Big Funds, VCs, Seen as Less Attractive to LPs

Limited partners are again prying open their checkbooks, but they are looking to take capital to middle market funds in greater numbers these days, according to an annual Probitas Partners survey conducted across a group of 183 institutional LPs.

More respondents said next year they are likely to back middle market buyout funds ranging in size from $500 million to $2.5 billion and small market funds of up to $500 million (46% and 37%, respectively) than institutional LPs that were looking to invest with $2.5 billion to $5 billion funds and mega-LBO firms pushing funds of $5 billion and up (a paltry nine and five percent, respectively).

“A lot of people are beginning to think there is too much capital” going into the $5 billion and greater funds that, in many cases, are struggling to either manage or deploy capital, says Kelly DePonte, a partner with placement agent Probitas Partners.

The global economy’s rebound triggered deal valuations’ return “to at least where they were in 2006,” DePonte tells peHub, creating difficulty for bigger buyout shops that still struggle to raise enough capital for deals.

Distressed and turnaround funds and secondary investment vehicles are falling out of favor with LPs, DePonte says. Fewer respondents said that in 2011 they would contribute to distressed and secondary investment vehicles than last year.

“Going into 2009, secondaries were hot,” with LPs, DePonte says. However, the combination of low-balling offers for secondary stakes and the private equity asset class weathering the recession in better-than-expected fashion has cooled LPs’ interest in buying up second-hand positions, he says.

Venture capitalists also continue to see their investor base eroded, the survey found. DePonte notes that, in 2006, Probitas’s survey discovered 16% of its respondents declaring they were no longer interested in backing VC funds. By the end of 2010, that percentage more than doubled and a third of the survey participants said they were backing away from the space.

“It keeps steadily going up,” DePonte says of VCs’ rejection rate. DePonte acknowledged that a restrained IPO market is offering too few exit opportunities for funds that have struggled against asset value declines and the tech bubble’s bursting a decade ago.

The study offers encouragement for some LBO shops—particularly those investing in emerging markets. After lagging behind Western Europe in investors’ eyes, Asia’s desirability has steadily grown and investors in PE funds now look to countries like India and China as they would more traditional plays in developed nations. In Asia, LPs said they are increasingly bullish on their economic prospects and plan to commit capital to LBO shops focusing on investments there. But even as commitments to Asia-focused PE shops grew substantially from 2009 into 2010, the projected amount of capital raised will fall far short of what LBO firms raised from 2006-2008.

Russia has virtually fallen off investors’ radars when looking at emerging markets, according to the survey, something DePonte chalked up to political instability and the prospect—however slim—of businesses being nationalized by the Russian government.

Also, investors were far less likely to back funds concentrating on Latin America than those seeking deals in Asia, according to the Probitas survey. Still, DePonte notes, institutional LPs eyeing Latin America are growing in number—just not at the pace that investors keep piling into China and India.

“When people look at Latin America, they’re really focused on Brazil,” DePonte says.