8 percent. That's the number to beat if you're a GP in private equity. The market is littered with unfortunate funds that will not outperform the standard 8 percent “hurdle”, or preferred return, and therefore will not yield any carried interest for the managers.
The 8 percent preferred return is a common term in private equity partnerships. It is based on an understanding between LP and GP that if a private equity fund fails to beat a lousy, annualised 8 percent return, the whole enterprise has been a waste of time. And, in order to enhance the low return to investors, GPs are restrained from cutting performance further by carving out an additional 20 percent fee.
Producing envy in the hearts of private equity GPs, hedge funds rarely have hurdle rates. In other words, a $1 billion hedge fund that turns in a 1 percent return over a year will pay itself $2 million in carry, despite having vastly underperformed a bank savings account.
Among the very few private equity firms to avoid a hurdle rate is New York-based Warburg Pincus. The firm has never had a preferred return included in its partnership agreements, and the giant new vehicle it is currently raising is no different, according to sources.
Warburg Pincus is currently in the market with Warburg Pincus X, a vehicle with a target of as much as $15 billion (€10.2 billion). In October the firm reached a first close on $9 billion – impressive, considering its previous fund raised a total of $8 billion in 2005.
Globally minded LPs are clearly attracted to Warburg Pincus' international experience and long track record. Among the LPs to commit to the new fund are the Washington State Investment Board, which committed $750 million, and Oregon Public Employees' Retirement System, which parted with $425 million.
Warburg Pincus has significantly outperformed an 8 percent watermark in previous funds. Vintage year 1998, 2000 and 2001 vehicles from the firm are currently showing net IRRs of 10.6 percent, 14.5 percent and 17.7 percent, according to public records.
A relatively disappointing 7 percent IRR on a $15 billion no-hurdle fund would yield a roughly $200 million payday for the GP. It wouldn't be something to crow about, but, for the GP, it would be much, much better than nothing.
SHASTA CLOSES $250M TECH FUND
US venture capital firm Shasta Ventures has garnered $250 million (€174 million) in commitments, largely from returning investors, for the firm's second fund. “This new fund enables us to continue our strategy of working with early-stage entrepreneurs who are leveraging technology to improve customer experiences,” Tod Francis, a Shasta managing director, said in a statement. The three-year-old firm's first fund, which closed on $210 million in 2005, has made 22 investments to date across sectors including consumer and business internet services, mobile and wireless, and software and infrastructure.
LEHMAN RAISES $670M HUNG BRIDGE FUND
Lehman Brothers has raised $670 million (€464 million) for a hung bridge fund that will invest in leveraged buyout-related debt. The fund intends to employ 3.5 times leverage, bringing its total available capital to $3 billion. Lehman and its employees committed more than $130 million to the fund, which will primarily invest in first lien secured positions in leveraged buyouts in the US and Europe. Michael Guarnieri, formerly Lehman's head of credit research, Thomas Kramer, formerly co-head of leveraged finance, and Timothy Van Kirk, formerly head of leveraged loans, will manage the new fund.
AIG HIGHSTAR COLLECTS $3.5BN FOR INFRASTRUCTURE
Infrastructure-focussed AIG Highstar Capital has closed its third fund on $3.5 billion (€2.4 billion), including $800 million for co-investments. The fund is twice the size of its initial target, and more than four times the size of its predecessor, which closed on $800 million in June 2005. Highstar founder and managing partner Chris Lee attributed the size of the fund to increasing investor interest in infrastructure, particularly among Canadian and European pension funds. The fund has already made several high profile deals worth a total of $1.6 billion, including three port operators and two waste management companies.
FIRST RESERVE, SHIPPING VET LAUNCH $300M VENTURE
Energy-focussed private equity firm First Reserve has formed a new fund, Diamond S Holdings, with shipping industry executive Craig Stevenson to invest in energy-related shipping assets. Stevenson was most recently chairman, president and chief executive of global tanker company OMI. He previously worked at Sabine Towing & Transport and Seabulk and Hvide. The US buyout firm will commit $300 million (€212 million) to Diamond S from its most recent private equity fund, First Reserve Fund XI, which closed on $7.8 billion in September 2006 and is the largest energy-focussed global fund ever raised.
SPINOUT CCMP CLOSES $3.4BN FUND
CCMP Capital has closed a $3.4 billion buyout fund (€2.4 billion), the New York firm's first since spinning out of US investment bank JPMorgan last year. Like its JPMorgan Partners predecessor, CCMP II will continue to focus on the consumer, energy, healthcare, industrials and telecom sectors. But unlike the previous fund, which was diversified in terms of investment stage and included venture investments as well as mezzanine, the new fund will focus strictly on buyout and growth capital transactions.
MHR TRIPLES ITS MONEY FOR DISTRESSED
Special situations and distressed investment firm MHR Fund Management has more than tripled the size of its previous fund with the $3.5 billion (€2.5 billion) close of its third distressed-for-control fund. MHR Institutional Partners III held its first close toward the end of 2006. Fund III's original target was $2 billion and it had a hard cap of $2.5 billion. The fund will invest in distressed mid-market companies in the satellite, communications, media, energy and biotech industries, and expects to invest in approximately 20 companies.
DFJ TARGETS GROWTH-STAGE INVESTMENTS
Draper Fisher Jurvetson has broadened its investment strategy with the closure of its debut growth-stage fund, DFJ Growth, on $290 million (€203 million). Unlike the 22-year old firm's early stage-focussed core funds, DFJ Growth will pursue Series B and Series C tech investments in companies “where technical risk is behind the company and there's some evidence of market validation in terms of revenues or bookings, or in some cases, subscribers or users,” said Mark Bailey, a managing director of DFJ Growth.