Private equity turns to new fundraising tactics in tough market

Private equity firms are increasingly raising money to buy individual companies on a deal-by-deal basis, as they struggle with a downturn in the market and investors look for ways to cut management fees.

A record $31bn was deployed by “deal-by-deal” investors last year, according to data provided by private equity advisory firm Triago, defying a broader dealmaking and fundraising slump in the industry.

This was more than five times the amount raised and invested in 2019. More than 700 companies were acquired by private equity in this type of deal last year, more than double the total from five years ago.

Among those offering or considering these types of deals are some of finance’s biggest names, including hedge fund Elliott, US investment giant Hamilton Lane, as well as others such as European credit firm Hayfin, said people familiar with the details.

“Barely a conversation goes by with investors who aren’t looking at, or are open to, doing deal-by-deal type investments,” said William Clegg, a partner at private equity advisory firm Colmar Capital. “It’s everyone from insurance companies, [to] sophisticated family offices and even sovereign wealth funds.”

Traditionally, private equity firms raise money from investors in a structure that locks in cash for more than a decade. This is used to buy a portfolio of companies. The firms charge management fees of between 1.5 and 2 per cent and take 20 per cent of the profits when portfolio investments are sold on. The structure means private equity executives can make good money on fees even if they have not invested their clients’ money.

However, after a decade-long industry boom, private equity groups have been struggling to sell portfolio investments and to convince investors to lock funds up for long periods with high fees attached. Including venture capital, the industry raised $803bn last year, the lowest amount since 2017.

Dealmakers have also found it hard to find attractive new deals in a higher interest rate environment, leaving them sitting on $4tn of ‘dry powder’, or uninvested client funds.

The deal-by-deal approach can be an easier sell to investors. It often means lower, more bespoke management fees, though dealmakers can demand a bigger proportion of profits when the investment is sold on. But investors also know where their money is being spent from the start of the process.

“Deal-by-deal transactions are favoured by institutional investors because they have the opportunity to cherry pick their preferred companies,” said Sunaina Sinha Haldea, head of private capital at Raymond James. “These deals typically come with lower fees than traditional fund investing.”

Investor money can also be put to work and returned more quickly than from a traditional pooled fund, which is particularly relevant in a slower market where firms are earning fees on mountains of uninvested cash.

“A lot of general partners are sitting on dry powder,” said Matt Swain, chief executive of Triago, which specialises in raising money for these types of transactions. “The [deal-by-deal] management team won’t sit on their money which is important in this environment.”

Investment banks are looking to get in on the action. In December, California-based Houlihan Lokey announced a deal to buy Triago.

The difficult fundraising market has also increased the attractiveness of deal-by-deal investing to executives who want to set up on their own.

“The primary fundraising market has been challenging for everyone including named brands, and it’s almost been closed for first-time funds,” said Andy Lund, co-head of Houlihan Lokey’s private funds group. “There has been much more activity on the deal-by-deal front.”

For dealmakers who have struck out on their own, deal-by-deal investing can help them build a record and relationships with potential investors to tap if they want to raise a fund in the future.