As managers set out to establish their own practices, sophisticated LPs have a potential once-in-a-lifetime opportunity to identify and invest in a select few who will define the next generation of private equity.
Imagine a sophisticated limited partner in the early 1980s and 90s looking for that sought-after edge. As they explore alternative investment strategies, they discover some fascinating startups in the private equity space with, at the time, limited brand recognition. Names like KKR, Blackstone, Carlyle, Silver Lake, TPG and others.
They jump in, intrigued to work with these young and hungry dealmakers who are trying to build their own businesses at the same time. They invest from the beginning and enjoy a long and fruitful upward trajectory, building indelible relationships and working hand-in-hand with the future titans of private equity. These LPs were bold and lucky enough to be at the forefront of a great first wave of private equity, finding and benefitting from a once-in-a-lifetime opportunity.
The private equity industry has greatly matured since then, with many of these pioneering firms raising hundreds of billions of dollars, becoming public companies themselves and expanding into other asset classes. But under the surface, there’s a new batch of next-generation leaders leaving the well-established firms and starting out on their own, creating another once-in-a-lifetime opportunity for LPs.
This monumental moment is being driven in part by “The Great Resignation,” a significant and lasting cultural event where employees across all sectors reevaluate their careers, their personal and professional priorities, and their visions for their place in society. While media coverage of “The Great Resignation” often focuses on the service industry, this phenomenon is also readily apparent in the financial industry, inclduing private equity.
While we can’t expect every resignee to become the defining PE titan of the future, there is a subset of deal makers with proven track records, strong networks and entrepreneurial drives that often surpass established leaders in the field.
They are looking to make a change in their own careers and establish their own approaches of conducting business, bringing fresh perspectives and new ways of investing to the industry. They are committed to doing things differently as a reaction to the static and rigid nature of the firms they previously helped to build. It is these individuals who will define the future of the industry, and we believe there is an exciting opportunity to help them launch their own firms and bring their visions to life.
Similarly, there is a significant opportunity for institutional investors to support this select group of entrepreneurs and their respective firms, especially those who want to invest directly into operating companies, rather than solely participate in a traditional blind pool PE fund. Finding the right ones will be hard and forming a close and mutually beneficial relationship with them will be extremely important for successful outcomes.
As managers go out on their own, their funds may find it challenging to gain attention against both the established firms in the space and the increasing number of like-minded startups. Because of this and based on our experience and partnerships with newly established firms, they may offer higher degrees of access and investment opportunities than traditional PE funds and an overall greater alignment of interests. This closer access to the source of alpha and greater alignment can yield very strong returns over time, as it did for the original pioneers of PE.
To be sure, not every newly-established firm will have equal levels of success. However, if you’re adept at knowing how to spot the best managers and support them as they grow their new firms, you will have the opportunity to participate at the ground level in some of the most powerful and transformative deals over the coming years, serving as a trusted part of their network and potentially seeing outsized returns for your efforts.
The first-mover advantage can be tremendous. Due to the pandemic, LPs have found it difficult to conduct proper due diligence on first-time managers and therefore many have decided to stick with the familiar names. Findings from Private Equity International’s LP Perspectives 2022 Survey found that 31 percent of respondents are “just as likely” to commit capital to new managers, a seven-percentage point decrease from the previous year. A whopping 49 percent said they won’t invest in first-time managers, up from 29 percent the previous year. Furthermore, data indicates that first time funds may in fact generate stronger performance than established funds, thereby providing immediate value to those who place trust in talented, emerging managers. Per Pitchbook, “first-time funds deliver outsized returns more frequently, deliver poor returns less frequently, and return capital more quickly.”
With this context, interested LPs must act quickly to take advantage of the moment. We are seeing no shortage of institutional, family, and individual investors who are seeking interesting investment opportunities and who are beginning to recognize the benefits of the expected surge in new funds. Institutional investments in private equity have exploded over the past year and are only expected to increase, as alternatives are “set to surpass $17 trillion in AUM within the next four years,” with private equity and private debt being the main drivers of growth.
Rather than look back in two decades and wonder what might have been, today’s environment presents a unique opportunity for sophisticated LPs to engage directly with deal makers and meaningfully shape and influence the institutionalization of their offering.