February 10, 2017
Interviewed by: David Snow
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Fundraising Roundup – Private Equity 2016 Review & Outlook

The 2016 fundraising numbers are in, and a panel of experts dives into the year’s most important trends, including the trouble LPs are having getting allocations to brand-name firms, why there was a boom in venture capital fundraising, and what caused stagnation in the fund-of-funds business.

The 2016 fundraising numbers are in, and a panel of experts dives into the year’s most important trends, including the trouble LPs are having getting allocations to brand-name firms, why there was a boom in venture capital fundraising, and what caused stagnation in the fund-of-funds business.

Fundraising Roundup
Private Equity | 2016 Review & Outlook

David Snow, Privcap:
Hello and welcome to Fundraising Roundup. I’m David Snow, CEO of Privcap and today we’re joined by Alan Pardee of Mercury Capital Advisors and Leopold Peavy of Preqin. Gentlemen, welcome to Privcap today. Thanks for being here.

Leopold Peavy, Preqin:
Thank you, David.

Alan Pardee, Mercury Capital Advisors:
Thank you.

Snow: We’re talking about fundraising in 2016. The numbers are in and we’re going to have a great conversation about what we think are the interesting trends for private equity fundraising in a pretty significant year for fundraising. Starting with you, Leo, give us the overview. How big was 2016 and where do you think it will rank in some of the more recent years from a private equity fundraising totals perspective?

Peavy: We keep growing and getting stronger in terms of an industry and actual total capital closed. In 2016, we saw the most amount of capital raised since the financial crisis, at $353 billion. While we’re not at 2007 and 2008 levels yet, it looks that we’re incrementally getting there every single year. And there is an incredibly high demand for private equity across all institutional investors. We have about 59% of all active institutional investors looking to allocate to private equity or actively allocating to the asset class.

Snow: An observation for you, Alan: as you look at the list of the largest fundraises in 2016, it’s remarkable that almost all of them have a high Roman numeral after them—Fund 7, Fund 8, even a Fund 9. These are all brand-name firms that have been in the market for a long time and have seemingly had few problems raising their follow-on funds. What’s behind that trend?

Pardee: LPs have very few other places they can go in terms of investing capital and getting attractive rates of return. But at the same time, everybody’s a bit nervous. Is this a top? Will the market suddenly change? Is there an external shock that could happen that could change the way people think about this asset class and all asset classes whether liquid, public, private or what have you?

There’s a lot of capital available in our marketplace, but there’s the old saying, “Nobody gets fired for buying IBM.” Nobody gets fired for investing in Blackstone, so there is a certain wave of embracing of the established manager that is a change from where we were in say 2013 or 2014, where the newer managers were thriving almost at the expense of the established managers—that’s inverted. The established, real, long-tenured firms are doing quite well in terms of raising capital.

Snow: It must be a challenge for investors and maybe investors that are newer to the asset class, that have, as you say, a significant amount of capital that they want to put to work in private equity. They would love to do it in the latest Leonard Green or Apax fund and yet there are limited spots in those funds, if at all. So, how do you put capital to work responsibly when these highly sought-after, seasoned managers have limited availability? Where do you go?

Pardee: LPs are finding themselves having to be far more proactive than they were in the downturn, for sure, but even in the last upturn. They are proactively going to general partners to find out what funds they want to invest in, doing the diligence early and getting a relationship going with a general partner that might be an established fund manager that might not be as big as some of the biggest funds that are catching a fair number of the headlines, but the $1-billion or $2-billion fund—even the $71-billion fund—that has a high enough Roman numeral, strong track record, differentiated deal flow and activity. LPs are seeking out those managers and there’s a fair amount of activity going on before the fundraising is officially announced. So, there’s effectively a pre-marketing going on in both directions between the LP and the GP in advance of fundraising.

Peavy: Speaking with several LPs who have quite large private equity portfolios and are connected throughout the industry, they still aren’t able to get into many of the top funds you would expect them to be able to get into due to the phenomenon of one-and-done funds. So, they have about a month to get into the data room. Then, those funds close quickly and they’re not able to invest again potentially for another three or four years until that manager has another fundraise. So, it’s all about timing, building relationships and being proactive on the LP side as opposed to just writing the check as they used to maybe before the financial crisis.

Snow: OK, next topic. VC fundraising is reaching a level not seen since the dot-com days. We all remember the dot-com days ending in roughly 2000, where more capital had been raised for venture capital strategies than even for buyout strategies. In 2016, venture capital firms worldwide raised the largest number since the 2000 market. An overview question for you, Alan: what is driving the level of interest in VC funds in particular?

Pardee: At some level, it’s jealousy. The idea that the unicorn or herd of unicorns that have come into the public markets over the last while means that somebody who is a venture capitalist did well in those companies. And the idea of an LP wanting to find their way into those early and frequently, if they can, is part of what’s driving this interest in VC. That said, it’s not as though venture capital fundraising is easy. The numbers are bigger and that’s obviously translating to a demand in the marketplace.

But the VC funds that have performed best really are a small handful. If you start taking apart the performance data, you find yourself seeing a much smaller subsection of firms within the VC world than you might find within the private equity world, real estate world or others that have been the top performers.

