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First-time funds balloon as star managers spin-out

Veteran dealmakers are increasingly spinning out from the large private equity houses to raise multi-billion-dollar funds. Will a more recessionary mood force some to reconsider?

Veteran dealmakers are increasingly spinning out from the large private equity houses to raise multi-billion-dollar funds. Will a more recessionary mood force some to reconsider?

As private equity firms grow to be more like the bureaucratic corporations they once tried to break up, some of their more entrepreneurial, high-ranking staff have become restless.

The result has been a growing number of star managers with track-records stretching into the decades ready to spin out with their own funds.

“When the asset class is bigger, there are more and more new managers reaching a certain age where they are thinking more about what they should do for the rest of their career,” says Ari Jauho, founder and chairman of Certior Capital, which seeds emerging managers in Europe.

The ability of these managers to raise billion-dollar-first-time funds has been turbo- charged by the fundraising environment of the past two years, but for many who have launched their own funds this year, the future looks more uncertain.

“There’s usually a cyclical ebbing and flowing of traditional spin-out managers,” says Carolina Espinal, managing director at HarbourVest Partners, which invests in emerging managers. These spin-out managers can also be ultra-sensitive to the prevailing macroeconomic climate.

First-time private equity funds generally have been trending down since 2017, when they peaked at more than 1,000, according to Preqin data. The growth in first-time buy-out funds has been far more resilient however. First-time funds have also grown in size: the average first-time fund closed last year was the second largest on record, at over $180 million.

Since the pandemic, when virtual fundraising took off, several high-profile names have pushed their first funds well past $1 billion. One of the largest was Arctos Sports Partners Fund I, which raised more than $3 billion. It is expected to be surpassed shortly by Patient Square Equity Partners – launched by 21-year KKR veteran Jim Momtazee in 2020 – which is reported to be on track to close at more than $4 billion.

Each spin-out manager may have a different back story but their motivation is the same: to grow large funds with differentiated strategies.

While Jim Momtazee watched a succession plan at KKR unfold and several high-profile figures depart the firm, a string of senior unrelated departures at Carlyle resulted in the formation of another first-time fund last year: Capitol Meridian Partners, set up by two former Carlyle executives.

In September, former Carlyle partner Jay Sammons launched another new private equity firm, this time with reality TV star Kim Kardashian, focusing on consumer and media investments. Kardashian follows a growing trend of celebrities and sports stars launching or backing their first venture capital funds.

“We are seeing a fair amount of veteran dealmakers, who no longer want to navigate the political pressures and bureaucracy of a large firm,” says Christine Winslow, managing director at Grafine Partners, established in 2019 to invest in emerging managers.

“These proven dealmakers find the pressures and politics distract them from what they love to do – which is dealmaking. They may also want to create a culture that reflects their own values and establish a corporate DNA that more fully integrates a focus on climate and diversity.”

Track-records lengthen

Fundraising is the greatest challenge for a first-time fund, but a veteran manager’s track-record usually helps open doors.

A survey by Private Equity Wire conducted in September found that almost half of respondents (46%) said the track- record of an emerging manager is most likely to determine their success in the current market, more than their investment strategy or fee offering.

“There are some super impressive spin- outs with stellar track records because some of these people have been able to capitalise on the really strong run of assets over the last 18 months, and complete maybe one, two or three high-profile exits in this super robust exit environment,” says Gabrielle Joseph, head of due diligence and client development at placement agent Rede Partners.

The trend is not all positive, though. This new generation of new superstar spin-outs is making it much harder for other new managers, who may have a less impressive CV, to break-through.

Sophisticated risk-taking

“There’s an increasing sophistication in the first-time funds and spin outs that we see; they’re very ambitious, and they tend to have a high degree of differentiation built-in,” says Joseph. “Often, they have already invested an awful lot into building the organisation that supports this differentiated approach, which is also a fairly high-risk thing to do. It involves finding lots of like-minded people who have a high-risk appetite, and it often involves investing significant capital of your own too.”

As the general fundraising market tightens, new investors in these funds are paying more attention to the ‘Goldilocks’ spin-out manager: a good track-record should be balanced by a big enough pile of carried interest to fund the new venture, but not so much that it leaves the manager with little appetite to make money. Such a dynamic tends to favour men at a certain stage in their career, says Joseph, but she also notes a recent increase in the number of husband- and-wife spin-out teams too.

There are conflicting views on whether a more recessionary environment will discourage further managers to spin out when they reach this point in their careers.

“Managers will often want to go back to their roots – that’s the common explanation for wanting to spin-out and raise your own fund when things are going well, and the macro environment is good,” says Karl Adam, partner at placement agent and advisory firm Monument Group. “But are they also willing to take a risk on a first-time fund in a recession or downturn?” According to Preqin data compiled by Private Equity Wire, the number of first-time buyout funds crashed to a record low in 2009 after the GFC and took almost five years to return the pre-crisis average.

A climate of increased risk and volatility can hamper start-up ambitions in any industry but, in some cases, the lower carry expectations that can come with a recession may free up more managers to spin-out and establish their own fund.

“Periods of dislocation can make people reflect on where they are in their economic position, and when their carry is going to materially pay off,” says Espinal. “For those people who are entrepreneurially minded, and looking to make that leap, you can spend the time to build your own franchise without sacrificing the big pay-outs if you stayed on.”

According to PitchBook data last year, emerging managers broadly come back to market in two-to-five-year cycles, in the same way mature funds do, but at each stage around a third fail to raise their subsequent fund. Venture capital, which has arguably seen the greatest market dislocation over the past year as valuations have crashed and fundraising stalled, tends to see a greater number of first-time funds due to their lower average size.

Will first-time managers here be dissuaded or spurred on by the current mood?

“In down markets, when margins are squeezed, when bonuses decrease, we can see departures, even at the highest level so I don’t believe that we will see any sort of reduction in the number of very motivated, highly resilient managers that want to start their own gig,” says Francesca Whalen, managing partner at Latin America-focused private equity firm Integra Groupe. “With the flexibility that we have today, there are opportunities everywhere and I think that dislocation unveils even more fascinating places, and that we can create our own niche.”

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