How to clear the fundraising hurdle

What can firms do to improve their hit rate with LPs?

It’s a tough fundraising environment for emerging markets funds right now and travel restrictions are not helping the situation. What can firms do to improve their hit rate with LPs?

Private capital fundraising for emerging markets has been on the decline for a few years now - a trend that the pandemic has only exacerbated. The uncertainty brought about by COVID-19 had led investors to deploy capital with managers they already know and in markets they perceive as safe havens in what many have dubbed a “flight to quality”.

“The amount of capital flowing to emerging markets versus developed markets presents the former with significant challenges today,” says Daniel Schoneveld, Principal at Hamilton Lane. “We were already seeing capital diverted to more developed markets, but as the pandemic has taken hold, investors are sticking to what they know best and are familiar with.”The figures back this up. In 2016, these markets reached a high point in aggregate capital raised, with 1,750 funds attracting US$311.3bn, while in 2017, record numbers of funds closed, at 1,900 raising US$305.4bn between them, according to Preqin. By 2019, however, these totals had fallen considerably to 934 funds and US$220.8bn raised.

As the pandemic struck in 2020, just 637 funds closed on an aggregate US$140.6bn.This is despite a decline of just 9.8% in total capital raised by private markets globally between 2019 and 2020, suggesting that developed markets fundraising has held up well by comparison.

“The COVID-19 situation has tended to push people towards things that are already in their universe,” says Steve Cowan, Co-Founder and Managing Director of 57 Stars. “As a result, there has been a real bias towards an exceptionally strong fundraising environment for large and established firms and that really impacts the smaller, less well known names in what has become a further bifurcation of capital globally.”

Smile, you’re on camera

While some of this shift in capital flows is down to investors looking for familiarity in the face of uncertainty, the move to video calls in the place of face-to-interactions has especially hampered newer emerging markets funds. Even those investors – principally the development finance institutions (DFIs) – with a mandate to support new managers have had to tread carefully.

“We have continued to look at fund managers through the crisis,” says Anne Fossemalle, Director, Private Equity Funds, European Bank for Reconstruction and Development. “And we have committed to two funds using online due diligence only, including a first-time fund. But on both occasions, we had met the GPs before. We haven’t yet committed to fund managers we haven’t met.”

And, in contrast to the situation with more established funds in developed markets that have often been able to accelerate the fundraising process using video calls, remote due diligence for many emerging markets funds has taken longer than before.

“We thought initially that not meeting people would be an advantage because we could wrap up due diligence faster,” adds Fossemalle. “But we have found it actually takes longer. You can’t spend a whole day with a manager because of Zoom fatigue and you don’t get the informal discussions over coffee breaks where you can really see the team dynamics in play. It takes much longer to get to the bottom of things.”

Alison Klein, Manager, Private Equity at FMO, agrees. “We invest in frontier markets where it was already difficult to fundraise. We’ve managed to stay active and we’ve made a commitment in the last year to a first-time fund, but we had met them before – we wouldn’t feel comfortable committing millions to a manager we hadn’t met in person. Video calls can work for due diligence meetings under these circumstances, but we’ve found that it takes materially longer.”

This may partially explain why the average time on the road for a frontier markets fund has increased from 26 months in 2019 to 42 in 2021, according to Preqin.

We have committed to two funds using online due diligence only, including a first-time fund. But on both occasions, we had met the GPs before.

Anne Fossemalle, Director, Private Equity Funds, European Bank for Reconstruction and Development

Hybrid is coming

There are clearly shortcomings to raising funds via video calls, yet many investors believe that their adoption over the past two years could well take hold for parts of the fundraising process. Initial and introductory meetings, for example, could be done online to determine whether there is a fit. In the long run, therefore, fundraising efforts might take less time overall. “Two years ago, a lot of time was spent travelling to meet different GPs,” says Schoneveld. “It’s easy for LPs now to screen managers without leaving home or the office – that means we can really direct our resources to managers we want to focus on.”

GP tips

Given the current scarcity of capital going to emerging markets and the development of more hybrid fundraising processes, GPs will need to adapt how they approach LPs in future. Here is some of the advice veteran emerging markets-focused LPs can offer future fundraisers.

1. Start early.

This is especially pertinent for first-time funds and those raising for frontier markets, given the reticence on the part of many investors to commit without meeting face-to-face. “It has never been easy to raise a first-time fund, but over the past year or so it has been harder than ever,” says Klein. “Don’t give up, but do start early. Establish connections where you can – that will give you a runway to raise virtually if needed.” It will also cut-down on the amount of cold-calling needed – a challenging thing to do in a digital environment. “There is a real value in introductions – they will give you an extra hook with LPs,” she adds.

2. Understand clearly who you are talking to.

“If you’re meeting via screen, you really only have one shot at impressing LPs, so you have to bring out your message to get the most out of the time you have,” says Schoneveld. “A hybrid fundraising model will require greater efficiency and more targeting of LPs, as opposed to having random conversations with people who may have pennies in their pocket.”

This is a point Fossemalle backs up. “When you are approaching LPs that already know the region in which you operate, don’t waste time talking about the background,” she says. “Focus instead on your strategy, how the team functions and – importantly – what your pipeline looks like.”

3. Be open and honest about lessons learned.

“LPs don’t just want to hear about your best deals,” says Fossemalle. “They also want to hear about what went wrong in less successful deals and what GPs have learned from this.”Blame-shifting won’t wash, she adds. “We don’t want to hear it’s the fault of partners who have now left or of macro events. The GP holds responsibility for the strategy and composition of the team.”

4. Be mindful that you are competing with other GPs - everywhere.

Investors may be increasing their allocations to private markets, but their resources are not infinite and there are many GPs vying for their attention. “Competition for LP interest is overwhelming and it will increase,” says Schoneveld. “As a global firm, we review thousands of funds each year, but even for LPs with a focus on specific markets, the number of GPs they review is continually increasing. GPs are competing not just with those in their market, but elsewhere.”

Indeed, Janusz Heath, Senior Managing Director and Head of Investment Management, Emerging Markets at Capital Dynamics offers the following advice to emerging markets GPs: “Don’t think that managers in developed economies that LPs can commit to are not producing exceptional returns.”

It’s also worth bearing in mind that LPs benefit from information asymmetry in fundraising situations. “The LPs you talk to have a wealth of information you don’t have access to,” says Schoneveld. “They know your competitors and they have a sense of the minimum benchmarks for the sector and/or region you are focused on. Do your homework – think about how you fit into a particular bucket and what makes you unique.” Klein echoes this. “You are competing with an LP’s existing portfolio because there is already a relationship with these GPs,” she says. “The incentive to add one with all the risks and resources that takes is relatively small so there’s a high bar for new relationships. GPs should really think about how they can add value to an LP’s portfolio.”

5. Don’t overlook your organisation.

It may be tempting to focus on the more exciting topic of dealmaking, but the less glamorous side of creating a robust firm is at least as important to investors. “LPs focus on GPs as an organisation – a fact many GPs don’t always appreciate,” says Schoneveld. “We want to know what kind of reputational and organisational risk we are taking because we see GPs as a counterparty in investments. We want to know whether the firm will survive the next ten or so years and how it will fare through cycles.”

“LPs are with a fund for ten or more years, so we want to see evidence of institutionalisation,” adds Klein. “We don’t just want to see a pitch made by a couple of very smart people who’ve done some great deals; we want to see commitment to building a partnership that can endure, evidence that the team will make the right investments targeting impact and return, consideration about who is in the team today and who will be there tomorrow, and clarity that governance, operational and regulatory risks are all managed correctly.”