‘Hard’ Fundraising Caps Melt in Private Equity

Funds are blowing past self-imposed fundraising limits and industrywide records, and their number one priority is still gathering more.

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Asset gathering remains the number-one focus at private equity firms despite record fundraising.

Investors, in turn, are questioning how much they are shelling out in management fees to their oversubscribed general partners. Private equity CFOs surveyed by EY named asset growth as their top strategic priority, followed by talent and then cost management. Small and large firms deemed fundraising equally important, with 55 percent of respondents adding that they expected to raise a new fund this year.

More than 100 private equity CFOs weighed in for the report, It follows another record-breaking year for private equity, in which 900-plus funds sealed about $640 billion in new commitments, according to EY. Data firm Preqin declared 2017 the industry’s biggest fundraising year ever.

This capital avalanche heaped dry powder, or undeployed capital, up past $1 trillion for the first time in December, Preqin said. Less than a third of private equity vehicles hit or exceeded their stated maximum fund size between 2007 and 2010, versus 56 percent between 2015 and 2017, separate Preqin figure showed. Hard caps, the data suggested, are not so firm after all.

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“Given that the current environment sees most successor vehicles target significantly more capital than their predecessors secured, that they still breach their limits is a mark of how much capital is flowing into the industry,” said Christopher Elvin, Preqin’s head of private equity products, in a statement. “Investors may have concerns on this front though, over the rate of deployment of capital, as well as concerns over the fund drifting away from its original strategy.”

The consultant said these rising asset levels have spurred some investors to demand “higher returns at lower fees.” Of the private equity executives surveyed, 73 percent said their firm had been pressured by investors to reduce management fees. Although 10 percent of managers said they’ve made concessions on fees, 68 percent defended their price, citing either a “unique” strategy or strong past performance.

One in three surveyed CFOs reported firm profit margins were declining. Another 19 percent said they’ve maintained their margins through strategic cost cutting or rapid revenue growth.

Most respondents said they had adopted “nontraditional” investment offerings to better meet investor demands. More than three-quarters offer co-investment opportunities, while 40 percent extend to select clients fee breaks. Customized side letters come into play for 37 percent of respondents, while just under a third are using separate accounts.

When it comes to reporting fee and performance data, 78 percent of surveyed managers said were at least somewhat flexible to investor requests. One in four permit investors to fully dictate how and what data are reported. Only few investors required general partners ahdere to the Institutional Limited Partner Association’s reporting template, which was designed to standardize and simplify private equity reporting to limited partners.

Christopher Elvin