The private equity fund-raising business is changing radically, thanks to the collapse of the stock market and plan sponsors' being left with little capital to invest. It takes twice as long to raise a fund as it did a year ago, and the amounts general partners expect to raise often have been cut back.
But it's going to get even tougher for general partners, predicted Donald Phillips, chief executive officer of WestLB Asset Management LLC, Chicago.
"In the '90s, plan sponsors were just getting into the asset class, and everyone wanted to start committing. Now, those whose allocations are complete are going to be very selective.
"Now the pension funds just have some holes to fill and are looking for specific strategies," said Mr. Phillips. He added that general partners will have to prove to potential limited partners that they will have the deal flow in which to invest, something that wasn't required before.
Pension funds are experiencing a liquidity crunch. The steady stream of distributions that had been used to fund new offerings has slowed to a trickle, causing fund officials to reduce commitments and delay making them as long as possible. At the same time, many are overallocated because their public market portfolios have shrunk, causing their private equity allocations to swell.
The numbers speak for themselves. According to the most recent figures from Venture Economics, Newark, N.J., fourth-quarter commitments to new venture funds slowed to $18.2 billion, down from the $27.5 billion in the third quarter. But for the year ended Dec. 31, venture funds raised $92.3 billion, setting an all-time record; they raised $60 billion in 1999. Buyout fund commitments rose to $19.7 billion in the fourth quarter, compared with $12.6 billion in the third quarter. For 2000, buyout fund commitments rose to $71 billion, from $61.8 billion in 1999.
Jesse Reyes, vice president at Venture Economics, said fund raising this year will slow from 30% to 50%, and the greater slowdown will occur in venture capital. "Buyouts may be down by 30%, while venture fund raising could be down from 40% to 50%."
Bright spots exist
But the picture is not entirely bleak. Bright spots exist as smaller funds move into the asset class for the first time and some larger pension plans continue to grow their private equity portfolios. Among them: the $169 billion California Public Employees' Retirement System, Sacramento; the $90 billion New York State Teachers' Retirement System, Albany; the $31.4 billion Massachusetts Pension Reserves Investment Management Board, Boston; and the $6 billion pension plan of American Airlines Inc., Dallas.
And plenty of general partners are successfully raising new funds. The top-quartile performers are still very much in demand. Also, new categories that are more appropriate for the times, particularly distressed debt and secondaries, are gaining more attention.
Parag Saxena, managing director private markets at INVESCO, Atlanta, noted the entire business is going through a slowdown. "Last year the typical buyout fund made a lot fewer investments than the venture funds did. Now the typical venture fund has more investments that need to be taken care of because most of its companies are not going public at the speed they did 18 months ago."
Dealing with the slowdown
WestAM's Mr. Phillips estimated that up until now, 85% to 90% of plan sponsors in private equity funds were U.S. based. Starting this year, however, he expects just 75% to 80% of the funds' investors will be from the United States, with European and Asian pension funds making up the difference. There seems to be particular interest from Japanese pension systems, he said.
Many industry experts say the slowdown will have some positive results. Salem Shuchman, general partner at Patricof & Co Ventures Inc., New York, recalled that during the euphoria of the past several years, potential portfolio companies wanted investors to make quick decisions about backing them, not allowing sufficient time for proper due diligence. "We walked when that happened, but a lot of companies went public that shouldn't have," he said. "Now times are different and we're getting the time to do the work and distinguish ourselves as an investor. We're back to a calmer environment and finding lots of great companies out there to fund."
Patricof, which has been investing for 30 years in up and down cycles, is backing companies at a slower pace now, knowing it will be funding its companies for a longer period, since it won't be taking them public for a while.
He noted that venture firms will be looking at exit strategies other than the public markets, such as strategic sales for cash or stock in another public company.
New funds
Meanwhile, several new funds and funds of funds are seeking investors, and those with strong franchises have been able to attract capital. Mr. Phillips - whose firm recently closed on a $360 million fund of funds - said this fund originally had targeted $300 million, and had to turn away investors whose documents weren't completed by the scheduled closing date. And Lazard Technology Partners, New York, the technology venture capital arm of Lazard Asset Management, closed its second fund, LTPII, in March, raising $300 million - $50 million over its target, said Russell Planitzer, managing principal. The fund will focus on early stage telecommunications companies based mainly in the East, where pricing is better than on the West Coast, Mr. Planitzer said.
Other new vehicles, such as a $500 million fund of funds being marketed by Russell Capital, the alternative asset subsidiary of Frank Russell Co., Tacoma, Wash., and a $400 million buyout fund being marketed by the Blackstone Group, New York, each is attracting early support from previous clients.
Those having the hardest time are first-time funds, because limited partners are choosing to re-up with general partners they have invested with in the past. But some of the first-timers are managing to raise money by being included in funds of funds.
Pilgrim Baxter & Associates Ltd., Wayne, Pa., is raising a venture fund of funds, targeting pension and endowment fund investors that are new to the asset class as well as those that want to invest through a fund of funds instead of directly. Even though there is somewhat of a backlash against venture capital, "those who understand it know they have to commit to it every year to avoid running into problems with vintage-year funds," said Carol Proffer, managing director of private equity advisory services.
Funds offering unique strategies are still in demand, observed Mike Fisch, president, American Securities Capital Partners LP, New York. He said his firm is perceived as one of the few that specialize in middle-market deals averaging $200 million. Investors in his latest fund, which has raised $300 million and is targeted at $500 million, include the $500 million endowment of Vassar College, Poughkeepsie, N.Y., and the $11.2 billion University of Texas Investment Management Co., Austin.
The mood today
Mario Giannini, president and chief operating officer at Hamilton Lane Advisors Inc., a Philadelphia private equity consulting firm, said pension funds that got aggressive about increasing their venture exposure in the last two years are no longer in that mode. "They're not cutting back, but they are letting the venture in their portfolios slip back to a smaller percentage of their total private equity allocation as the investment cycle plays out. If the venture allocation was in a range from 15% to 35% of their (private equity) allocation, they'll let it come back to 20%."
Typical is the $50 billion State of Michigan Department of Treasury Bureau of Investments, Lansing. A year ago, the system was building its private equity program to 14% of assets from 8%, and its venture program to 20% of private equity from 8%. Dave Turner, private equity administrator, said the private equity allocation is now 16.5%, slightly over its target range of 15% to 16%. The venture allocation has grown to 17.5% of private equity, and there no longer are plans to raise it to 20%.
Like many of its peers, Michigan has been suffering from a lack of liquidity because of reduced distributions, and has cut back the size of its private equity commitments to existing partnerships by 40% to 50%. It is committing little to new partnerships.
The situation is also tight at the $32.7 billion Public Employees' Retirement Association of Colorado, Denver, and at IBM Corp.'s $46 billion U.S. defined benefit plan.
The Colorado fund is too cash-poor to make many new private equity investments because in the past year it has begun using $200 million of its investment income to help pay retiree benefits, in contrast to previous years when the plan was overfunded and investment income was re-invested, explained Don Shaefer, spokesman. He said the system has 11.3% of total assets in alternatives, well above its strategic allocation of 8%, and it is not looking for new partnerships.
