18 Feb 2019
Skin in the game becomes a challenge as fund sizes approach record highs
- Continued growth in average fund size drives up expected commitments
- General partners (GPs) expected to commit an average of $55m to their next fund
- More than one in eight GPs don’t know how to fund their proportion of personal commitment in the fund
- GPs increasingly consider reinvesting carry to fund their proportion of commitment
Triggered by both limited partner (LP) requirements for more skin in the game, and the rising demand for private equity funds pushing up fund sizes, GPs are struggling to free up funds for increasingly large personal commitments, according to the 2018-19 Investec GP Trends survey.
The research, which surveyed 289 private equity professionals around the world, revealed that GPs expect to commit an average of 2.9% to their next fund. While this is a drop from 3.3% 12 months ago, the rise in average fund sizes – up from $1,765m for the 5 years from 2014-2018 1– means that GPs are having to find a higher commitment in absolute terms for this generation of funds. With the average target size of funds currently raising reaching $1,903m2, the amount that GPs and their teams are expected to personally commit now stands at approximately $55m.
This challenge is likely to become more acute as funds continue to grow: Over half (55%) of respondents expect that their next fund will be more than 25% larger than their current fund, and one in eight (12%) expect their next fund to be twice as large as its predecessor. For larger buyout, infrastructure, distressed and secondaries funds, figures quickly reach eye-watering levels.
More than one in eight (13%) GPs don’t know how they will finance these personal commitments in their next fund, a rise of 5 percentage points compared to 12 months ago. This is particularly challenging for future leaders, with nearly a quarter (23%) of those below partner level unsure of how they will meet commitments.
Jonathan Harvey, Head of European Fund Finance at Investec, explained:
“Fund sizes continue to climb: in 2018, 250 funds worth more than $500m closed3, with an average value of $2,299m. The optimism of the industry makes sense given the continued demand for private equity from the buy-side in their hunt for yield, but GPs face a challenge in funding their commitments.”
Jennifer Choi, Managing Director for Industry Affairs at the Institutional Limited Partner Association (ILPA) expanded:
“Next generation leadership may not have accumulated the wealth to commit the right amount to the GP commitment.”
To personally fund their portion of commitments, 39% of GPs surveyed in the report stated that they are planning on reinvesting carry and/or co-investing proceeds from previous funds, while 14% will use external debt financing. However, relying on carry can become risky when expected returns are not generated and in turn funding lines become uncertain.
Simon Hamilton, Head of Global Fund Finance, Investec concludes:
“Funding commitments with carry simply means that GPs don’t have the cash available, now. This can be risky, particularly as the uncertain outcome of unfolding political events coupled with concerns around the growing amount of dry powder in the market are becoming harder to ignore.
We hope that the optimism in the industry is well-founded, but it makes sense for GPs to explore the options available to finance these commitments. This is particularly true for GPs where individuals below partner level are expected to commit meaningful sums. These individuals, from which future generations of firm leaders will emerge, may still be some years away from any carry payments.
It is important for LPs to see that the GP commitment to a fund comes from the entire investment team – it is a key alignment mechanism. The fact that so few team members below partner level know how they will fund this is an issue.
Investec can help provide certainty around GP commitment financing, allowing staff to focus on what they do best: investing and generating returns for their investors.”
(1) Source: Preqin, funds with value of more than $500m
(2) Source: Prequin, funds currently raising with target size of more than $500m
(3) Source: Preqin, funds with value of more than $500m, 2018
For more information, please contact:
Fatima Ismat, Lansons (PR agency for Investec CIB) - 020 7566 9709
Luke O’Mahony, Investec (Public Relations) - 020 7597 5261
About the research
A survey of 289 private equity professionals, conducted by MJ Hudson, in the UK, Mainland Europe, North America and the Rest of the World.
About the Investec Funds team
Together, Investec Fund Finance and Investec Fund Solutions provide strategic financing and risk management solutions to funds and fund management teams globally. This unique set of capabilities offers flexibility and strategic solutions at each stage of the fund cycle, as well as to the GP itself.
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