Emerging managers go niche to score in tough fundraising climate

Bobby Sharma knows how to make money in sports. From his stint as global head of basketball and strategic initiatives at sports and entertainment giant IMG, to his decade-long role as VP and general counsel of the NBA's Development League, Sharma has learned a lot about the sports business and made some friends along the way.

With this experience, Sharma, alongside sports transaction financier Kyle Charters, launched his own mid-market private equity firm focused on sports media and entertainment: Bluestone Equity Partners. This week, the new firm secured a $300 million close on its first fund.

"Part of our thesis is that this is an underserved part of the market—meaning there's nobody in the market that has an expertise in the sports business and in private equity and transactions generally," Sharma said. "I'm talking about … expertise that my partner and I have from growing up in the industry."

Bluestone seems to be an outlier at a time when many first-time funds are struggling to raise capital as LPs pare back their private market allocations. But the firm's success also demonstrates that emerging managers that do raise capital are able to do so by pursuing niche strategies and leaning into pre-existing industry connections.

The overall fundraising environment has been bleak. After a stellar 2021, the total capital raised by US PE firms fell by about $20 billion year over year, according to PitchBook's 2022 Annual US PE Breakdown. A major factor in the fundraising decline is the impact of the denominator effect, whereby falling stock markets left LPs overexposed to the private markets, straining their ability to make fresh commitments and pushing back the fundraising timeline.

LPs have also been more reluctant to lock up capital with younger managers that lack the track record of returns on their investments. From 2020 to 2022, total first-time fund count from US PE investors who were founded after the year 2000 dropped from 79 to 42. Total fund size for these younger managers also dropped over $1 billion over the same two-year period.

Mega-fund activity made up the bulk of the fundraising that occurred last year. Fund sizes of $5 billion or more brought in over half of the total capital raised in 2022, pulling in $178.5 billion across only 13 funds. Meanwhile, US PE funds sized between $100-250 million raised just $7.5 billion collectively in 2022; even smaller players (valued at under $100 million) raised a mere $3 billion in total last year.

When it comes to attracting investor capital for flagship funds and fund families, established players tend to benefit from their tenure and track record. With the exception of Vista Equity, which was founded in 2000, the world's largest PE firms were all founded before the turn of the millennium.   First-time fund managers tap into their networks

Fundraising activity among younger firms established after 2000 was concentrated to just a few large vehicles. From 2020 to 2021, the fund size of US PE investors founded after 2000 grew from $159.8 billion to $181.5 billion, but fund count shrank from 393 to 315.

Many of these new firms with larger funds are the products of spin-out PE shops, new firms established by former executives from the big-name PE firms that attract capital quickly.

Take healthcare-focused private equity firm Patient Square, founded by former-KKR executive Jim Momtazee, which recently surpassed its $3 billion fundraising target, raising $3.9 billion for its debut fund and becoming the largest first-time fund ever raised. Patient Square started fundraising during the onset of the coronavirus pandemic.

"Raising capital for a new firm is always difficult, but launching in the middle of a global pandemic added an extra layer of complexity," said Jake Cabala, Patient Square's head of fund partnerships. "We knew that meeting LPs in person was extremely important, and as soon as we were vaccinated, we started meeting people wherever we could and wherever they felt safe and comfortable."

Another spin-out is Turnstone Private Equity, a Norway-based fund-of-funds that launched at the end of January after six members of the investment team at Argentum—one of Norway's largest managers—followed their former CEO out of the firm. While Turnstone adopted a niche strategy, targeting lower middle-market assets in western Europe, their most attractive quality to LPs is the team's track record.

"We're a team that's been working together for many, many years: eight in total. In such uncertain times, that is a very important factor to see for LPs," said Oda Knudsen, Turnstone's investment director. "It feels safer to be able to show that you've actually been able to do this before and also through cycles."

In the case of Bluestone, Sharma's sports industry connections are a core tenant of the firm's investment strategy. In addition, Sharma's co-founder Charters spent the last 15 years of his career in investment banking, PE, and advisory services facilitating sports, media and entertainment transactions, and in 2021, Charters was a recipient of Sports Business Journal's "Forty Under 40" award. Sharma said his and his partners' relationships extend across all professional sports leagues and federations.

"It's a very closely held industry historically and has remained so even as it opens up to investment capital," Sharma added. "But we are particularly well-situated to take advantage of the opportunities in that complex market."

Young firms explore untrodden corners of the private markets

Niche strategies, like those at Sharma's Bluestone or Turnstone, which has a highly specified geographical target, are a green light for investors, who typically already have exposure to generalist strategies through their investments with large, multi-strategy asset managers. LPs are looking for something different in their smaller managers.

"In this increasingly competitive environment, it's important to have a well-defined strategy versus a generalist approach," said Jeff Magny, founder of Lincoln Road, a lower middle-market private equity firm.

In addition to pedigree and a niche strategy, emerging managers have an advantage in that they are able to access opportunities in the lower and middle market that may be out of reach to larger funds that are restricted to big-ticket investments. Moreover, emerging managers also have fewer LPs compared to large, multi-strategy firms, which allows their focus to be specialized and tailored to specific groups of investors.

As such, even with the challenges of the current market, some industry participants feel there is cause for optimism. With the correlation between distressed vintages and high-performing funds, and the projected easing of the denominator effect, Joe Hartman, partner and national co-lead of private equity transactional services at KPMG, expects PE fundraising to recover.

"Although I do know of certain organizations having pain due to the market dynamics and fundraising, I'm very confident that fundraising will stabilize and continue to expand in 2023 and thereafter," Hartman said.

Corrections: An earlier version of this article incorrectly reported how much total capital raised by US PE firms fell year over year. Capital fell by about $20 billion, not about $20 million. (February 10, 2023.)

A previous version of this story attributed a written quote to Jim Momtazee, managing partner at Patient Square Capital. The quote has been updated to reflect attribution to Jake Cabala, the firm's head of fund partnerships. (February 14, 2023.)

Featured photo by Vasyl Shulga/Shutterstock

This article originally appeared on PitchBook News