At the 2024 Private Equity Forward Forum, Cooley partners Jaclyn Lavin and Dave Selden will moderate a panel discussion on how the current environment creates nuances for fund terms. We examined the current state of private equity financing and fund formation, including increased investor oversight, particularly around environmental issues. , social and governance (ESG), diversity, equity, and inclusion (DEI), and the use of liquidity provisions and net asset value (NAV) facilities. A panel discussion discussed the interesting changes in investor composition and continued momentum in general partner (GP) secondaries. Finally, the panel noted the Securities and Exchange Commission’s continued focus on private capital.
Panelists for the session are:
Faris Elrabie – Partner, Devon Park Advisors Derek Pease – Director, Legal – Fund Formation, Silver Lake Duwain Robinson – Partner, Chief Financial Officer (CFO) and Chief Compliance Officer (CCO), Ascend Partners
Important points
Resilient yet concentrated funding environment. Cooley’s moderator began by discussing general funding trends. After peaking in 2021, funding has been declining rapidly in recent years. The slowdown in limited partner (LP) exits, and thus distributions, has limited LPs’ ability to deploy new capital, thereby constraining the funding cycle. In the first half of 2024, 365 funds closed globally, down from 580 funds in the same period last year. However, private equity financing remains resilient, with total capital raised rising slightly from $327 billion in the first half of 2023 to nearly $330 billion in the first half of this year. Funding concentration is at its highest level in more than a decade as investors continue to make new commitments to major asset managers. However, middle market funds have raised $81 billion so far, 52% of all funds raised in 2024. While the funding environment remains challenging for new managers, by allocating almost exclusively to existing managers, LPs may be missing out on significant revenue potential, and are seeing top decile gains from emerging managers. The buyout fund outperformed its established peers by nearly 7%. The private equity investor base is expanding and the “typical” composition is changing. Investors outside the U.S., including European investors and non-sovereign investors in the Middle East, are increasingly turning to private equity to gain exposure to the U.S. market. Panelists noted that high-net-worth and ultra-high-net-worth family offices are investing more frequently in private equity funds, recognizing that private equity has outperformed public markets in recent years. He also pointed out that in some cases, he was writing larger checks. One panellist warned that sponsors need to consider default protection when taking on high-net-worth individuals, as the likelihood of default is greater. There has also been a surge in the raising of bank-sponsored feeder funds to invest in private equity funds, and demand for investment companies registered as LPs is also increasing. Increased focus on ESG and DEI. Panelists noted that private equity investors are increasingly paying attention not only to issues related to DEI, but also to ESG issues. There is an increasing focus on ensuring that private equity sponsors are properly tracking and reporting ESG and DEI metrics and targets. One panelist noted that some sophisticated investors want their interests to carry over in relation to the achievement of sustainability outcomes and goals. Investors also want to know that buyers of a fund’s portfolio companies will continue to support the same ESG and DEI goals after the sale. Strengthen scrutiny of fund conditions. Given the more favorable financing environment for LPs, panelists noted that LPs are rejecting any “off-market” terms. Additionally, more companies are requesting side letters, and typical side letters are becoming more robust to address increased regulatory complexity. Another panelist noted that investors in general are becoming more and more sophisticated, and that the breadth and depth of investors’ operational scrutiny and documentation comments are not correlated with the size of their commitments (LP scrutiny and Even if the commentary is small, it is just as robust as a large LP). Panelists also said changes to previous fund terms are subject to intense scrutiny from investors and GPs will need to provide a rationale for any material updates. Investors are focused on borrowing, especially NAV facilities. Borrowing limits included in private equity fund agreements have been steadily increasing in both the US and Europe, with most funds able to borrow more than 30% of their investors’ commitments. NAV loans in particular have become a hot topic, raising concerns about why and how investment managers use these debt instruments. Panelists said investors opposed the use of leverage to make distributions (some refer to them as “synthetic distributions”) and may approve of the use of debt to fund investments. pointed out that it was high. Investors are also concerned about how the use of leverage will be reported in a fund’s reporting, specifically its performance. Another panellist said investors do not want fund sponsors to permanently include the ability to use NAV facilities in fund documents without approval from an investor advisory committee. He further added that even though a private equity fund’s governing documents may permit the use of NAV regimes, private equity is a relationship business, so it is important for fund managers to be transparent with investors and use NAV regimes. He noted that it is important to discuss the reasons for using the system. No one wants to be surprised, so it’s important for fund sponsors to proactively talk to investors and get buy-in. There has been increased activity in the secondary market, particularly with respect to single-asset continuation funds. Global circulation in the first half of 2024 was $68 billion, an increase of 58% from $43 billion in the first half of 2023. Panelists noted that fund managers are increasingly using continuous funds (mainly single-asset) to hold their best assets for the long term. This could be prolonged in the face of a decline in M&A activity. Continuation funds allow fund sponsors to provide liquidity to investors seeking liquidity, while also raising additional capital and maintaining ownership of the best-performing assets. Another panelist added that a successful secondary would allow fund sponsors to continue working with portfolio company management teams, while also providing liquidity options for existing investors seeking liquidity. He also said investors are increasingly looking to own trophy assets, regardless of the actual fund manager. The SEC continues to focus on private finance through its rulemaking and enforcement activities. The current SEC remains focused on private fund advisors and actively pursues them through rulemaking, inspection, and enforcement. This stance is expected to continue at least until the end of this year’s election. One panelist noted that the challenge for private equity sponsors is to report returns to investors in an SEC-compliant and understandable manner. Another panelist said his biggest concerns are cybersecurity and ransomware, and that he strives to minimize that risk at both the fund and portfolio company level, along with implementing proper reporting. . Another hot topic is record-keeping, with the SEC focusing on off-channel communications (using personal devices for text messaging and WhatsApp and not capturing these communications). There are also some recent examples of enforcement actions, such as the SEC’s announcement in August 2024 of fines of approximately $390 million against 26 companies for large-scale record-keeping failures.
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