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Getting funding - the truth

Any firm that has attempted to raise money over the last couple of years will know just how difficult and frustrating the market is at the moment. So what can prospective fundraisers do to increase their chances of accessing that vital institutional capital?

With the exception of the crazy late 1990s and 2000, the process of raising a private equity fund has never been particularly easy. Nor has it been an activity that many fund managers have ever relished - months spent on the road to persuade potential investors of the merits of their offering, hours spent answering lengthy due diligence questionnaires and the prospect of having the detail of their professional, (and sometimes personal) lives delved into, scrutinised, double and triple-checked and then, ultimately, judged.

It may not be much fun, but this is as it should be. Investors are the people who put a fund into business and so they have every right to get comfortable with the people and strategy presented to them before they decide to commit. The problem is that, right now, the process has become harder than ever for most firms. In some respects, this is counter-intuitive. After all, there are more investors interested in private equity now than historically and the number of funds of funds in existence has shot up dramatically over recent years. In theory, there should be more available capital in the market than previously.

But there are certain considerations for potential fundraisers to take into account, many of which affect some investors' ability or willingness to invest in private equity. There are the obvious factors, such as the investors that have been hurt by recent poor private equity returns, a pain only worsened by huge losses on public equities investments. There are the regulatory considerations, too, such as the Basel II accord, which will hamper many banks and insurance companies' ability to invest in illiquid assets, including private equity. And there are plenty of other reasons not related to private equity that may prove to be barriers to investment in the asset class - accounting regulations, tax problems, etc.

Yet possibly one of the most frustrating hurdles for many firms that are either fundraising at the moment or that are seeking to go to market in the next few months will be the current appetites of many private equity fund investors, whether they be institutions or funds of funds. Observers of the fundraising market have for some months noted investors' so-called ‘flight to quality'. This is reflected in the apparent ease of some firms - mainly brand names - of raising money, while others struggle even to reach a first close. In the current environment, if you are not a Sequoia, a Permira or an Abingworth, then your fundraising effort is most likely going to be extremely protracted. Such was the (rather depressing) feeling at the recent Capital Creation fundraising forum.

The fact that investors are flocking to the tried and tested well known names of the private equity world is unsurprising, given their experience over the last few years. Faced with disappointing - and sometimes - negative returns from their private equity portfolios, many investors have had the understandable reaction of seeking what they consider to be a safe haven for their capital. It's part and parcel of what is now understood to be a cyclical industry.

This problem is only exacerbated by the fact that funds of funds also have to go on the fundraising trail and persuade investors to commit to their offerings. This was a point highlighted by Standard Life's Johnny Maxwell. ‘We as funds of funds have to be careful,' he said. ‘The skill sets of many funds of funds seem to evolve according to what is flavour of the month among institutions.' The rationale for investing in a fund of funds obviously varies from institution to institution, but the most common reasons include access to invitation-only funds, outsourcing of private equity fund investing and gaining a level of diversification that would be difficult to achieve over a relatively short space of time. But another reason should also be sourcing of opportunities that an institution may not have the time or resources to research ie, finding funds that are below their radar screens - rather than the Permiras and Sequoias of the industry.

It's this purpose that many funds of funds appear to have forgotten, according to Keyhaven Capital's Sasha van de Water: ‘Funds of funds are often as guilty of being lemmings as institutions are. They follow the trends of the day. If all the boxes aren't ticked, or the fund is too small, then GPs often won't even get face time with funds of funds.' The problem is particularly acute for the less established funds. ‘The fundraising climate is particularly harsh for first-time funds,' said Hamilton Lane's Kelly Moylan.

Sadly, there is little that firms out fundraising can do to shift these appetites. They simply have to accept them as a feature of the industry, frustrating as that may be. There are, however, some practical steps that they can take to help smooth the process and ease some of the pain.

1. Expect fundraising to take a long time. This may sound obvious, but the truth is that many firms underestimate how long it will take to get them to the final close. Those that have only raised during the good times may expect to attract capital in six to 12 months. That is way too optimistic in the current climate. ‘Fundraising will be tough,' said Duke Street Capital's Jamie Weir. ‘There are a lot of hurt people out there. It won't take a year; it will take 18 months at best.'

