Fundraising in the Current Environment

It is a cold winter out there for many firms trying to raise institutional capital. A process that is never easy feels even harder in the current moment. The chill in the air may be with us for a while, so below are thoughts on how to bundle up and make it through.

Accept Reality
It is very hard to raise institutional capital at present and there are clear reasons why. Understanding what LPs are going through and thinking will make outreach more constructive.

LP Overweights Have Gotten Worse, Not Better
Established institutional LPs overwhelmingly came into 2022 overweight private investments vs. their asset allocation targets, and then saw their liquid investments decline sharply in value. (A 60/40 stocks/bonds portfolio is still down 15% YTD.) LPs’ private assets have generally not had similar markdowns, which means that they are even more overweight vs. their allocation targets today. Further, their unfunded commitments, which were similarly very high coming into this year, are also now an even larger percentage of their now smaller asset bases.

Consequently, LP’s formal commitment budgets or informal appetites for new commitments have shrunk very dramatically, and at a disproportionately larger rate than the declines in the market.

You’re Competing with Public Markets
LPs are almost all multi-asset class investors, and so capital for a new private fund is implicitly competing with opportunities in the public markets. Public markets have seen dramatic declines in many areas, and public equity and hedge funds managers are pounding the table for capital. Likewise, credit yields are as attractive as they’ve been in many years.

Conversely, private markets are seeing some markdowns and pockets of distress but generally haven’t seen the repricing the public markets have. The bid/ask spread from buyers/sellers in the private markets still seems wide and LPs have plenty of dry powder at firms they already know which are ready to buy when the frictions in the market abate.

LPs Are High-Grading
LPs will often say things like “we’re really trying to concentrate our portfolio in fewer manager relationships.” In practice, LPs will often have a “wish list” of GPs they want capacity in and, of late, LPs are finding wishes can come true. Many long sought-after firms have had capacity and these high profile / very established managers take a lot of the oxygen out of the room for other firms.

These LP behaviors will take at least a year and maybe two or longer to abate. Best to be pragmatic and see the world as it is, then hoping for a fast comeback.

Adapt Capital Strategies
Many GPs will need to re-evaluate their capital strategy. Raising a fund from a small handful of prestigious LPs is the ideal for many. The more grounded goals for GPs today are being able to stay in-market as a buyer of assets as prices improve, increase AUM and duration of track record, and reach for the ideal in more favorable fundraising environments.

Think Like a Fundless Sponsor
Firms should recognize that even in environments where LPs are saying “no” to blind-pool new commitments, there are many investors who will say “yes” to a homerun deal.

Pre-fund SPV deals have less attractive economics vs. a blind pool fund, but GPs are much, much more likely to find an audience for a showstopper one-off opportunity. Closing deals this way at least generates some fees for the firm’s working capital and, more importantly, enables a GP to be in-market and building a track record for when then fund fundraising environment turns more favorable.

A silver lining of this approach is carry can come much faster with a series of SPVs than with a fund, given the absence of a fund’s waterfall.

Fish in New Ponds
There are pockets of the market that did not come into 2022 overweight privates and are still actively building exposures. The challenge is they are less likely to be in a GP’s direct orbit and require creativity to reach.

RIAs – This channel has been going through massive consolidation over recent years, and there are many firms that manage $20Bn or more that are not well known. They are widely divergent in their appetite for privates and sophistication in underwriting, but there are many who can write $25-100M commitments and may even do so with a single check from an organized internal fund-of-funds vehicle.

Overseas – There are great investors outside the US who want more exposure to US private opportunities. There can be significant regulatory and relationship-building challenges in going overseas, but the upside is the non-US institutional pools of capital tend to be very large check writers.

Fresh Capital – These are the white whales, but they are out there. New family offices and charitable foundations crop up every year. Likewise, there are always some number of institutional investors which have a change in leadership and/or policy, which lead them to a substantially increased appetite for privates.

