With virtual fundraising becoming the norm, the emphasis is less on face-to-face interactions and more on what new managers can offer that their bigger rivals can't.
Established GPs hold sway with the vast majority of LPs. GPs who have raised four or more funds accounted for about 78% of the capital raised by private capital funds since 2006, as of Dec. 31, according to PitchBook's 2020 Annual Private Fund Strategies Report. Emerging managers—with three funds or fewer on their resume—accounted for the rest.
During the pandemic, emerging managers' share of the pie has gotten even smaller. Last year, they accounted for just 11.7% of private equity capital raised globally, a 15-year low, compared to about 18% the previous year, the report showed.
That's partly a result of travel restrictions caused by the pandemic. LPs—unable to do due diligence on new managers in-person—have opted to back established GPs that can offer the added comfort that comes with their brand and sheer scale.
"LPs have, by and large, focused on existing fund relationships, followed by groups that are well known to them that they have followed for a period of time," said Ophir Shmuel, a London-based managing director at Eaton Partners, a placement agent that advises both experienced managers and first-time funds.
Many LPs require that a member of their investment committee meet in person with a manager before committing for the first time.
These meetings are a vital chance for LPs to grill a fund team about their track record and investment strategy, and they are considered one of the only ways to size up potential investing partners for many years to come.
Such commitments can prove to be lucrative too. As of Q2 2020, 17.7% of first-time funds had an IRR of more than 25% compared with 11.3% of vehicles that are Fund IV or later, according to PitchBook's latest private equity fund performance data.
Some of these funds aren't run by completely unknown teams. For example, Los Angeles-based Gallant Capital Partners, which hit a $378 million close on its maiden fund in July, was founded by an experienced team that spun out of The Gores Group. Similarly, the UK's Corten Capital, a tech-focused firm set up by former partners from PE giant Warburg Pincus, reached €392 million (around $468 million) for its debut vehicle.
With capital to deploy, many LPs are relaxing the rules and investing in managers whom they may have not met physically. In some cases, they rely on the fact that an outside adviser has met the GP in person as a way of complying at least with the spirit of their due diligence standards.
LPs are attracted to the potential discounts emerging managers can offer in the form of co-investment opportunities.
Mounir Guen, CEO of placement agent MVision, said there are still large LPs looking to invest in emerging managers and first-time funds for this reason.
Co-investment is a means for LPs to invest in companies alongside GPs. By investing directly into a portfolio company, they avoid some of the fees that come from investing indirectly via the blind pool fund with other LPs. But such opportunities can be scarce when investing with highly sought-after managers.
As Guen pointed out, "They won't get that in some established funds because they're the new investor and there are another 12 investors in front of them that will be prioritized."
Some LPs have been slow to adopt procedures that allow for remote due diligence, he said. Part of the reason for this is the numerous internal protocols that LPs have to overcome.
"For example, some firms could move to video conferencing quickly and it took a couple of months to go through the internal processes to approve it, but others had to go through committees to decide what software to use," Guen said. "Around September time, it all clicked. Now due diligence is incredibly efficient."
Despite a delayed adjustment process, 2020 was still a good year for mega-funds. The largest managers raised record amounts in relatively short order. In July, CVC Capital Partners held a €21.3 billion final close on its eighth flagship fund after just four months on the road, as many existing LPs re-upped the commitments. Similarly, Thoma Bravo took seven months to raise $17.8 billion for Fund XIV.
"The bifurcation of the market was really brought to bear during COVID-19, where it has been that much harder for emerging managers to make new connections," said Eaton Partners' Shmuel.
Nevertheless, the prognosis appears to be brightening for emerging managers' prospects. A recent LP survey by Eaton showed that 71% of respondents had the same or greater interest level in emerging or first-time managers than they did a year earlier.
Featured image by David Malan/Getty Images