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Fundraising trends in a more challenging market
Macroeconomic factors have considerably impacted the private funds market in the first half of 2023, across Europe and notably in Spain. Isabel Rodríguez, head of the investment funds team at King & Wood Mallesons and George F. Furnivall, English lawyer specializing in the fundraising and structuring of investment vehicles, discuss the strategies developed to mitigate the challenging fundraising environment throughout 2023.
ABOUT THE AUTHORS
Isabel Rodríguez is the head of the investment funds team at King & Wood Mallesons’ Madrid office. Isabel is vice-president of the legal and regulatory committee of Invest Europe, member of the board of cirectors of the Private Equity and Venture Capital Institute, and the secretary of the board of directors of the International Women’s Forum Spain.
George F. Furnivall is an English lawyer specializing in the fundraising and structuring of investment vehicles. With more than eight years’ experience, he has developed his professional career in London and Dubai, where he has advised sovereign wealth funds, private equity and venture capital funds, infrastructure funds and hedge funds.
Macroeconomic factors such as high inflation, increased cost of debt and weak performance of equities have substantially impacted the private funds market in the first half of 2023. Europe, Spain included, has been just as affected by this as other regions, with the Spanish market seeing a 46% drop in investments in the first half of 2023 against the same period in 2022 according to SpainCap. Globally, investors have become more selective when choosing how they allocate their capital and, as a result, the private funds market globally has seen longer closing timelines, fewer final closings taking place and a smaller number of sponsors successfully raising capital in the market. Asset disposals by private equity funds in Spain reportedly dropped by well over half compared to the first half of last year, with a substantial increase in investment write-offs in parallel, ultimately leading to fewer distributions for limited partners. As a result, across regions the flow of institutional investors in private funds has slowed significantly. Facing these headwinds, sponsors have had to adapt to a new, more challenging fundraising environment and have done so in a variety of ways, including placing an increased emphasis on relationships with existing limited partners, seeking out capital from new sources in the market, offering more tailored and deal-specific opportunities to limited partners, and even turning to entirely new fund strategies.
Strengthening existing ties
In a weaker market there is often a flight to quality, and fundraising has been no exception. Many limited partners have preferred to re-invest in new vintages of funds in which they have previously invested, following triedand-tested paths with a strong previous track record.
Spain remains well-positioned and competitive in this environment, with its private funds market showing strong signs of growth and potential to attract more capital
Familiarity with deal teams, existing industry sector allocations and favorable past performances have made some managers more attractive to returning investors. Equally, sponsors have worked to strengthen relationships with existing limited partners in order to create reliable, long-standing strategic partnerships into the future. Through offering management fee discounts and other favorable investment terms, sponsors have been able to build on existing investor relations and procure the return of previous cornerstone or anchor investors to new funds. Additionally, building a wider investment platform with key investors, for example through co-investment arrangements, continuation vehicles and separate managed accounts, as described below, often in each case with arrangements that are favorable to limited partners in respect of fees and carried interest, has allowed general partners to further entrench relationships with existing and previous investors. :
Building new bridges
Notwithstanding the above, investors are still deploying capital with more caution and are not necessarily always committing to successor funds, thereby creating a need even among the more established managers to complement fundraising from pre-existing clients. Furthermore, for newer managers with a less proven track record, it is harder to access existing sources of capital, which therefore drives a need to source new investors. One option general partners pursue in response to investor caution is casting a wider net when targeting new investors. Through relationships with global placement agents and investor consultants, for example, greater contact between US managers and prospective international investors is occuring, such as European institutional investors, pension plans and family offices, and Middle Eastern and Asian government-backed funds and family offices. This has been a two-way street with intermediaries also offering access to international investors for European funds. In Spain, for example, there has been growing global interest from investors, including US financial institutions and pension plans.
In Spain, a broadening investment base has led to an overall increase of 22% in new investor commitments against the same period last year
Looking beyond jurisdiction, sponsors have also sought to broaden the scope of their investor base. In particular, there has been an increasing push towards accessing suitably qualified individual investors. This includes targeting family offices and financial institution managed accounts and aggregator vehicles. Newer entrants in this market, such as digital platforms that seek out private equity allocations for retail investors that meet regulatory thresholds, are providing another source of capital for general partners. At the other end of the spectrum, the European market, including Spain, benefits from access to certain public programs, such as the European Investment Fund, Fond ICO Global, and the Institut Català de Finances (ICF), which have been increasingly approached by sponsors looking to secure substantial commitments. In Spain, notwithstanding the challenging market backdrop, this broader investment base has led to an overall increase of 22% in new investor commitments against the same period last year as reported by SpainCap, making it the best half-year for fundraising on record in Spain with over €1.3 billion raised
Wider range of investment opportunities
One method general partners are using to retain and attract investors is the use of deal structures that are tailored to specific investor needs. There has been a renewed focus on the quality of portfolio companies in the current market and managers are faced with longer holding periods for certain assets, and in turn a slower deployment of capital and therefore a delayed return to the fundraising market for subsequent funds. As a result, there has been an increased volume of GP-led secondaries transactions and continuation vehicles to maximize value from selected portfolio companies. Additionally, many limited partners have been pursuing co-investment opportunities to increase their exposure to higher quality assets, often with reduced fee and carried interest arrangements designed to appeal to investors. Limited partners have also shown substantial interest in other deal-specific arrangements from general partners, such as single-asset funds and separate managed accounts, which provide a more focused investment strategy, increased investor influence and control over the investment policy and, again, often provide preferential rights in respect of fees and carried interest. Although providing potentially less financial upside for general partners, these mandates can provide additional revenue streams and assist with developing relationships with limited partners. This has been just as prevalent in the Spanish market, where international fund managers continue to show strong interest in Spanish businesses. Following on from the focus on quality assets, sponsors are increasingly looking at secondaries fund strategies, which allow investors to gain exposure to high quality existing portfolios and investments. In Spain, 2023 has seen successful secondary fund closings, reflecting strong investor appetite. In parallel, against a higher interest rate environment and tougher bank borrowing conditions for companies, credit fund strategies have become an increasing focus. Globally, credit and direct lending funds have enjoyed a surge in popularity with investors seeking reliable returns, although there is a sharp investor focus on high-grade lending. While this boom has spread across international markets, Spain has not seen a notable uptick in credit fundraising, but has continued to enjoy cross-border private debt deal activity involving international funds.
As we get closer to the end of 2023, much remains unclear and difficult to anticipate in respect of market conditions. However, as equity markets eventually recover and investor demand for private funds regains momentum, even in a higher interest rate environment, many of these developing trends will be here to stay. For example, there is no suggestion that the growing internationalization of the European market will cease or that the increasingly diversified investor base will no longer continue to demand access to private equity and similar asset classes. With the cost of debt financing anticipated to remain high, at least in the-short term, we can expect that investors will, in general, continue to enjoy a stronger negotiating position than may previously have been the case. In parallel, sponsors will continue to pursue investment strategies and transaction opportunities that are attractive to limited partners and that complement their existing private equity portfolios.
Overall, Spain remains well-positioned and competitive in the current environment, with its private funds market showing strong signs of growth and potential to attract more capital, both in Europe and from further afield. Equally, the country is still a popular target jurisdiction for international sponsors, offering value opportunities for funds looking to deploy capital in different sectors and across a variety of strategies.
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