The LP piñata syndrome

Private equity investors want more. And they don’t want to share.

More than half of all investors — including 88 percent of mid-sized LPs with between $5 billion and $10 billion of assets — complain they could not commit as much as they’d like with their favorite managers, according to a recent Coller Capital survey.

Yet the same survey points out that almost 90 percent of the same LPs ranked the growing size of private equity funds among their chief concerns with investing in the asset class.

Both complaints are valid. Unfortunately, LPs can’t have it both ways.

The economics of fundraising provide little incentive for successful GPs to keep fund sizes in check. When a fund strategy works, LPs want more of it, and GPs are more than happy to raise larger funds to meet that demand.

The firms are heavily compensated for doing so. If you’re a GP, would you rather collect a 1.5 percent annual management fee on $5 billion of committed capital or $10 billion of committed capital? Maybe it’s more difficult to put that capital to work, and you’ll almost certainly shell out larger equity checks on new deals, but the revenue that pays your annual salary (excluding carried interest) just doubled.

That’s roughly what’s played out with Vista Equity Partners, which closed its fifth flagship fund on $5.8 billion less than two years ago. Vista originally set out to raise $3.5 billion for Fund V, but continued to market the vehicle well after it surpassed its fund target in response to LP demand.

“The thing that I tell our LPs is, the only reason we raised $6 billion (with Fund V) is because we didn’t raise $10 (billion),” Vista Founder Robert Smith told Columbia Business School students in early 2015.

Smith’s comments hinted at the future. Less than a year later, the firm began marketing Vista Equity Partners Fund VI with an $8 billion target and $10 billion hard cap.

LPs rightly fear that as firms raise larger and larger funds, they may drift away from the strategies or deal sizes that brought them success in the first place. While Vista’s strategy remains firmly rooted in enterprise software, Los Angeles County Employees’ Retirement System documents indicate Fund VI will include roughly a half-dozen more portfolio companies than Fund V. The firm’s minimum investment size doubled to $200 million.

The prospect of a larger fund and bigger deals should send Vista LPs reeling, considering the findings in Coller’s survey, but it hasn’t. With Vista’s history of netting top-quartile returns, many LPs consider Fund VI an attractive and easy re-up. LP memos suggest Vista Equity Partners Fund VI will be oversubscribed.

Vista isn’t a particularly unusual case. The GP commitment pushed Leonard Green & Partners Fund VII $500 million above its $9.1 billion hard cap for third -party capital. Investors have been flocking to Thoma Bravo’s new fund, which set a target that almost doubled the size of its 2014 predecessor. Siris Capital blew through its hard cap earlier this year.

Imagine an oversubscribed private equity fund as a piñata at a birthday party. When it’s too small, some kids complain there isn’t enough candy. When it’s too large, the same kids will chow down king size bars until until they puke.

Here’s the thing with birthday parties: Usually there’s an adult in the room.