Fund documents usually stipulate a percentage (70% to 75%, in most cases), but the terms used in provisions can have a significant effect on what the percentage means in practice.
Most fund managers operate multiple funds, and they look to launch successor funds before they have “deployed” the full value committed to an existing fund given the need to reserve a percentage of the fund’s commitments for budgeted capitalization of existing investments, future follow-ons, fees, and expenses. In contrast, investors want reassurance that the best investment opportunities will be offered to the existing fund first, and will therefore require fund managers to deploy a certain percentage of an existing fund’s commitments before launching a successor fund. This also helps ensure that executives are focused on the existing fund until it is appropriately deployed.
How much are they required to deploy? The amount varies, but analysis of Goodwin’s Terms Database for Private Investment Funds indicates that more than 80% of funds have a target of 70% to 75% of commitments. The analysis is based on data from 91 funds that closed in the past 18 months.
The percentage varies by asset class and other factors. Funds that expect to make significant follow-on investments, such as venture capital funds, typically push for lower requirements, often in the range of 65% to 70%. Only 15% of funds will have to deploy 80% or more.
Setting the Terms
Investors and fund managers negotiate thresholds, and they are set out in provisions included in fund documents. Provisions usually specify how much a fund must deploy (as a percentage of overall fund commitments) before the manager is permitted to “close,” “manage the making of investments in,” or “earn a fee from” a new fund with a similar strategy. These terms allow fund managers to structure and market new funds, and to accept investors into the new fund, before the threshold is met.
Less frequently used are terms such as “raise,” which is ambiguous, or “market,” which means that there will likely be a significant gap between the required percentage being achieved and the new fund being able to make investments, given the time it takes to market to and close in investors.
It is also important to consider what counts toward the percentage figure. Funds are rarely required to invest the full percentage agreed to in fund documents. In many cases, amounts that are contractually committed or reserved for a particular investment and amounts drawn for fees and expenses may count. This is particularly important for funds with a development strategy for investing in other assets with staged funding needs. As a result, funds with the same requirement in terms of percentage deployed may have quite different restrictions on successor fund activities in practice.
Successor fund restrictions are under scrutiny more than ever as managers, faced with a tougher fundraising market, grapple with the timing of raising a successor fund. Going too early can lead to softer investor appetite and a slower fundraise; going too late risks management fee receipts drying up. For fund managers making this strategic decision, having provisions in their existing fund documents that allow them the flexibility to pick the optimal time to launch a successor fund is a key focus.