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As First-time Funds Struggle, PE Startups Try Fundless Model

The COVID-19 pandemic accelerated the flight-to-safety fundraising trend resulting in big, established private equity firms attracting massive capital inflows in a short time. New managers, unable to meet limited partners in person and sidelined due to LP risk aversion during the pandemic, are dealing with a far bleaker fundraising reality. 

Last year was the worst for new managers for at least the last five years. According to Preqin data, North American general partners raising first time funds accounted for 3% of total capital raised in 2020, down from 6% in 2016. Of all funds closed, first time funds accounted for only 13% of the total. 

Off the fundraising trail 

Given the first-time fund constraints, some new firms founded during the pandemic are opting to forgo fundraising, saving time and cost on an entire ecosystem that includes placement agents, fund structuring lawyers, regulatory fees, road shows and marketing. 

Broadview Group Holdings LLC, a middle market private equity firm launched in January, is structured as a company, not a fund, said Clay Hunter, who co-founded the firm with Jason Logsdon. Broadview has investment capital from a commodities trading operation, which Hunter said provides permanent capital, freeing the firm from the burden of fundraising to focus on building businesses. 

“One of the beautiful things about this structure is that it is incredibly easy to raise capital, whereas with a fund we would have to go and form a new vehicle, then go out and raise, talk to other investors and get them all to sign. We are employing all the same processes and best practices [of private equity], but without the baggage of having to raise a fund. And therefore, the criteria is that we’re going to think a lot more like business owners than we do as investors.”

Broadview has already made its first investment, taking a majority stake in Solution Matrix, Inc., a manufacturer of cold therapy gel bags and compression bandage wraps. 

The rising popularity of blank check companies has also provided some new firms an avenue to avoid traditional fundraising. Patient Square Capital, headed by Managing Partner Jim Momtazee, who was at KKR for 21 years, was founded in August 2020. The healthcare-focused firm began by launching a special acquisition company called Montes Archimedes, which in October 2020 reported raising about $400 million. 

Middle market firm Rubelmann Capital, founded this year by Peter Rappaport, who was previously a partner at a multifamily office, does not have a fund but is working deal-by-deal alongside family office investors and has already invested in Priority Inc. and acquired assets from ICD Publications, Inc. 

“Perhaps the COVID-19 environment gave everyone a chance to reflect on how they want to spend their time and who they want to spend it with and what they want to do professionally,” said Elizabeth Weymouth, founder and managing partner Grafine Partners LP, an alternative asset management firm that helps new private equity firms scale up. “Most of these people love doing deals in their sector and then they’re launching new firms even with all the inherent risks of doing so because if not now, when?”

Grafine Partners supports new GPs in several ways, including help with co-investors, deal sourcing and investment capital. “All the things that they would otherwise waste 12 to 18 months trying to accomplish on the fundraising trail to allow them to do what they do best, which is to invest,” Weymouth explained. 

She added that spinouts are increasingly coming from big private equity firms, particularly those that are public, as people with a more entrepreneurial mindset leave to startup their own operation. 

“As the big firms get bigger and more institutionalized, the culture there is less entrepreneurial,” she said. “The focus for them has transitioned to AUM growth away from pure alpha generation. And in many cases, as these firms grow, the investment professionals want to return to their passion of doing deals in their sector … rather than being part of a large bureaucratic organization.”

Grafine’s first official year was 2020, but Weymouth believes the number of new private equity firms is growing. Over the past year, she said her firm has talked to 122 new platforms and she estimates that 40 – 60 of them were spinouts from alternative asset management firms. 

Never Say Never

With other avenues to raise capital, new private equity shops have more options to go fund-less, at least initially. Some may have good reason to forgo fundraising, such as waiting out noncompete agreements with their former firms that preclude soliciting certain LPs. 

Kelly DePonte, managing director of placement agent Probitas Partners LP, said that a new firm may start out doing only single deals, aiming to lay the foundation for a future fundraise. 

“Sometimes a new firm will do two or three deals, raising money from friends and family or institutions that they know. Family offices are very often willing to back a deal as opposed to a fund overall. But what the GP is usually trying to do is to make this track record real and be able to communicate to LPs that, ‘yes, I have deal flow.'” 

In fact, no one seems to have categorically ruled out fundraising. Patient Square, according to industry reports, intends to raise a fund though the firm itself has not confirmed that. 

Hunter, from Broadview Group, said with his firm’s permanent capital structure there is no need to raise a fund, but he adds, “Never say never.”