Interview: Charles Bauer, VP, Investor Relations, HM Capital
Charles Bauer serves as Vice President – Investor Relations for HM Capital. Mr. Bauer spent the first 11 years of his career in public service serving as Chief of Staff for a United States Congressman with a special focus on fundraising and donor relations for the Congressman’s campaign. HM Capital Partners is a sector-focused private equity firm that primarily makes control investments in the energy, food and media industries, where the Firm has extensive experience, expertise, relationships and access to differentiated deal flow. Since inception, the Firm has completed more than 150 transactions in these sectors for a total transaction value in excess of $26 billion. I would like to thank Chuck for providing his insight into this aspect of the Private Equity value chain and educating me on some of its nuances. I hope you enjoy the interview.
Once your firm establishes a target fund size, how do you start the fund raising process?
(CB): When determining a fund size, you evaluate a number of factors including the amount of capital your firm can effectively invest over the course of an investment period (typically five years), the market opportunity for your particular investment strategy and the state of the fundraising market in terms of available capital in the marketplace.
What are the time commitments that you then need to meet in the fund raising process?
(CB): The timelines and plans for the actual fundraising are fairly straight forward. In today’s environment, I think most firms have increased their proactive marketing to prospective limited partners during periods when they aren’t raising a specific fund. Utilizing these periods to continue to build relationships and educate the LP community on investment activity, the macro-environment for your investment strategy and keeping them better appraised of your return to market timing.
Most firms will start fundraising with pre-marketing activity where they will spend time with the existing investors of the current fund, determine the status of their investment program, available capital to deploy in a given year and willingness to support a new fund. During this period, the firm is soft-circling commitments from existing LPs and beginning to determine how much “new capital” will need to be raised in order to achieve the target goal for the fundraise. During this pre-marketing period, firms will also engage new relationships they have established to alert them that the firm expects to come to market in the next 6-9 months. This is important because most institutional investors will maintain a forward calendar and will base their investment pacing and resource allocation on what they know is going to happen in a particular calendar year, so it is best to always provide institutions with as much lead time as possible to identify when your particular fund might fit in that particular calendar year’s workload. As an example, some funds may only have quarterly board meetings and if you engage an institution in February, with a hope of holding a final close in May, you may have automatically eliminated an opportunity for a commitment because the institution has a full agenda for the March meeting and you won’t be open for their June meeting.
Most institutions will have a third party advisory group / consultant that assists them with asset allocation models, diligence on funds and in some cases can have discretionary authority to make commitments. The fund will also engage the consultant community during this period to determine what type of information that particular consultant would like to receive to begin an evaluation of a particular fund and where this fund might fit within their client base.
[ed note- Advisory Consultants in this instance provide advice to large or institutional investors who place money in Private Equity. These advisors may conduct due diligence and be in initial screen for the investor. They are sometimes, but not always present for investment decisions.]
Official fundraising begins when the Firm distributes the Private Placement Memorandum (PPM). . The PPM is an executive summary of the fund consisting of items such as the target fund size, investment strategy, market conditions, prior experience and track record, biographies of key principals, and your legal terms. Based upon a successful pre-marketing, the Firm will begin collecting commitments and once they have achieved a scale amount of commitments towards their fundraising goal, they will hold a first close, whereby they can begin making investments from the fund with that capital. Typically, the fund’s legal agreement negotiated between the General Partner and the Limited Partners will provide the Fund 12 months from the date of the first close to hold its final close.
What happens if you miss the close date?
(CB): Due to the timing issues mentioned above, it is possible that as you approach the final close of the Fund, it may become apparent that some Limited Partners may require additional time to get final approval or finalize the legal documents. In this situation, the Fund will request an extension from its Limited Partners to extend the final close date for some period of time. Most Limited Partners will ask for a list of the LPs that require additional time and only those LPs would be allowed to be admitted to the fund during this extension period.
Speaking of Limited Partners (LP), what makes a good LP? Is there a particular profile you look for?
(CB): First of all you are truly looking for partner that will participate in long term investing with your firm. Ideally it is someone that can bring market knowledge and has a consistency dedicated to the asset class so they will participate in multiple funds. A good LP will also possess a certain amount of flexibility as well to help the fund achieve its goals. As an example, some General Partners will put value of Limited Partners that will have active co-investment programs and can participate in deals alongside the fund if the required equity to close a transaction is larger than the equity the fund can commitment to any one given deal (most Fund legal documents will place a concentration limit on the percentage of equity that can be deployed in any given underlying portfolio company).
Much has been written about the pressures on Limited Partners who have commitments to Private Equity funds, but are facing their own financial shortfalls in the current market. What are you seeing in regards to new fund raising?
(CB): I am currently between fund raisings, but we see a significant impact to the fund raising market now. Two main issues are driving the slowdown in the fundraising market, the denominator effect and the slower pace of distributions from GPs back to LPs.
The steep decline of the public markets has created something called “the denominator effect” for many institutions whereby the overall value of their investment portfolios has dropped putting pressure on their asset allocations. This can be explained as follows: a portfolio (valued at $1000) has a Private Equity investment allocation percentage of 10% ($100). Now if the portfolio value drops 30% ($700), the investor has a smaller investment amount to work with for private equity ($70) affecting their ability to make current and future commitments. The second issue is that as the credit market has dried up, the ability and the attractiveness of selling assets in this environment has become increasingly more difficult and there is downward pressure on purchase multiples, so those investors that do not have to sell assets in this market are choosing to hold on to their portfolio assets until a time that the market restores itself. Because there is very little sell side activity going on, the amount of distributions LPs are receiving has declined dramatically over the past 18 months and most institutions model out a certain level of distributions for fund future fund commitments in their alternative asset program.
[Additional material on the state of PE fund raising http://blogs.wsj.com/privateequity/2009/04/03/pe-fund-raising-plummets-in-1q/ ]
[For more on the Denominator Effect http://scorebrokers.blogspot.com/2008/06/denominator-effect.html ]
Please comment on the Secondary Market. How does it affect your fund raising? How do you work with them?
(CB): The secondary market for the private equity market continues to mature and provides a form of liquidity to LPs that are looking to rebalance portfolios, reduce their number of overall fund commitments or need to create liquidity for their institution. Based on what we discussed earlier about the state of the fundraising market, activity in the secondary market has increased and there has been a significant amount of time spent discussing the secondary market in the press and trade journals.
Typically, if we have a LP that needs to access the secondary market to sell one of our fund positions, we will work with secondary firms to help them better understand the portfolio, the existing companies, our expectations for those companies and timing for exit, so they can form some type of value judgment about what they would pay for that asset. During fundraising, we might work with a secondary firm to create a “staple transaction” whereby we partner with the secondary firm to purchase an existing fund asset from a Limited Partner that has chosen not to recommit to the new fund and the secondary fund will commit to making a primary commitment to the Firm’s new fund. This is advantageous to the secondary firm because they typically will be able to use distributions from the secondary fund purchase to fund the primary commitment for the new fund.
[For more information on staple transactions and secondary markets http://www.wilmerhale.com/publications/whPubsDetail.aspx?publication=8554 ]
