• Uptick in exits and resulting distributions should ease LP liquidity constraints in medium term
• Emerging managers, sector specialisation likely to attract investors
• Improved market could unlock wave of GP stakes activity

Fundraising has been a battle for many private equity (PE) firms in recent months, with many deeming this to be the toughest market they have ever experienced. But, with the slow opening of the exit market as a sign of easier capital formation for general partners (GPs), re-found liquidity is expected to benefit established and emerging managers alike.

Just 34 funds raised a collective EUR 76.5bn in 1Q24, marking the worst quarter for the number of fund closes in at least 10 years. It also puts 1Q24 far behind the average of 50 fund closes with EUR 84.4bn raised per quarter seen over the past two years.

This lull is of little surprise to market participants spoken to by Mergermarket, who pointed to last year’s tough M&A market. Sponsor exits in Europe dropped 17% to EUR 96bn in disclosed deal value across 527 deals in 2023, according to Mergermarket data.

The headline figures also do not reveal activity beyond announced closes, with many GPs eking out commitments across multiple closes or in pre-marketing for new vehicles or strategies.

Sentiment among limited partners (LPs), the investors who provide capital to funds run by GPs, is “cautiously optimistic” with a view to 2025 rather than 2024, said Maren Stadler-Tjan, a partner in the investment funds team at Clifford Chance. “Known asset managers are still launching funds and new vintages, and there is still demand for semantic strategies like healthcare and technology.”

Funds registered or launched in 1Q 2024 include Oakley Capital VI and Palatine Private Equity V; in 4Q 2023, funds registered included CVC Growth III.

Low exits boost LP power 

The much-awaited exit market thaw should finally allow GPs to return some capital to their LPs. Distributions-to-paid-capital (DPI) will continue to be a key theme for LPs in 2024, with many ranking their GPs based on this, said Pilar Junco, managing partner and chief client officer (CCO) at private asset manager AltamarCAM.

“LPs are being told by their GPs that they should expect more distributions this year – they need these, especially from larger managers, to maintain liquidity and continue deployment,” said George Lyons, managing director at private capital adviser Asante Capital.

The past few weeks have seen several long-awaited exits trade, including Ardian’s sale of UK-based audio equipment business Audiotonix, and Triton’s exit from market research company Norstat. However, LPs will not immediately see the liquidity from fresh exits, given the time needed for transactions to close.

In this environment, the balance of power has already shifted to LPs, with GPs setting up tailor-made sub-vehicles to accommodate specific requests such as more co-investments, special rights or most favoured nation (MFN) clauses.

“This might have been dealt with in a side letter in the past, but investors are often looking at one fund to go into the full platform of a manager,” Clifford Chance’s Stadler-Tjan added.

Large-cap grab

Although the higher cost of capital meant that large-cap dealmaking has been subdued in recent quarters, 11 megacap (> EUR 10bn) funds added EUR 185.6bn to the total amount raised last year. This dynamic led to a crowded market in 2023 and is one of the reasons why fundraising in 1Q 2024 remained subdued.

Large managers have had plenty of airtime with LPs and these fundraises often take place over a longer period; for example, EQT X, which held a final close in February 2024 on EUR 22bn, was first announced in January 2022. The vehicle was already 30-35% deployed at the time of its final close, according to a press release from EQT [STO:EQT].

“When larger managers, in particular, have had a tough fundraising period, they ramp up the machine to do more pre-marketing,” said AltamarCAM’s Junco. “They give their LPs more warning, aiming to hold their first close in a year, whereas it used to be three to six months. This is particularly the case for re-ups: if LPs aren’t given sufficient warning, they can skip a fund generation.”

In some cases, LPs that manage private equity strategies are having a harder time getting their allocations, with areas like private credit looking more attractive, said Christian Mankiewicz, head of portfolio management at Federated Hermes Private Equity.

These LPs will reserve most of the available capital for established relationships, that are easier to steer through committees and can ensure inclusion in the next fund, he added.

Emerging surge

Although their PE allocations are tight, when it comes to new relationships, LPs are carefully considering which new themes to add in Europe. There is already increased demand for smaller managers that can source primary deals, where there can be better pricing and more options for value creation, said Asante Capital’s Lyons.

1Q 2024 saw final closes from the likes of German software investor Maguar Capital and industrial climate transition investor Vidia Equity, after the so-called “flight to quality” in recent times has meant many have lost out on commitments in favour of larger, more established managers.

“The emerging manager name is a bit of a misnomer,” said Mankiewicz from Federated Hermes Private Equity.  “These are typically very experienced people who have been investing for 15-20 years but have now spun out under their own banner.”

These GPs are attractive because they have often worked on a deal-by-deal basis before going out to raise a fund, meaning that there is a strong alignment to deliver strong returns from day one, he added.

“One theme is increased demand for smaller managers who are able to generate primary deal flow, sourcing directly from founders where you can get a pricing edge on the buy, selling in a competitive process at a premium once the business has been professionalised,” said Lyons.

Single-sector specialisation continues to be a popular theme for LPs considering European strategies, as well as generalist managers who have been able to narrow their focus to a narrower set of sector verticals, he added.

Trouble could be brewing for managers who take a more old-fashioned approach to investing, with those “left behind” likely to struggle to raise successor funds, said Lyons. “If they don’t have a focused strategy or sector specialism, a lack of edge can translate into mediocre returns.” LPs will look for GPs with good portfolio management skills, using capital call facilities used to narrow the spread between gross and net returns. “We have seen the best GPs hold winners longer and make money quickly, with quick exits, when markets overheat as we saw in certain sectors during the pandemic,” he said.

More fundraising, more GP stakes? 

By raising new flagship funds or new strategies, private equity firms boost their assets under management (AUM), and therefore the fee streams they earn from managing their LPs’ capital. These fees make investing in private equity firms themselves, not just their funds, an appealing prospect.

“The GP stakes market is looking really positive right now after the pick-up in the fundraising market. Sponsors that have raised funds are coming forward to put themselves on the market,” said a financial services banker.

While large managers such as CVC Capital Partners and BC Partners have previously sold stakes (to Blue Owl Capital [NYSE:OWL] and Blackstone [NYSE:BX] respectively), much of the recent activity in Europe has been concentrated on the mid-market, including firms such as Inflexion, Synova and MML Capital Partners.

“The mid-market is much more addressable than the large-cap,” said the same banker. “Most of the large-cap sponsors have already sold a stake or are listed, but that metric is only around 5% when you look at the smaller GPs.”

While GP stakes investments also depend on LP appetite, recent fund launches indicate that investors are keen to take advantage of the value within GPs. Asset manager Azimut registered its debut GP stakes fund in Delaware in March 2024, as reported. New capital entered the market last year via the debut fund from newly established GP stakes investor Armen.