With private equity fundraising timeline hitting an all-time high of 19 months in 2024,1 fundraising in the current market is a daunting prospect for any private fund manager. Reviewing relevant fund terms and planning ahead ensures that a manager has the tools it needs to satisfy investor concerns and address other issues that may arise during fundraising.
For a typical close-ended fund, it is customary to have an 18- to 24-month fundraising period (rather than 12 months in more buoyant times), with the manager having the ability to extend final closing with investor consent. It is increasingly common to build in a grace period of a few weeks (for which no investor consent is required) to admit pre-identified investors who need more time to go through the formal subscription or AML process—this can benefit both managers and investors alike.
If it becomes apparent that investor consent is required to extend the fundraising period, managers should approach this in a transparent and timely manner. From an investor's perspective, being approached for an extension late in the day, without having received any interim updates, is likely to raise difficult questions. Typical negotiation points with first closing investors tend to be around the fund's ‘hard cap' or maximum size, the fundraising period and other milestones tied to the end of the fundraising period. Managers run the risk of re-opening these discussions with existing investors or having to re-trade other ones as concessions to obtain existing investors' consent to extend the fundraising period.
In an environment where investors wield bargaining power even at later closings, managers should be prepared to couple the fundraising extension request with a request to consent proposed amendments to the fund agreement sought by new investors. Fund agreements are often drafted to be permissive of such amendments, without the need for investor consent on the basis of the manager's ability to agree amendments that are not materially or disproportionately adverse to investors.
One area that can be fraught with sensitivity for managers and investors if the fundraising is prolonged is the equalisation provision. Fund economics typically assume that, upon payment of the equalisation amount, all investors can be treated as having been admitted at the outset of the fund life. The equalisation amount payable by a new investor has two core elements—the amount of its commitment that would have been drawn down from an investor had it been admitted at the initial closing, plus a premium or interest charge in respect of such amounts.
Typically, investments are held at cost during the fundraising period absent any events that may affect valuation materially. A longer fundraising period increases the risk of an event that changes the valuation of the investment. Managers therefore look to incorporate flexibility to vary the basis of the equalisation payment in instances where the current valuation, rather than the acquisition cost of the investment, may be more appropriate. In such cases, investors will typically want comfort on whether this will be done on the basis of the third-party valuation, rather than at the manager's sole discretion.
Equalisation interest is payable in excess of a new investor's capital commitment and can therefore have a meaningful impact on an investor's returns. Managers therefore need to calibrate the equalisation rate carefully so as to balance the interests of existing investors whilst not disincentivising new investors, noting that the interests of the first closing investors and later closing investors are likely to diverge.
Slower fundraising may also impact the pace of the fund's investments, necessitating interim warehousing arrangements with third-party co-investors or other vehicles affiliated with the manager. Ensuring that the fund documents contain clear disclosure on pricing and appropriate mechanics to manage the conflicts of interest is critical from an investor's standpoint. From a manager's perspective, if a fundraising ultimately falls short of target, there should be enough leeway in the fund agreement to make allowances for any investments that ultimately do not comply with size-based investment restrictions negotiated by investors.
Finally, in some instances, it may be helpful to say less. For example, several managers set out the eligibility criteria for first closing incentives, such as early bird fee discounts, expressly in the fund documentation. However, given increasing investor bargaining power, managers should be careful not to rule out the use of such tools to incentivise investors later on in the fundraising process. Such matters can always be agreed bilaterally with investors in their side letters and subject to the ‘most favoured nations' process at the (much-awaited) end of the fundraising.
1 Buyouts Insider, 17 January 2025
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