Innovative Incentives in Private Equity Fundraising

Based on a recent article published in the Financial Times, this newsletter explores the evolving landscape of private equity fundraising. As the industry faces its most challenging environment ever, firms are employing innovative strategies to attract investors. We’ll take a closer look at these strategies, focusing on the various incentives and sweeteners being offered to lure reluctant investors.

The Current Fundraising Landscape
The private equity industry has experienced a significant decline in fundraising during the first half of 2023, with a 35% drop compared to the same timeframe in the previous year. This decline has created a stark imbalance between the capital that firms are seeking to raise and the funds that investors have available to allocate. The situation has been described as the worst since the global financial crisis, prompting firms to take unprecedented measures to attract investment.

Strategies to Attract Investors
To entice investors, leading firms such as CVC Capital Partners, Ardian, TPG, and Cinven are offering a variety of incentives, each tailored to appeal to different investor needs:

• Offering Management Fee Discounts: Some firms are providing substantial discounts on management fees for large investors. For instance, CVC’s recent offer on its €26bn fund allowed some investors to pay a management fee of 1.375%, less than the standard 1.5%.

• Enhanced Co-Investment Opportunities: By offering co-investment without fees, firms are allowing investors to take a more substantial part in individual deals. Ardian’s recent deal with the Abu Dhabi Investment Authority, which included $2bn for co-investment, is a prime example.

• Temporary Breaks from Management Fees: Known as management fee holidays, this tactic provides temporary relief from fees for the largest investors, making investments more attractive in the short term.

• Sharing Management Fee Revenue: In a novel approach, TPG entered into an agreement with the Alberta Investment Management Corporation, providing a share in the fund’s management fee stream in exchange for investment commitment.

The Effect on Investors and the Market
These incentives are primarily aimed at the largest backers of private equity, such as pension plans and sovereign wealth funds. By reducing overall fees, these sweeteners can enhance net returns, especially during times of economic uncertainty and rising interest rates.

The shift in fundraising dynamics has undoubtedly tilted the balance of power towards investors, allowing them to negotiate better terms. However, it’s worth noting that the traditional fee structure in private equity, often referred to as the two-and-twenty model, remains largely unaltered.

Conclusion: A Changing Landscape
The private equity industry’s response to the current fundraising challenges illustrates a significant shift in market dynamics. By offering unprecedented incentives, firms are adapting to attract investment in a highly competitive environment. While these measures are effective in drawing investors, they also signal potential underlying issues within the industry and may herald broader changes in the future.