At Hamilton Lane, we regularly preach the benefits of using data to drive our insights rather than relying on anecdotes or gut feelings. For months now, many of us have been speaking amongst ourselves about fundraising and how busy it seems. To be honest, activity levels feel incredibly high across the asset class. And yet the data is telling us something quite different than what our gut feelings would suggest. In fact, it’s telling us to expect that 2020 will prove to have been a flat year for capital raised, and the volume of fund opportunities received during the year was actually down about 2.5% in 2020 vs 2019.
How can that be? Certainly some of the reduction in absolute numbers can be attributed to lost months given uncertainty around the pandemic: Fewer funds were launched in Q2 2020 than usual, bringing down the 2020 total. Even ignoring Q2 2020, and despite increases in opportunities received in Q3 and Q4 2020, as well as Q1 2021, the growth is not as high as you might think. By that calculus, volume is up only 10-15% depending whether you compare it to Q2 2018 through Q1 2019 or Q2 2019 through Q1 2020.
So why does it feel like there is so much more stress on the system today? It doesn’t seem to be fully explained by the growth of fund launches or capital being raised. Our take is that it has to do with the approach to fundraising that GPs are taking. Said differently, the courtesy of the process has diminished. From changes to fundraise timelines to the amount and detail of information provided, the last nine months or so have been a more difficult environment for investors to plan around. The pendulum seems to have shifted to favor GPs with regard to what they need to provide to LPs, as well as their ability to drive to a first close, potentially raising more money or driving more GP-friendly terms.
For the last decade, I have imagined the process as akin to a grocery store checkout experience, with semi-orderly queues across multiple checkout aisles. GPs set targets and timelines, giving LPs appropriate forewarning; GPs and LPs respectively manage pipelines and deal flow to these expectations. Sure, there have always been exceptions, especially for those hard-to-access funds, but there was some semblance of order to it all. More recently though, it feels like we are experiencing the shopping rush on a busy holiday weekend.
As I see it today, high-quality and performing managers generally coalesce into a few styles. (Notice I said high-quality managers, so this doesn’t include groups that will struggle to raise their next fund because of performance or other issues.)
- The Line Cutters. Their performance is only beaten by their egos. They don’t worry about managing relationships or helping LPs manage to a timeline. They have plenty of suitors and they are the prize; just sign the dotted line. They might have just finished raising their last fund yesterday, and don’t forget they’ll want better economics on this next fund. We’re all frustrated with how they act, but they’ve convinced themselves it’s only because we’re secretly jealous of them.
- 15 Items Or Less. These are GPs with great platforms and, in many cases, with performance to match the line cutters, but they value relationships and have world-class investor relations groups keeping the senior team in check. They will be direct and raise quickly, but they plan and get ahead of it. These groups will likely use incentives like a first close discount to at least get into the express lane.
- The Orderly and Polite. These GPs are waiting patiently at the back of the line. Today they are starting to recognize that likely means 2022 and not 2021 at this rate. They accept this fate for various reasons, though for many it’s not underperformance, it’s just they can’t message 50+% returns for 2020 either.
- Still Shopping. These are the GPs that are asking attendants for help in the aisles. They will solicit feedback from LPs, and quickly realize their mistake as they get told dates like H2 2022 or even 2023. Some will be fine (their performance or historical relationships will help them raise), others will realize they need to become a line cutter or find another way to jump to the front of the queue. Those who are less proactive, will face a long fundraising road despite being a high-quality manager as they wait for LPs to prioritize them.
- The Virtual Shoppers. This is more a prediction for the future, despite reflecting our current reality. As travel reopens, will there be managers that rely on technology to raise capital exclusively from the comfort of their offices or homes? We think some, particularly those in demand, will try to retain this benefit as much as possible for as long as possible.
So what are the consequences of some of this?
- Time back to market is getting shorter and shorter for some GPs
- Will we witness a GP launch their next fundraise before making the first capital call in their prior fund? Ok, fine, that’s unlikely, but what about raising subsequent funds every year? Adjustments to percent drawn feel a lot like those EBITDA adjustments we all talk about, and those line cutters are bringing time between raises down to 12 to 18 months right now without any sign of waning enthusiasm.
- LPs will face a lot of difficult decisions around how they prioritize allocations for the year
- Should I spread my commitments across more relationships with smaller tickets?
- Borrow instead from my 2022 allocation?
- What if I prioritize my top relationships and play for time with the others?
- Investment Diligence, Operational Diligence and Legal review time frames will be compressed
- Review and analysis of opportunities will be more reliant on GP data rooms rather than bespoke requests to verify information. Things will inevitably be missed as LPs rush diligence.
- LPs will focus on segments of the market with which they’re most familiar, or on their longest and closest relationships, rather than targeting new names.
- Performance will move up the list. Short-term numbers will be all the rage. Funny how we all say this is a long-term asset class, isn’t it?
- Last, but certainly not least, legal teams will be in high demand. This demand will be particularly acute for those coveted quarter end closes.
Keeping with the grocery store theme, our advice to LP shoppers is to have a list. Have a plan of what you want to do and generally stick to it. Yes, you should maintain some flexibility in your budget to be able to execute on something unexpected, but if you shop without a list, your cart will be full before you know it. And potentially with a lot of junk you don’t need. Or missing out on the good stuff you should be picking up, all of which could combine to skew your portfolio inadvertently.
For GPs, our message is also to have a plan, and then to over-communicate about that plan. Don’t assume your LPs know what you are thinking; make a schedule, share that schedule and stick to it. Try to streamline where you can to avoid unnecessary legal work and other issues that might arise. Avoid surprises, for yourselves and for your investors. Communicate, communicate, communicate.