Private equity firms are likely to flood the market this year looking to close new funds. But expect plenty to fail in their quest, as limited partners, burned in the past cycle, remain wary of over-committing to the asset class.
Those were findings of a private equity white paper with the subtitle “Keeping LPs Happy” published today by accounting firm Grant Thornton.
The firm estimates that globally there are about 700 private equity and venture capital funds either already in the market or expected to be raising funds during 2011, citing PitchBook data. The influx partly results from funds that normally would have raised capital in 2009 and 2010 postponing fundraising as they awaited more favorable market conditions.
So what will it take to attract new investment and keep LPs happy in this competitive climate? Grant points to better alignment of interests, largely in the form of provisions that reserve financial rewards for general partners who produce investment returns for LPs. Others things LPs are looking for include improvements in infrastructure and operations to reduce costs and greater industry specialization.
LPs who invested in private equity during its peak fundraising years have reason to be wary. Private equity vintage funds from 2007, for example, are showing an average internal rate of return of -14 percent. Mezzanine funds from the same year are showing an average IRR of -32 percent. Top-quartile firms, as usual, will have an easier go at fundraising.
“Fundraising will be subjective based on the GP. There will be a growing divide between the haves and have-nots. Fundraising will be very easy for some because they have had spectacular track records and a loyal LP base. These firms won’t have to make huge concessions either,” said Erik Hirsch, chief investment officer for investment adviser and funds-of-funds manager Hamilton Lane, cited in the report. “Then there’s another group for which none of this is true. These firms are having serious problems, which will eventually lead to a weeding out in the market.”