Global Outlook 2024 Report

NEWSLETTER

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Chapter Two: Fundraising

Lindsay Creedon, Partner, Stepstone Group

Following the shock and dislocation of the pandemic, private equity fundraising in 2021 fully recovered back to its 2019 levels. The average fund size continues to rise, and the velocity of new funds entering the market is accelerating. At the same time, LPs are staying the course on their pacing plans – increasing their allocations in some cases – a clear sign that investor interest in this asset class remains strong. As the economy continues to show signs of recovery and growth, we foresee another robust year for fundraising in 2022.

With more exit paths available, including SPACs and continuation funds, realisations have increased, and LPs continue to seek opportunities with an attractive risk-return profile in which to deploy capital. As such, fundraising cycles are shortening. In 2021, we saw the average time for GPs returning to market fall to approximately three years, compared with a four-year gap historically. Fund sizes are growing too, especially as small and mid-market funds graduate upward to larger transactions.

As a result, the fundraising market is crowded. From an LP perspective, re-ups are coming around quicker than ever, leaving less capital available for emerging managers to be included in mature programs. Many LPs have small teams devoted to private equity and therefore limited capacity to vet new managers. They are also incentivised to stick with the highest performing GPs currently in their portfolio. On the flip side, top-tier GPs are spoilt for choice when it comes to managing their LP base, tapping existing relationships for increased allocations.

With a faster pace of fundraising and deployment, what of due diligence? The pandemic forced GPs and LPs to adapt to a virtual due diligence environment, though in-person meetings did slowly return in the second half of 2021. But the lack of in-person meetings over the last two years has hurt managers coming to market for the first time, with the exception of new managers with demonstrable track records from prior firms.
Another trend we’re seeing is the creation of more funds and products targeting different parts of the market. For example, a manager with a successful late-stage growth equity fund may tap existing LPs to create a fund to target early or mid-stage growth opportunities. Similarly, we expect more impact funds to come to market in 2022, by both small firms dedicated to impact investing, and large institutions leveraging the resources of their firms to create them. Along those lines, ESG principles have been more fully incorporated into investment underwriting by LPs and GPs alike.

The trend toward specialisation will continue, as sectors like tech and health care continue to penetrate more of our everyday lives. GPs with strong sector specialisation have shown higher returns than generalist managers and have had an easier time raising new funds. But even for industries that have fallen out of favor, all is not lost: savvy private equity investors continue to emphasize the importance of diversification by sector, strategy, geography and vintage year. In addition, with the growing volume in the secondaries market, expected to be USD100 billion in 2021, it is easier for investors to achieve such diversification and allocate incremental capital to sponsor-backed companies.

All of the above gives 2022 a strong fundraising floor, and we look forward to a healthy market in the coming year.

Andrew Bentley, Partner, Campbell Lutyens

2022 looks like it will be a very congested year for private equity funds, with potentially twice as much capital being sought from LPs than the busiest year we’ve ever seen.

Plenty of GPs will get funded very fast, but many GPs will have a more drawn-out process as LPs figure out what allocations they will get into rival GPs funds before deciding what is left for the rest. This is despite most GPs having had very good performance in the last 12 months.

The crush in 2022 will inevitably spill over into 2023 because the industry won’t be able to raise the EUR 300 billion that the GPs are asking for during one single year. It’s not possible.

We’ve already seen a bifurcation of outcomes in fundraises: some get done very quickly, by which I mean, within four to six months; and others take 12 to 18, or even 24 months.

For a few years now, the bigger, established funds have been coming back with larger funds quicker. It creates congestion and a lot of pressure. And that pressure gets dissipated in different ways.

We’ve also got private wealth making inroads into the sector. In general, private wealth feeders focus mostly on the biggest brand name GPs and don’t seek the middle market firms. All these trends support the bigger firms.

So where are we going to be at the end of 2022 if that continues? The middle market and the independents and sector specialists are going to need to generate even stronger returns to be able to compete.

The big GPs have been building their sales teams and proliferating their product offerings trying to dominate the LP capital available. It’s an unbelievable power play out there, with these groups trying to get as much LP allocation as possible by addressing every single part of an LP’s private fund requirement.

High deployment rates suggests that dry powder is not a problem.

The speed of deployment is a symptom of the fundamental shift in the upper reaches of the industry from focusing on carried interest from investments to seeking to maximise the value of the shares in the GP itself. Deployment drives fund growth which drives share prices and shareholder value. GPs are of course concerned about entry values, but there’s not fundamentally much most of them can do because they have to keep deploying, and we are in the market that we’re in.

Specialism is how the middle market in particular is trying to manage this: focusing on sectors and themes where they have a clear edge. That edge is necessary and a very real reason why they and not the other 15 to 20 people bidding for an asset will secure it. So generalist private equity is out and having a specialist focus is in. In 2021, specialisms in technology and healthcare were very sought after and in 2022 we expect specialisms in sustainability and energy transition to be very sought after.

