LPs in first-time funds seek size caps on Fund II

Limited partners who make significant commitments to managers of first-time funds are asking for size caps on Fund II — a term that is more show than substance because it’s unenforceable, according to panelists at an industry conference Wednesday.

“We’ve heard LPs have put a hard cap on the next fundraise,” said Eric Hanno, managing director at AlpInvest Partners at Emerging Manager Connect East on Wednesday. “LPs can get frustrated when they back a successful firm and they grow by three times.”

Other panelists agreed that some LPs are asking for caps on the next fund size as part of overall negotiations of terms on new funds.

Such a term, though, is “unenforceable,” said Gordon Hargraves, partner at Private Advisors. The fund-size cap can be put in place, but by the time Fund II comes around, if the manager is in high demand, the manager may just ignore the agreement, he said on the conference sidelines.

The idea of capping the size of the next fund is designed to build a long-term partnership, said Kelvin Liu, a partner at Invesco.

Asking for a cap is a way to determine the manager’s ambition: Is the debut fund simply a stepping stone to a $1 billion fund down the line, or is the manager serious about operating in the smaller market at a disciplined fund size? Liu said.

“We don’t want to be single-fund investors; we want to be longer term investors,” Liu said.

Interpreting a new manager’s ambition is vital to forming a partnership. “What do these individuals and the firm want to be when they grow up?” said Jason Andris, managing director at Venture Investment Associates. “Is $300 million a stepping stone to $600 million, which is a stepping stone to $1 billion, or are they going to stay in this zone for the next decade?”

Such caps result partly from the aggressive PE-fundraising environment, which Hargraves called a “food fight.” Because of the environment, the GP has the leverage in negotiations around fund terms, panelists said.

“It’s a feeding frenzy right now. … 10 years ago it was crickets,” said Joshua Sobeck, partner at 747 Capital. “Now it’s unbelievable. You have to be there early and have a reputation … in order to get access and help managers to put terms in place that make sense for everybody.”

Action Item: Contact Jason Andris at VIA: jandris@viafunds.com

Gordon Hargraves of Private Advisors. Photo sourced from the firm’s website.