2. Make sure investors know your timetable. It's a point often overlooked by firms. Investors generally have an idea of how much capital they will be deploying each year and will know roughly where they would like to invest it, even if they take an opportunistic approach. Some even build a forward calendar of when groups in which they would like to invest are likely to be out fundraising. Keeping investors informed of your fundraising plans will help ensure that they keep you in mind for a particular period. This applies equally to existing and new investors.

3. Maintain an open dialogue with your existing investors. Firms are increasingly recognising the importance of investor relations. Whether it is the result of a difficult fundraising environment or simply an increasing professionalism in the industry is unclear. But the fact is that it is generally easier to get an existing investor to re-up than it is to attract a wealth of new investors (presuming, of course, that you have delivered on your promises).

4. Target the right investors. Again, it sounds obvious, but it's remarkable how little many firms know about the investors they pitch to. A scattergun approach doesn't work and if anything, it will alienate investors who could be interested in future funds of yours. So part of the answer is to do some research. But it's more than this. Members of the investment community, especially those in the US, talk to each other. One of the best chances you have of easing the fundraising process is getting access to the most influential members of that community. As Cabot Square Capital's John van Deventer put it: ‘Find the lode. A lot of investors are affiliated to each other in one way or another. They will talk to each other about you.' Cabot Square raised the majority of its capital through US family offices and endowments - ‘these are close-knit communities,' he said.

5. Extend your investor base. Look further afield for capital. If you're a European fund, don't just target European investors. Head for the US. Many institutions there (see Cabot Square, above) are starting to look outside their domestic borders for opportunities, and they are looking especially towards Europe. But think, too, about investor type. Sure, there are the usual suspects - the pension funds, insurance companies, funds of funds, etc - but there are others. Did you know that 27 per cent of Blackstone's latest fund came from private individuals?

6. Be honest. ‘LPs have been lied to, cheated and abused,' said van Deventer. Investors' due diligence process have become increasingly rigorous over recent years and so any half-truths will quickly be discovered and when that happens, a fund won't stand a chance. ‘If you don't believe a story, then don't tell it, and if you do, don't embellish it,' continued van Deventer. ‘And anyway, if you are not telling the truth then it probably means that there are issues that you are not dealing with.' Trust between limited and general partners has probably never been more important.

7. Give your investors timescales. One of the most common complaints among fundraisers is the length of time it takes investors to reach decisions. Admittedly, some are quick, but many will take several months to reach any kind of conclusion and can slow down the process excruciatingly. BS Private Equity's Francesco Sironi advised setting a timetable. ‘If you give investors ten months, then they will take ten months - and possibly more. If you give them two months, then they may take two and a half.' This tactic will obviously only work if you know that investors are genuinely interested in what you have to offer.

8. Understand that no means no… There is almost nothing more irritating to an institution than a GP that won't take no for an answer. If an investor has refused to commit at the beginning, it is highly unlikely it will do so later on (unless, for example, it has asked you to come back once you have reached first close). Pestering them after they have refused you only wastes their time - and yours.

9. …but profit from the experience. There are, however, things that you can learn from a rejection. ‘Don't snub a turn-down,' said Weir. Many investors will be happy to provide you with reasons for rejecting your fund. These may help with approaches to other investors and they may even pinpoint flaws in your fund that you weren't aware of. At the very least, they should help you work out whether you should approach these investors in any future fundraising efforts.

10. Be fair. Don't try and get away with terms that are tilted in your favour. ‘Documentation and terms should not be difficult,' said van Deventer. ‘Investors are your partners - they are putting you in business. Do the right thing. The LPA is a true partnership, not just a legal document.'

None of this is rocket science - and it's not intended to be. But talking to investors, it's always surprising how few firms actually follow some or even any of these pointers. In some ways it is understandable. Private equity investing requires a certain self-belief that can often cloud what many might consider to be better judgment. These points are also unlikely to lead to success in all cases. But they are sound pieces of advice from a handful of people who have managed to raise funds at a time when the odds have been stacked against them.

The fundraising forum was part of Capital Creation 2003, organised by WBR. For further information, please visit www.wbr.co.uk

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