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April 25, 2023

PE Funds Struggle to Raise Capital While Waiting for Valuations to Drop

Isos Capital (Isos7 Growth Equity) and Bluestone Equity Partners (Bluestone Capital I) recently announced new funds focused on the sports, media and entertainment industries. The private equity firms join a crowded field seeking to invest in the space, a collective that includes but is not limited to; Ares Management, Arctos Sports Partners, Dyal Homecourt Partners, Velocity Capital Management, Dynasty Equity Partners, Manhattan West and Verance Capital.

It would be logical to assume institutional capital has been free-flowing and that many of these funds have simply been slow to deploy assets. M&A volume slowed in H2 2022, at least relative to 2020 and 2021, and continued to sputter through Q1 2023.

The reality is the institutional fundraising environment remains challenging, particularly for first-time managers, capital cannot be allocated until it has been raised and several of the firms who have announced funds have yet to close them.

And those that are well capitalized, have been waiting for valuations to drop.

However, as good companies are increasingly forced to market, funds with dry powder should be positioned to capitalize.

“Founders were operating in an environment where an unlimited ability to secure funding was almost a given over the past couple years,"  Lyle Ayes (founder and CEO, Verance Capital) said. "But rationality has started to enter the market and there are good deals out there now that valuations have been reset."

Verance raised a $200 million fund in 2020, prior to the market shift.

The emergence of a couple new PE funds is not reflective of the current fundraising environment or institutional investors’ feelings about the sports, media and entertainment industries.

Those headlines are always going to be there if people think they can raise money.

But there is a difference between announcing a fund and collecting the capital, and the percentage of the former that accomplish the latter is smaller than one might expect.

For perspective, Dyal announced in May 2020 that it would be raising $2 billion to buy minority stakes in pro sports teams. Nearly three years later, the firm has just a

quarter of that amount

committed.

And the appetite for LP stakes or franchise investments remains greater than it is for other opportunities in the ecosystem.

That is because nearly everyone believes pro teams will continue to increase in value. Even in recent bear cases (see: Jerry Richardson in Carolina, Robert Sarver in Phoenix) the franchises have sold at record valuations. 

There are lots of other categories, including sports tech and more recently streaming, that have had obvious ups and downs.

The NBA, NHL and MLB have also relaxed bylaws to allow for additional sources of capital to invest.

“So, now you have a continued strong tailwind,” Ayes said.

However, the macro-economic environment has made it difficult to raise any kind of private market fund. According to Pitchbook’s 2022 Annual U.S. PE breakdown, the total amount of private equity raised in ‘22 dropped nearly $20 billion YoY.

Caution flags went up among institutional investors because interest rates went up. When the interest rate is zero, the cost of risk is zero. Now that interest rates are five percent; the cost of risk is five percent.

2022 was also the worst year in a century for owners of a 60/40 bond stock portfolio, a description that fits most institutions, and economists spent the better part of last year predicting a recession was on the horizon.

The macro has made institutions, which already had expectations for fund managers related to experience and credibility, even more selective with allocation.

That has proven to be challenging for sports funds and fund managers without a track record of having raised, invested, and managed institutional capital before.

“Quite frankly, it always is [difficult] for a first-time fund,” Adam Sommerfeld (managing partner, Certus Capital) said.

While the fundraising environment has been a factor in the suppressed transaction volume, funds with dry powder have also been slower to deploy assets.

That's because investors tend to pull capital back when they perceive the macro to be turning down.

There has been a relative dearth of attractive investment opportunities too.

“Companies who didn’t need money –whether lucky or good– were not coming to market to raise additional funds over the last 6–12 months,” Ayes said.

“But now, the reality for a lot of those companies is unless they are profitable, they can’t wait much longer before needing to raise capital in a less robust financing market,” he added.

And with a relative lack of well-capitalized funds and a surplus of available talent in the marketplace, those with dry powder on the balance sheet are expecting to find an environment ripe “to win deals, get the right ownership and really add value,” Isaiah Kacyvenski (co-founder, Will Ventures) said.

“Historically, amazing companies have come out and been built during a down market,” Brian Reilly (co-founder, Will Ventures) added.

For informational purposes, more than half of the early-stage VC’s $150 million Fund II comes from institutions (think: endowments, foundations).