US fund of funds HRJ Capital recently took the rare step of hiring an investment bank to shop its funds and management company to half a dozen or so potential buyers – and that is in addition to having earlier this year hired Probitas Partners to sell some of its (generally unfunded) commitments to US, European and Asian buyout funds, as well as some distressed and international venture assets.
These are not the actions of your typical LP dealing with liquidity problems simply brought on by a tougher market climate, though the financial crisis certainly compounded HRJ’s woes.
The fund of funds ran into hot water with an aggressive over-commitment strategy last year that left it potentially unable to meet capital calls as well as repay a $70 million warehouse loan to Silicon Valley Bank. That loan, collateralised in part with HRJ’s management company, had been used to finance pre-commitments to funds, so that in turn HRJ could attract LP commitments by marketing a specific group of fund interests.
While the practice is not unheard of, it’s more often used by the captives of banks or insurance companies that will secure a loan with a parent’s (deep) balance sheet, said a source familiar with the firm. And the strategy runs in to trouble when the fundraising environment slows. “But if push came to shove, larger financial organisations would backstop the ‘pre-commitments’,” the source said.
“This is an extreme example,” said another source familiar with the firm’s problems.
“HRJ is a rather unique situation in that there are not that many funds of funds selling pre-committed vehicles, and not many using a credit line. Even over-commitment with usual blue chip players is not a common approach,” agreed Peter Laib, managing director of European fund of funds Adveq.
HRJ is also unusual in terms of its initial concept. Founded in 1999 as Champion Ventures and led by former NFL football stars Ronnie Lott, Harris Burton and Joe Montana, it was based on the premise that getting into top-tier VC funds was so difficult you had to be a sports star to get a small allocation. Its LPs were fellow professional athletes and coaches.
Over the years, it expanded its focus on venture capital fund interests to also encompass private equity, special situations/distressed investment and real estate fund and most recently closed a $195 million special situations-focused fund of funds last year.
The firm’s relationships with elite VC managers is one of the main reasons Swiss alternatives advisor and fund manager Capital Dynamics said it found the assumption of the struggling firm and its $2.2 billion in assets so attractive. Once finalised, the deal will also give Capital Dynamics a toehold in the real estate fund of funds business, which it had previously not had.
While most market observers agree the HRJ case is not likely to be replicated, fund managers wishing to expand via mergers and acquisitions are expected to have plenty of choice in coming months and years.
“We’re going to see huge change and consolidation and it’s going to work at a pace that maybe we can’t even predict at the moment,” said one London-based GP. “You’ve already seen some household name firms that will probably disappear and there are people out there saying it’s not a question of when they raise their next fund and how much it will be, but if they raise their next fund. There are a number out there who are effectively dead beyond their existing funds.”
Younger funds of funds as well as captive groups at large institutions like insurance companies are also increasingly pointed to as prime take-over candidates, as parents look to divest non-core assets.
But, as several sources pointed out, mergers among private equity firms – particularly those driven by one or two key individuals – may be even more difficult than mergers in other industries, yielding complex structured transactions.
“Whenever you merge human capital, it’s not easy,” cautioned Laib.