PitchBook recently caught up with Sixpoint Partners co-founder and partner Eric Zoller for a Q&A on the state of private equity fundraising. The interview covers topics such as the challenges GPs are facing coming to market, a shift toward distressed opportunities, strategies in approaching different classes of LPs and more.
The PE industry is sitting on ample amounts of dry powder, so with concerns out there around how much room the latest cycle has to run, what does the fundraising environment look like for you?
2016 should still see a robust fundraising environment. Although robust, there is definitely heightened concern from many market participants that suggest we are in the latter stages of the fundraising cycle. Nobody has a crystal ball and nobody knows how long this cycle will last, so given these concerns, LPs and investors are shifting some of their focus. They’re increasing their focus towards deep value investing opportunities and sector specialists. In the event of a market downturn, those GPs are better positioned to try and work with their companies through the downturn because of the sector expertise and relationships they have. In addition, firms have been looking to deploy capital into distressed situations, which I think represents a sweet spot for LPs right now. A couple of years ago, we felt that some LPs were a bit early in the distressed cycle so investors were evaluating managers and holding back on making investments, yet I think today investors think it’s the right time to put that capital to work.
Can you speak to some of the challenges GPs coming to market with funds are experiencing?
While the environment is robust, fundraising is not treating everyone the same. There is still a wide range of GPs that very much need help fundraising, either because they haven’t been in the market for a while or they need help telling their story. I think in particular this can be an issue for spin outs as well. These are very strong managers that have an attributable track record and have an overlapping team, but they are out fundraising for the first time together, so those groups really need help raising capital and that’s a big focus of ours at Sixpoint Partners. Further, I think valuations and that uncertainty in the market today is increasingly a problem. We’re seeing some deals come to auction and get pulled or they don’t get the full price and that type of volatility can impact exits, which will be a critical driver for fundraising.
In order to take advantage of certain opportunities such as distressed investments in an uncertain window, what can managers do to accelerate the velocity of their fundraise?
Whether buyout or distressed, managers need to think about building relationships with LPs and implementing an effective communications strategy, rather than “handling” their LPs. I think there was a time when GPs thought that as long as they were sending quarterly letters and giving deal updates, as well as popping in once in a while to see their LPs, was a sufficient form of communication. Now, the competition for LPs time is much greater and so to capture their mindshare you need to have a coordinated communications and pre-marketing investor relations plan and not an ad hoc communications effort. In addition, that plan needs to reflect some customization for different types and classes of LPs you’re engaging.
Can you speak to these different classes of LPs?
You have LPs that like to be first movers, either because they are incentive driven or they like to drive the terms of documentation, and it is important to identify these firms upfront in your fundraising effort. Make it a point to go visit those LPs before you go to market and let them know who you are and what your investment strategy is. You can also show them some deals early on and potentially get them to back you, maybe out of your existing fund on a co-invest basis as a way of letting them see how you diligence and source a transaction, and further letting them understand the DNA of your firm.
A second class of LPs includes those who want to see some development in the fund. Maybe they need a different kind of incentive including the ability to co-invest or maybe a fee-break, and as such, you don’t want to approach this class of LP too early.
There’s also a class of LPs that tend to be final closers. They want to see that you’ve had fundraising momentum and that you’ve done a couple deals. They want to know that the team is already fully built out and everything is in place and they want to come in and know the fund is going to achieve its target. So with this class, you can’t just show up and introduce yourself at the end, but you want to introduce yourself early and understand that this class tends to move later in the process, but can move very quickly when they do.
What do you see in terms of spin-out vehicles in the current landscape?
We think there is increasing receptivity on the part of LPs for spinout funds in particular, because they offer a great value proposition and an opportunity to offer outsized returns. We also think that LPs think there is greater alignment of interest on the part of spinouts relative to firms that have grown over time. Looking at statistics, we’ve seen some suggest that 70% of LPs either intend to or have a willingness to invest in spinout managers or new funds over the course of 2016.
On the GP side, you have a combination of several factors driving these vehicles and their related fundraising efforts. One is aging founders, where maybe an initial founding management team of a sponsor isn’t ready to cede control, and thus, a subset of the team deems it’s time to spin out. We’ve also seen the growth of the recapitalization and restructuring market from the secondary perspective. So a subset of those restructuring funds will spin out and reconstitute themselves under a new form. So the statistics we’ve seen there is that there are over 1,300 funds globally housing close to $200 billion in aggregate capital, and thus, have not raised a subsequent fund since 2007. What that means is that a subset of those funds might be a multi-strategy fund that might have different investment verticals and as certain verticals become non-core as firms grow, you’ll see those pieces spin out.
Eric Zoller is co-founder and partner of Sixpoint Partners LLC, a global investment bank serving the middle market private equity industry. Mr. Zoller is responsible for helping to set strategic direction for the company. He has overall responsibility for global distribution, secondaries and co-heads the firm’s fund origination effort. He is also involved in all major operating, management, fund origination and investment decisions of the company.
Sixpoint Partners, LLC, is a registered broker/dealer, member FINRA and SIPC