Thomas McComb, Private Equity Portfolio Manager, JP Morgan Asset Management

We expect to see robust activity in the private equity fundraising market in 2022, similar to what we have seen over the past several years.

There are two main factors driving this. Firstly, returns continue to be strong. Buyout returns have been compelling, especially in growth segments such as technology in recent years. Additionally, after a difficult decade in the 2000s, returns in venture capital (VC) and growth funds among the best firms have done an exceptional job of securing more capital to each of the sectors and attracting new entrants. Returns on well-implemented private equity portfolios have produced a substantial premium on the public equity benchmarks.

Secondly, distributions have been quite strong, both from buyout and VC and growth funds – we have seen a robust exit market. Trade and financial buyers have both been quite active. We have also continued to see a robust IPO market, with some firms using SPACs as another avenue to a public exit. We would expect the years following 2022 to continue to be favourable for private equity funds raising, assuming the current conditions with regards to returns and distributions persist.

Established investment firms continue to use their franchises to generate product extensions. While this has been common among the ‘mega-funds’ for a number of years, we are starting to see funds in the small and mid-markets pursue such strategies. We are seeing larger and mid-market firms raise small cap funds, co-investment funds and credit funds. Growth funds are becoming the ‘must have’ product extension for VC funds, with others considering additional verticals and geographies.

In 2022, firms with strong established track records, with differentiated strategies, should continue to perform well.
Technology is playing a role in a few ways here.

Firstly, the rise of virtual meetings particularly by VC firms, which were being implemented before the pandemic, have accelerated. While we do not expect in-person meetings to be eliminated, many initial due diligence meetings and some follow up ones are now conducted virtually. These enable GPs to spend more time in their office raising capital in place of extended road shows. Secondly, technology also enables much more sophisticated use of data which helps GPs better articulate their story, and LPs to better evaluate them.

Finally, technology as an investment sector, is obviously a core area for focus for VC and growth firms. It continues to grow in importance for many buyout firms.

In terms of new talent, a number of investors, particularly newer ones to private equity, have established emerging manager progammes where they invest in funds raised by firms they expect to be the established firms of the future.

Newer groups will likely face competition from industry incumbents in two ways: the aforementioned product extensions by established firms; and an increased velocity of capital investment. Many firms are seeing a more rapid investment pace in this cycle which is necessitating a return to raise new funds more quickly than originally anticipated. In some cases, three to five year investment periods have shrunk to one and a half to three years.

In addition to having strong investment track records, new private equity firms will need to differentiate themselves through their strategies to overcome such challenges. Co-investments remain in high demand as do stapled secondaries. Investors want the ability to invest capital with more visibility, lower overall fees, and reduce blind pool risk.

Christine Tsai, CEO, Founding Partner, 500 Global

We believe that private equity and venture capital (VC) fundraising will be as active – if not more so – in 2022 as it was in 2021.

Last year’s VC fundraising activity through Q3 alone surpassed 2020’s record, and is expected to break the USD100 billion mark by the end of 2021. As pension funds, endowments, sovereign wealth funds, universities, and high net worth individuals continue to seek increased exposure to private markets, we think the influx of capital into private equity and VC funds will continue at an accelerated pace.

Looking ahead, there are several global technology trends that we expect VCs will be watching closely. We believe an increasing number of firms will seek opportunities to invest in companies that are based outside of traditional tech hubs, both within and outside of the US, which also means investing in less obvious founders who come from various geographies, demographics, and backgrounds.

As a result, we will potentially see more US-based venture firms expand their physical presence in frontier markets, especially in Latin America and the Middle East. We believe firms that focus their time and attention on building strong relationships in nascent tech ecosystems are the ones that are likely to be most successful long-term.

We also believe that the momentum we saw in 2021 will likely carry over into 2022. Right now, deal activity is at an all-time high. Just in October, more than USD54 billion was invested in 2,000-plus companies globally. We’re seeing accelerated growth in the fintech industry. Venture capitalists invested a record total of USD39 billion in the first three quarters of 2021 in fintech companies. This already surpasses the USD20 billion raised for all of 2020.

While macroeconomic issues cast a shadow on the economy, we believe tech investing will continue to grow post-pandemic. We are backing entrepreneurs who are building innovative solutions to meet evolving consumer and business needs.

The world is still combating a global pandemic, which continues to pose a risk to populations and businesses in certain sectors, such as travel and hospitality, retail, supply chain and logistics, and more. There are social and economic challenges that investors and founders need to be ready to navigate in the year ahead. Inflation, which soared to a 40-year high in early December, is of concern, as bottlenecks in the supply chain remain an issue.

We are adapting our investment framework to reflect the way some industries that benefited from the pandemic initially now need to adjust given the recovery, and how others that saw activity grind to a halt are seeing signs of life. Despite challenges, we believe there are opportunities for a new generation of disruptive companies worldwide, as the pandemic accelerates digital adoption and a new era of innovation unfolds.

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