Not-so-hard-cap

It has been said before and it bears repeating: now is an exceptionally good time to raise capital.

According to PEI data, in the first half of this year 333 private equity funds raised a combined $216.54 billion, the second highest level of H1 fundraising since 2010.

In such a buoyant fundraising environment, with the best managers garnering investor interest in some cases up to twice the volume of their fund target, it’s tempting for GPs to relax some of that fundraising discipline and accept more cash – even if it means moving the immovable hard-cap.

One example is Strategic Partners, which has raised over $6.55 billion for its latest secondaries fund and is yet to hold the final close, though its hard-cap was $6.5 billion according to pension fund documents. The Blackstone unit seems to be following in the footsteps of Hong Kong-based direct secondaries firm NewQuest Capital Partners, which surpassed the $520 million hard-cap on its latest fund to close on $540.5 million in June, and Altamar Capital Partners, which was seeking to extend the hard-cap on its debut venture fund of funds to €275 million from €250 million.

The whole point of a hard-cap is that it is a hard stop, a limit that cannot be breached. To do so requires consent from the majority of the fund’s LPs and a reworking of the LPA.

And it’s something that, in the main, investors are not happy about. A fund that looks vastly different in size to what was originally pitched can raise questions with investors around rate of deployment, co-investment opportunities and — crucially — whether the firm will be able to follow the strategy it sold to LPs.

“It is extremely frustrating when funds exceed their hard-caps,” Jesper Knutssøn, a principal at Danish fund of funds Danske Private Equity, told sister publication Private Equity International in May.

“When they triple their fund size, how can they claim that nothing changes and that they’re easily able to deploy the capital in the same way they used to? It simply doesn’t add up.”

Another European LP told sister publication pfm that the practice of increasing hard-caps “makes a complete joke out of the whole thing”.

While seemingly more prevalent in today’s market, due to both the paperwork and the delicacy of the discussion with LPs, actually resetting a hard-cap is not all that common.

One way that GPs can give themselves some wiggle room is to ensure the wording in the LPA excludes the manager’s commitment from the hard-cap. This is what Los Angeles buyout house Leonard Green did in June, hitting its $9.1 billion hard-cap on Green Equity Investors VII with third-party commitments and then added the GP commitment on top to close on $9.6 billion. At the end of last year Blackstone added a $500 million GP commitment to its seventh flagship fund to bring the total committed capital up to $18 billion, above its $17.5 billion hard-cap.

One private funds lawyer told pfm that her firm is seeing an increase in funds delaying setting a hard-cap until the fundraising process is well underway. Such is the case with Apax Partners’ latest fundraising; initially targeting $7.5 billion, the vehicle held its first close on $7.9 billion before setting a $9 billion hard-cap.

Perhaps this is the best way to resolve the tension between LPs’ demand for certainty and GPs’ desire for flexibility. What is clear is that hard-caps are still meaningful – and essential – for investors, but so long as the balance of power remains tipped in favour of managers, they will continue to push LPs beyond their comfort zones on terms.