How to be LP friendly? Raise shorter-term funds

Montana Capital was able to raise €400m in only 10 weeks as LPs are drawn to shorter-life funds.

Montana Capital was able to raise €400m in only 10 weeks as LPs are drawn to shorter-life funds.

When Montana Capital Partners raised its first fund two years ago, it decided to go with an annual programme because it thought it would best showcase the firm’s secondaries strategy.

“The idea was to show the benefits of secondaries and to present our investment strategy,” said Marco Wulff, who co-founded the firm with Christian Diller in 2011. “With a shorter period, you see the benefits in an amplified way.”

That strategy has worked well so far for the two ex-Capital Dynamics investment professionals. Last month, they closed their third fund, mcp Opportunity Secondary Program III, on its €400 million hard-cap.

In only a couple of years, they have managed to increase significantly the size of their fund, to reduce the time spent on fundraising and to increase their limited partner base.

Mcp Annual Secondary Program I closed in six months at its hard cap of €80 million from eight investors. The firm’s second fund closed in 2014 within three months, with €100 million from 10 investors. This time around, fundraising took only 10 weeks and attracted 15 investors.

The main advantage of an annual programme in secondaries for LPs is that capital calls are concentrated early on in the fund’s life and they can collect cash back faster too. Additionally, management fees step down earlier, and the fund becomes cashflow positive earlier than a 10-year fund would.

Secondaries lend themselves to this shorter-term fund life because they invest in more mature assets than other typical private equity funds.
“If you only have an investment period of one year, capital will be drawn faster and more capital will be drawn due to a smaller recycling effect. But it also comes back much faster,” Diller said. “Otherwise, you dilute the benefits of secondaries.”

There are some challenges to the shorter-term funds, which Montana experienced especially in the early days. One was to explain the product to the market: “We had some explaining to do to investors,” said Wulff. In addition, with annual funds, the GP has to go back to the fundraising trail every year. For LPs, that means they have to fill fund documents more frequently, creating additional work to investment teams that may be understaffed already.

But Diller believes it’s a trade-off that’s largely worth it. “On average, for three annual programmes, it’s three times the work for LPs to complete documents,” he said. “But the benefits of the short life outweigh these drawbacks.” Plus this time, Montana opted for a compromise by extending the term of the fund to three years, which still preserves the benefits of a shorter-term fund, but also means the firm won’t start raising its next fund until the end of 2018.

Even some of Montana’s competitors whose funds still follow the usual 10-year term believe the secondaries market will see more short-term funds. “It resonates well with LPs,” one person told me. “Investors are really drawn to the shorter window. It’s a smart way to be LP friendly.”

Montana isn’t the only fund manager with short-term funds. Adams Street Partners also does annual programmes in addition to its more traditional 10-year funds. But firms offering such structures are still few and far between. It will take some time to evolve but the secondaries market will likely see more partnerships opting for shorter-term funds or just different structures that would better fit their investment strategy.

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