The Problem With Cutting Fund Sizes

News that first-time fund West Hill Partners would fold reveals a slightly unsettling truth about shrinking fund sizes: While the move has been applauded at some mega-funds, it can be a death sentence for those in the middle market.

It’s just another reason for LPs to decline new commitments, even with old relationships. ‘What if the GP cuts its fund size, and we are suddenly over-exposed?’ they worry. That’s the fate West Hill suffered. The commitments it had gathered were contingent on the firm meeting its entire target. When it wasn’t able to do so, the investors backed out.

The situation is happening with more firms than just West Hill. LPs are hesitant to commit to a middle market fund that may not hit its target, as falling short may alter the firm’s allocation to certain sized funds. Likewise, no LP wants to suddenly find out it is inadvertently an anchor investor.

It all means that a firm’s target is more important than ever, and that cutting one’s fund size is a double-edged sword. To me, a smaller fund is a sensible way of admitting that buyout firms aren’t able to deploy the massive amounts of capital they had gathered in the boom times. To some buyout pros, it signals a defeat. There is a growing sentiment from LPs that GPs should simply get over it and be realistic, but as fundraising difficulties affect trickle down deeper into the middle market, we’re learning how important it is to hit one’s target.