After my last Q&A, I got a lot of messages and reachouts asking to discuss how we came up with the idea for Nextvest and to get my perspective on how the PE industry is evolving. To that end, I thought I'd start up more of a "discussion-focused" AMA to give my perspective and also to hopefully see some of the other PE folks on WSO chime in. Below is a starting point. --------- Today’s 'established' PE industry is actually quite new. LBOs and PE funds emerged in the 1950s and 60s, but the business model has not evolved significantly since then. The fund model has worked well for decades, and PE firms continue to strive toward larger funds and deals. But two recent trends show significant shifts: (i) PE investments increasingly go to the biggest funds and (ii) investors are seeking greater optionality, transparency, and GP-LP alignment (often through co-investments and deal-direct commitments). From those causes, we have seen significant shifts: - Reduced opportunity for new funds and growth of independent sponsors (both in quality and quantity). As top-tier PE talent departs from established funds, we have seen numerous deal-by-deal smaller shops created (instead of taking 12-24 months to raise a fund, they immediately pursue deals and arrange capital at the same time). - Attractive opportunities emerging in the lower middle market. Less capital has been targeted toward this segment. Risk-adjust returns remain high while purchase multiples allow more consistent and lower prices than those seen at other deal sizes. Do you agree? Are independent sponsors good or bad? What about the middle market? Where have you seen changes?
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My thoughts on the topic...
I've definitely seen a larger number of PE firms chase capital on a deal by deal basis. A surprising amount of PE firms (including all those MFs) delay most of their diligence to the very last minute because they don't want to spend millions on diligence without knowing that they have the deal "in the bag" so to speak. As a result, this opens up a gap in time where PE firms that were proactive about diligence can take the spare time to go raise capital.
However, capital raising can be quite difficult on a deal by deal basis and can sometimes kill a deal. Not all LPs are sophisticated investors, I've noticed that even some of the largest LPs simply don't have the industry ins and outs to fully understand certain investments. For example, opportunity A might be very appealing to LPs but realistically can only generate 10% return while opportunity B is at the face value unattractive but can generate +20% return. What PE firms sometimes do is that they raise capital off the back of opportunity A (generating momentum amount LPs) and later on invest in opportunity B via blind-pool-fund to get a normalized average return of 15% (very simplified example). When you try to raise capital on a deal by deal basis, it becomes that much harder to execute on opportunity B because you have to educate and convince the LPs that you're right.
That said, I feel like the ad-hoc capital raising strategy will be difficult in the long-run. To the OP... do you think or see changes in the incentive structure among larger LPs that will allow them to approve deals quickly and intelligibly?
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