LPs Ask Sun Capital To Cut Fund Size

Sun Capital Partners has a new headache to worry about, in addition to its rash of bankruptcies, personnel defections and NY Post antagonists.

Certain investors in Sun’s $6 billion fifth fund have informally asked the firm to consider a fund size reduction. The discussions are still at a preliminary stage, without any formal proposals having been yet been presented.

“It’s really the larger LPs who are having liquidity issues, which is as much of a driver here as anything,” says a longtime Sun investor. “They probably want all of their GPs to cut fund sizes, but you have to pick and choose… and Sun is an easy target right now.”

Why the bulls-eye? One reason is simple math: Sun has invested just around 26% of Fund V, which means there is plenty of dry powder that can be returned to sender. Moreover, the existing fund portfolio is littered with dogs like Kellwood, which has pushed its overall value underwater by approximately $500 million. Some LPs apparently like the idea of starting fresher sooner, with visions of Sun’s former glory dancing in their heads.

Finally, there is the issue of how much it actually costs to run Sun. The firm has laid off around one-third of its investment staff so far this year (although it does plan to hire new junior folks soon) and has been virtually new stagnent in terms of new deals. In other word, Sun’s current overhead and deal capacity are both lower than what they were when the $6 billion was raised.

But this is where things get a bit tricky. Most firms use management fees (i.e., a percentage of committed fund capital) for overhead. Therefore, a smaller staff can easily justify a fee cut. Sun, however, uses most of its management fee for the general partner contribution to Sun’s fund, on behalf of Sun’s co-CEOs and a group of other senior managers. To “keep the lights on,” Sun mostly relies on transaction fees (currently nonexistent) and portfolio company monitoring fees.

Given this system, one partial solution could be for Sun’s senior managers to alter their management fee structure so that they actually fund their GP commitment out of their own pockets. I say “partial,” because it’s not likely to be large enough to sate liquidity-strapped LPs. As such, my best guess — and it’s only a guess — is that Sun will ultimately reduce its fund size by between 10% and 20 percent (probably on the lower end). It also may alter its management fee structure, but that would be more to satisfy disgruntled junior staffers than to satisfy investors.

A Sun Capital spokesman declined to comment.