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Quart into a Pint Pot

A significant number of high profile private equity firms are expected to try and replenish their coffers over the next 18 months. But the fundraising trail will remain a rocky path to travel. As some funds reach their targets with consummate ease while others struggle to make any headway at all, Ray Maxwell of INVESCO explains what LPs are really looking for in today's challenging environment.

After a couple of very daunting years it is widely believed that a significant number of private equity groups, particularly in the large buy-out space, will emerge from the shadows to try to replenish their coffers during the coming eighteen months. Unlike the late 1990s when private equity was in the ascendancy and fund raising was a stroll in the park, conditions today are more akin to climbing Everest in high heels, at least for some. European private equity firms raised just E20bn in 2003, a dramatic decline from the E50bn in 2000.

It is probable that 2004 will manage to surpass the E20bn raised last year due to a combination of improving stock markets and a growing institutional interest in buy-outs from both sides of the Atlantic. But the improvement is unlikely to be overwhelming. Part of the problem is that many private equity groups remain wedded to the twentieth century model rather to one more befitting the twenty first century. Fund sizes, particularly at the top end of the market, like football transfer fees, grew like Topsy during a period when the both the IPO and M&A markets were experiencing an unprecedented boom. What is remarkable is that the M&A torrent has been reduced to a trickle but fund sizes, in general, have failed to follow suit.

I suppose one could argue that there are an ever -increasing number of buy-out opportunities in Europe and buy-out houses require a significant amount of dry powder to make acquisitions, especially in a period when credit is becoming tighter. On the other hand, as recent articles in the financial press have observed, holding periods for buy-outs have virtually doubled to six years since the late 1980s and there is a massive back log of investments that need to be realised in short order. What is clear is that large buy-outs have performed well over the long term and have provided attractive returns for investors. The BVCA Private Equity and Venture Capital Performance Measurement Survey for 2002 showed that, over 10 years, large buyouts have delivered average returns of 19.1 per cent and median returns of 27 per cent compared to 16.2 per cent and 20.1 per cent respectively for the industry as a whole.

Due to the nature of the fund raising cycle institutional investors this year will be facing an embarrassment of riches with a significant number of established names coming to market. The difficulty will be in knowing how to distinguish one offering from another since all will place themselves well within the upper quartile, or even higher. The choice is made somewhat more complex as there appears to be a coterie of groups that participate in each other's deals. For example, APAX and Permira have made an offer for New Look and 3i, APAX and Candover have bid for Hollinger International's UK newspaper titles.

In 2003, a trend emerged where some groups, with what I would call "ingredient x", raised their funds with consummate ease while others without this mysterious ingredient struggled to gain any traction. This raises the question as to what the characteristics that separate the good fund- raisers from the also-ran are. It would seem obvious that investors would select those groups that have a strong track record and a sustainable strategy. However, that is only part of the story and there are a host of other perceptions that shape investor decisions. They include the following:

-The strength of the brand. A number of groups have been assiduous in creating a brand that evokes quality and security. In the main, investors and their advisors are risk adverse and therefore they gravitate towards groups that are safe and are regarded as leaders in the industry. It is part of the "Big Blue" syndrome where nobody ever got fired for buying IBM.

-Associated with the above point is the continuing loyalty of cornerstone investors. If over 50 per cent of a fund can be raised from existing relationships completing the fund raising exercise becomes far less arduous. There is safety in numbers and therefore new investors will feel encouraged to join an investor base composed of their peers.

-Signature deals. There is nothing more powerful than a highly rewarding and well-publicised exit to excite investor interest. For example the sale of Homebase to GUS certainly did Permira no harm in raising its latest fund.

-Well-respected individuals. Occasionally newly formed groups will "get funded" if members of the team have established reputations in the marketplace.

-Good investor relations. Private equity groups recognise that marketing to both existing and prospective investors is a full time occupation. Because investors are regaled with products those groups that have maintained their profile through regular correspondence and meetings improve their chances of raising their fund. In addition, investors like to see a combination of success coupled with humility. The maxim "if you got it, flaunt it" does not go down well in Limited Partner circles.

Raising funds at the best of times is challenging and this year will be particularly so as more groups will be seeking to raise new capital. Although European buy-outs are commanding attention, not all groups will meet their targeted expectations primarily because it is impossible to put "a quart into a pint pot". The market is segmenting and sometimes it is difficult to understand why some groups achieve their targets while others are a "country mile" short. However, the strong contenders in the fund raising contest usually possess three key characteristics. They can demonstrate consistent performance across the cycles, maintain a high profile and invest heavily in their marketing effort.

Copyright © 2004 Ray Maxwell