The scramble for lifelines

For Capital Dynamics, the Swiss investment manager and adviser, the purchase of US funds of funds manager HRJ Capital was compelling for a number of reasons. One was the target firm's relationships with elite venture managers and its $2.2 billion of existing assets. Another was the toehold that Capital Dynamics gains in the real estate funds of funds business, which it had previously not had.

For HRJ Capital, the deal was more to do with pragmatism than opportunism. It had recently taken the rare step of hiring an investment bank to shop its funds and management company to potential buyers. Earlier, it had 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.

The firm had run 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 by HRJ's management company, was used to finance pre-commitments to funds, so that in turn HRJ could attract LP commitments by marketing a specific portfolio 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. The strategy runs into trouble when the fundraising environment slows. “If push comes to shove, larger financial organisations would backstop the pre-commitments,” says a market source.

“This is an extreme example,” adds another source familiar with the firm's problems.

“There are not that many funds of funds selling pre-committed vehicles and not that many using a credit line. Even over-commitment with [the] usual blue-chip players is not a common approach,” says Peter Laib, managing director of Swiss funds of funds manager Adveq.

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 the 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,” says 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 increasingly named as prime takeover candidates as parents look to divest non-core assets.

But, as several sources point out, mergers among private equity firms – particularly those driven by one or two key individuals – may be more difficult than mergers in other industries. “Whenever you merge human capital, it's not easy,” cautions Laib.