Private Equity Capital Raising: A Comprehensive Guide

Raising capital in the realm of private equity is a complex process that involves planning, regulatory considerations, and the careful management of relationships with clients.

This guide explores the entire private equity capital raising process, including fund construction and closing with investors in a more global concept than a jurisdiction-specific notion. It has been developed for fund managers, entrepreneurs, and advisory experts who wish to consider the capital-raising construct in a global or international PE context.

Overview of Private Equity Capital Raising

Capital raising private equity involves the activities by which fund managers secure financial capital commitments from regulated, professional, or private investors to provide funding for the acquisition or investment in a company. Capital-raising can be significantly different for a first fund (Fund I) compared to later funds (Fund II, III), as the team needs to establish its credibility and investor pool. 

Capital-raising in the PE context can be viewed through a cycle of three ‘phases’: financial planning, where the capital-raising objectives and firm targets are defined; fund marketing and outreach to prospective LPs; and the final phase, closure: the active engagement, signing of documents and commitment to invest.

Fund Formation and Legal Structure

The most common fund structure for PE is a limited partnership, which assigns investors two distinct roles: General Partner and Limited Partner. The GP will operate the fund and be legally responsible, while the LP will invest money in the fund.

When contemplating a fund jurisdiction, it is common to select an area that is favorable from a tax or regulatory perspective, such as Delaware, Luxembourg, or the British Virgin Islands. During the establishment phase, you will want to involve private equity lawyers to assist with standard documents, such as Limited Partnership Agreements (LPAs), Private Placement Memoranda (PPMs), and subscription agreements. 

Designing a Capital-Raising Strategy

Having a defined capital-raising process is the first step in establishing communications in the market. Fund executives must first centralize their goals, including the amount to be raised, the timing for filling out the fund, and its positioning. 

It is also relevant in identifying segments of institutional capital targets such as pension funds, foundations, family offices, and sovereign wealth funds. Each segment of capital will have different expectations, tastes, tolerances, and investment mandates. It is also valuable to establish clear roles and responsibilities for group members on capital-raising assignments to enhance efficiency and maintain continuity. 

Identifying and Targeting Limited Partners (LPs)

The investor profile and expected returns of each LP are necessary considerations in finding an appropriate Limited Partner. LPs can be pension funds, insurance companies, foundations, schools, family offices, or sovereign sponsors. Financing delayed returns with LPs requires well-performing funds, a reasonable investment strategy, and a credible investment team with positive outcomes.

Globally, LP behavior varies by region. For example, in North America, most investors prefer funds that are already performing, whereas in Europe, LPs tend to focus on environmental, social, and governance criteria.

Role of Placement Agents and Fund Advisors

Placement agents facilitate access for large institutional investors to PE fundraising. They simplify relations with the fund and potential institutional investors, helping to create a reliable network of contacts.

These individuals will not only facilitate relationships but also assist in the preparation of marketing documents, the definition of a fundraising plan, and ongoing communication with investors.

Agreements with these professionals usually provide compensation based on the amount raised and defined contractual terms.

Marketing the Fund to Investors

Fund marketing involves three main elements: history, team performance, and investment thesis. Developing a story supported by data can help identify and uniquely position the fund in a competitive landscape.

To maintain effective communication with prospective LPs, a variety of professional formats must be prepared. These include presentations (pitch decks), fact sheets, due diligence questionnaires (DDQs), and letters of intent.

Due Diligence and LP Evaluation Process

So, in practice, how do private equity firms raise capital? Due diligence begins the moment contact is made with prospective investors. They will evaluate team membership and experience, reviewing the risks and returns of prior investments.

At this time, it is essential to prepare an organized data room to hold all documentation: financial outcomes, organizational structure, legal agreements, low-resolution track record, and Q&A. Being open, honest, and responsive will affect the credibility of the manager and ultimately, the LP’s decision. 

Regulatory and Compliance Considerations

There is an abundance of regulations worldwide regarding the establishment of a private equity fund. Some notable examples include the AIFMD (Alternative Investment Fund Managers Directive) in Europe, which regulates investment funds and adds stability and certainty to regulations across the continent. Then we also have SEC regulations (US Securities and Exchange Commission) such as Regulation D and Rule 506(b)/(c) of the Securities Act in the United States. Anti-money laundering and transparency regulations on raising capital help to understand how do private equity funds raise capital.

Negotiating Terms and Closing the Fund

Selling your business to private equity means you are nearing the end of a long and complex process. Most importantly, these variables include management fees, the hurdle rate (the minimum return rate that the investor is certified to receive before the manager is allowed to participate in profits), and carried interest (the manager’s share of the profits).

The negotiations also lead to several closing events, such as the first closing—the first time the fund receives a formal financing commitment. Then, interim closings are held to add investors, and the final closing of the fund (also known as the “final close”) is announced when the fundraising period has been completed. The formal commitment to financial arrangements occurs when agreements are signed with limited partners and the legal documents are completed.

Challenges in Capital Raising

For all managers, the capital-raising challenge of PE can be daunting, especially for emerging executives.

• First, prospective investors will question how you raise money if you have no track record. This can create uncertainty about your ability to obtain private equity fundraising commitments.
• Second, once you begin marketing your fund, you are competing in a crowded market, and you must have a distinct differentiation from all other funds.
• Third, macroeconomic factors, including inflation and financial market volatility, will impact investors’ financial commitments.

When markets are fluid, uncertainty leads to delayed investor decisions or prioritization of established players. Additionally, there is the issue of “LP fatigue” (the over-solicitation of LPs to present investing proposals), which can cause LP disengagement.

Trends in Private Equity Fundraising

Private equity trends reflect institutional interest in co-investments and increased transparency. There lies an opportunity for Limited Partner (LP) investors to reduce fees and exert more control over their investments.

Additionally, investors are increasingly focused on ESG factors, often requiring funds to consider these aspects when making their investment decisions. At the same time, several funds are also increasing their focused engagement on specific sectors or geographic areas of interest.

FAQs

What is private equity capital raising?

It involves a PE firm’s negotiation and close with institutional investors to secure funding for its investment activities.

Who are the typical investors in a private equity fund?

Pension funds, sovereign wealth funds, insurance companies, endowments, and family offices.

How long does it take to raise a private equity fund?

There is no set timeframe, but it typically takes between 6 and 18 months, depending on various factors.

How do placement agents help private equity firms?

Placement agents help build relationships with institutional investors and facilitate the process of structuring capital raises.

What documents are required for capital raising?

The main documents are the Private Placement Memorandum (PPM), Intended Limited Partnership Agreement (LPA), and subscription agreements.

Are there regulations for global private equity fundraising?

Yes, regulations depend on the jurisdiction. The main regulations are AIFMD in the EU, SEC in the US, and local KYC/AML regulations.

References

McCahery, J. A., & Vermeulen, E. P. M. (2012). Private equity regulation: A comparative analysis. Journal of Management & Governance, 16, 197–233. https://doi.org/10.1007/s10997-010-9139-0link.springer.com

Institutional Limited Partners Association. (2015). ILPA Best Practices: Quarterly Reporting Standards. https://ilpa.org/wp-content/uploads/2015/07/ILPA-Best-Practices-Reporting.pdfilpa.org

Schulte Roth & Zabel LLP. (2013). Fund Formation and Incentives Report. https://www.srz.com/a/web/57490/8cfb3L/srz_pei_fund_formation_and_incentives_reportpdf.pdf