Snow: In fact, Leo, there’s even more capital in the VC market than the fundraising numbers indicate, right? So where are these other sources of capital coming from?

Peavy: Yes. Some of the other sources of capital are coming from corporate VC arms and they’re coming from even LPs such as sovereign wealth funds and family offices.

Snow: An important observation to make about VC is that some of these very successful unicorn companies are being started with very small amounts of capital, which suggests that it’s really about who you know and having access to those great ideas. And that sinking $100 or $10 million into a relatively large VC fund isn’t necessarily the path to making those outsized returns.

Pardee: That’s absolutely true and that goes to the point of the concentration of return at the top of the VC asset class; whether one wants to count it as a half a dozen firms or 10 firms, there’s a list of firms we could rattle off that do have persistence as it relates to being able to generate strong IRRs and multiples. Ending up in the other selection of firms ends up being a participant in the venture capital asset class, but not quite the same return outcome.

Snow: Alan, when your firm is considering helping a venture capital firm raise its next fund, what attributes do you look for that would indicate to you it’ll be a successful effort?

Pardee: We raise a very small number of venture capital funds in any given year and they tend to be very specialized. They might be specialized in the types of deals they do or the geographies they’re involved in, but they’ve shown several banner years of performance—either in a specific vintage or in a couple of vintages—that get us to a point of feeling comfortable that this is one that might not be in that very top tier, but that is going to be in the tier right below in terms of being accessible to limited partners and providing strong results.

Snow: OK, next topic. Is the fund-of-funds business stagnant? The recent statistics from Preqin would indicate that there seems to be something wrong with the fund-of-funds business model or at least with the demand that investors have for funds-of-funds. Last year, 2016, funds-of-funds around the world didn’t even crack $20 billion as far as fundraising. That’s roughly where they were from a fundraising perspective back in 2000, so [there hasn’t been] much progress since then. Here’s a more interesting statistic: only 61 separate vehicles were raised worldwide last year, down from 158 back in 2007 and down even from 2015, when there were 86 funds-of-funds raised.

Pardee: Being a fund-of-funds manager is being in a business that’s become tough over the last several years. Like many asset classes, there are a lot of choices available and people have to make some tough decisions. I would say that what you see primarily as it relates to the funds-of-funds numbers being so far down is that there’s been a rationalization of who are the strong, who are the survivors and who are the weak in this marketplace. Like most of our marketplaces for alternatives, it’s a haves and have-nots market.

There are certain persistently successful managers that have done well and continue to grow. And there are a lot of people by the wayside at this point. A number of funds that had been strong performers, decent-sized names and firms, seem to have withered over the last while.

The funds-of-funds provide an important service. They’re useful. They have a reason for being, which is for the smaller institution, the family office, to be able to participate in this market and participate in this asset class indirectly if they don’t have the team and the experience necessarily to invest directly on their own.

Peavy: Those fund-to-funds that have been established are always going to survive because they’re always innovating and coming up with services to provide to investors—whether it be having an expertise in a certain geography or a certain strategy because, as we said, many of these key investors are non-profit entities. So, they are not able to hire the in-house staff necessary to go scour the world for investments in an emerging market in five years that potentially may be hot.

Snow: There are a number of firms that, I guess, started life as offering regularly funds-of-funds, but now offer different strategies. One of the biggest fundraises last year was a $10-billion vehicle from Ardian that happened to be a secondaries vehicle.

Pardee: The secondaries business has been a robust business for fundraising and an attractive one in terms of rates of return and multiple for a while. So, the Ardian raise—you could point to Collar’s raise or Lexington’s raise. There are some very sizable funds that have been raised in the last while because the secondary funds have managed to innovate the type of transaction they’re in with the GP-led restructurings and other forms of investment that they’ve been active in of late that have produced some attractive rates of return.

Peavy: As these investors become more proactive and more sophisticated, they’re not going to be able to continue these relationships with some existing fund-to-funds where they’re being charged double-layer fees when there are a record 3,000 funds in market that they can invest into directly.

Snow: It’s now time for a highlight from our featured interview, Ed Conard, author of The Upside of Inequality. In this clip, Conard argues that failures to cut U.S. government spending will invariably impede economic growth.

Michael Ricciardi, Mercury Capital Advisors:
What would constitute, for you, a red flag as we move forward over the next several years?

Edward Conard, Author of The Upside of Inequality:
To think that we’re going to cut taxes without cutting spending—and somehow that’s the magic elixir that’s going to increase growth. I think you ultimately have to cut government spending, otherwise you’re just distorting.

Two things can happen: I can either come and tax you or I can say I’m going to lower your taxes, but then I need to borrow from you. By the way, when I have to pay you back in the future, I’m going to increase your taxes to pay you back. So, when did you really pay the taxes? You paid the taxes today. Or I can borrow it from the Chinese. Yes, but I have to run a trade deficit to do that and, if I run a trade deficit, there’s a guy in Michigan or somewhere who’s going to lose his job over it. I don’t think that’s a prescription for great growth. I think it might it might help rich guys.

Snow: That’s it for Fundraising Roundup. Thank you both for being here and sharing your insights. I hope to see you both again soon.

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