More Co-Investment Capital
If a fundraise feels like it is not going to reach its target, consider making the fund capital raised go further. The primary move here is to consider seeking co-investors for initial checks and/or SPVs to support follow-on opportunities outside the fund.

GPs will need to actively cultivate co-investment partners in their LP base and outside, if necessary. As above, the fees on SPVs and co-invests aren’t as good as having blind pool capital, but a firm continues to build its track record and AUM.

Nail Messaging
Fundraising is always an exercise in storytelling, but ever more so when the audience has many other things clamoring for their attention.

GPs that use Docsend or similar services to share decks can find it humbling to see how little time an LP actually spends looking at their finely-tuned pitch they’ve spent countless hours revising. No joke, if a GP can get an LP to spend 2 minutes on a Docsend pitch deck, it is a small miracle. It’s not because they are unprofessional hacks. Quite the opposite; it may be a GP’s life’s work, but the LP has seen hundreds and hundreds of well-qualified funds and likely have a fine-tuned sense of what they are looking for in an initial screen.

Clear, Compelling Statement of Value
In the most direct, plain language, what is the case for the strategy and firm to deliver great results? There needs to be a clear edge expressed that has a causal connection to a likely outstanding outcome. The best pitches have a sense of inevitability to them.

Create A Sense of Urgency
What in the pitch compels action? What is said that will outcompete the other things on their desk and the demands for other capital in other parts of their portfolio?

LPs will often say they are long-term investors and that they invest in relationships. Consequently, that means they have a lot of things various stages in-process ahead of a new offering, to say nothing of their likely large roster of existing investments. They may be looking for one or two new relationships a year, and that search activity may only be 25-30% of their time. Overcoming those hurdles is no small feat.

Resources
Delayed or diminished fundraising starves firms of fees and carry, which can be an existential threat to newer firms and a challenge to even established firms. There is a risk of a downward spiral if investors feel a GP isn’t equipped to execute its strategy and so withhold capital. GPs may find the need for a reallocation of current resources or the support of external capital to assure LPs they will have staying power.

Field the Right Team
Investment firms are nothing more than their people. As such, LPs won’t say “yes” to a firm that feels under-resourced for its stated mandate, and virtually none will commit ahead of seeing a mostly built-out team. For a newer firm, this may require raising additional working capital to support fielding a sufficient team.

Hold Your Best People Close
Established firms are not immune from people risks, even those without cash flow stresses. Superstar mid-career investment professionals may now see their switching costs as having declined substantially if their golden handcuffs of vesting carry are attached to funds that are underwater or less likely to deliver great results. The most entrepreneurial of the lot may see this as the time to take their shot at launching their own venture, despite the current environment.

Remember: Leadership = Dilution
Moments of stress in the business should fall most heavily on those who stand to gain the most in times of ebullience. Fair is fair! If there is working capital to be contributed, a larger portion of a GP commit to shoulder, or carry to be more broadly shared, that’s the responsibility of a firm’s leaders. These actions will foster the loyalty of employees, gain the respect of LPs, and keep a firm on track for long term success.

The opposite approach may mean a firm that loses its top performing next generation leaders or is seen as insufficiently resourced to execute its investment strategy. Either way, the LPs won’t put up with it and leaders need to stay ahead of these issues.

Multi-Year Planning
If a firm hasn’t done it in a while, it is certainly time to look at multi-year plans. Gaming through the way things may play out over a longer cycle is critical to managing the firm. LPs will be thinking about what operational stresses the business may be under beyond what is in the investment portfolio, and so firms need to stay ahead of them.

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Peace in the Struggle
Raising capital and creating a thriving investment firm is never easy; it’s not supposed to be! It is enormously stressful and requires every bit of patience and effort. It is always a good idea to slow down the process a bit to see things more clearly, recognize what the market is telling everyone, and prioritize where to best deploy your efforts.

Good luck out there!

November 2022

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