. offices to specifically target U.S. funds.

Huron, which also had a successful fund raise, welcomed new non-U.S. LPs to its latest fund because of the diversity they provide. Huron also recognizes the advantage it gives the LPs. "It's good for the LPs because it allows them to build a diversified portfolio in the lower middle market. The U.S. private equity market has outperformed many asset classes," says Perkins.

Although private equity fund returns have decreased over time, they are still outperforming many other asset classes. PE outpaced fixed income investments, real estate and public equity markets over both a five-year and 10-year time horizon.

Not Just Foreign LPs

Family offices and endowments are also filling the capital void as more of them look to invest directly into funds, and they've found access easier as private equity firms seek alternative sources of capital.

"Larger family offices are becoming more prevalent in private equity investments," says Conner Searcy, a managing partner with Dallas-based Trive Capital, a new private equity firm that raised $300 million for its debut fund, Trive Capital Fund I. The firm reached its hard cap in five months and was oversubscribed from its initial $250 million target. The fund invests in lower middle-market companies that possess transformational upside or are under-resourced and would benefit from an operation-focused partner.

"You see family offices a lot more than you did 10 years ago because 10 years ago it was harder for them to get into well-known, brand-name funds. Today, I am not aware of any private equity firms that are willing to cut off access to a potential investor. Even the hottest funds are looking to take on more investors to diversify," says Searcy.

In years past, family offices had trouble gaining access to private equity firms, and they would often use fund of fund investments to go around access restrictions. Today, private equity firms are more willing to deal directly with family offices, while family offices have become a lot more sophisticated as investors, with the confidence to invest directly into private equity funds. Funds of funds now make up just 6 percent of the total money raised by private equity worldwide, compared with 17 percent in 2007, according to Preqin.

Trive was able to score commitments from wealthy families and endowments as well as the traditional players such as pension funds. Additionally, Trive was able to bring in European investors without even leaving the U.S. "That wouldn't have happened 10 years ago," says Searcy, adding that his firm likes diversity in its investors for many reasons, including staggered time horizons and varied investing parameters. The firm has roughly two dozen LPs globally.

Apparently a trend toward diversifying the LP base has been coming for quite some time. "Private equity firms with fund sizes of more than $500 million had been more dependent on the North American pensions because they could write the largest checks, however they realized they needed to expand their scope as they pushed to become more global," says DePonte.

Going forward the trend is expected to continue. "This business is hard in every aspect," says Mullen. "We have to make sure we are staying ahead of the curve and fundraising is no exception."

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