Smaller private equity funds are undoubtedly facing significant hurdles in the current fundraising environment. This difficulty arises mainly because of their relative size and (often) lack of established track record compared to their larger counterparts. Investors tend to view larger funds as more reliable due to their history of managing substantial capital and delivering fairly consistent returns. As a result, smaller funds struggle to attract the same level of investor confidence and commitment.
In 2024, global private equity fundraising experienced a notable decline, decreasing by 30% to a total of $680 billion. This contraction in available capital has appeared to create a more competitive landscape, where only the most established and well-regarded funds can secure significant portions of the reduced capital pool. Larger funds, particularly those exceeding €1 billion ($1.09 billion), captured approximately 75% of the capital raised in Europe in recent times. This domination by larger funds underscores the disparity in fundraising success between these larger funds and smaller funds.
This continued trend of favoring larger investments with more established firms is expected to continue for the foreseeable future. Amid market uncertainty and volatility in specific markets, investors look to place their capital with firms that have a proven track record and can offer a semblance of stability. The perception is that larger firms can better navigate market fluctuations and generate returns, making them safer bets in times of economic instability.
Opportunities for smaller funds
Despite the challenges, smaller funds have certain opportunities to improve their prospects in 2025. Many of these funds are strategically focusing on niche tech sub-sectors, which present unique opportunities for investment and growth. By targeting specialized areas within the technology sector, smaller funds can leverage their agility and expertise to identify and capitalize on emerging trends and innovations.
To attract investor commitments, smaller funds are emphasizing their profitable returns from exits in niche investments. By showcasing their successful track record in these specialized areas, they can build credibility and trust with potential investors. Highlighting profitable exits serves as evidence of their ability to identify lucrative opportunities and generate returns, which is crucial for attracting initial commitments going forwards.
There is also a growing demand for innovative investment strategies, such as environmental, social, and governance (ESG)-focused funds. Smaller funds can differentiate themselves by adopting and promoting ESG principles, which appeal to a broad range of investors seeking socially responsible and sustainable investment opportunities. By aligning with ESG criteria, smaller funds can tap into a niche market that prioritises ethical and sustainable investments, potentially attracting a new wave of investors. However, there are some key challenges, in particular regulatory issues.
Smaller funds often struggle to access capital markets and compete with larger, established funds. Investors may hesitate to commit due to perceived higher risks and lower returns.
Smaller funds must contend with a multifaceted array of regulations that differ by region and sector. For funds focused on ESG criteria, this means complying with specific sustainability and ethical standards. For instance, the European Union’s (EU) Sustainable Finance Disclosure Regulation (SFDR) mandates that funds disclose how ESG factors are integrated into their investment strategies. Adhering to these regulations can be particularly demanding for smaller funds with constrained staff and financial resources
Smaller funds often struggle to access capital markets and compete with larger, established funds. Investors may hesitate to commit due to perceived higher risks and lower returns. In the ESG space, larger funds typically have more established track records and greater resources for sustainable projects
Conducting comprehensive due diligence and managing risks associated with ESG investments can present significant challenges. Smaller funds must ensure that their investments truly conform to ESG criteria and are not merely engaging in “greenwashing” (falsely claiming to be environmentally friendly). This necessitates robust risk management frameworks and continuous monitoring, which can be particularly demanding for smaller funds.
Regulatory authorities frequently demand extensive reporting and transparency from funds, especially those purporting to adhere to ESG principles. This entails furnishing evidence of the social and environmental impact of their investments. Smaller funds may find it challenging to fulfill these obligations due to the absence of advanced reporting systems and the necessity for specialized expertise in ESG metrics.
Regulatory landscape
The regulatory landscape for ESG investments is constantly evolving, with new rules and guidelines introduced frequently. Smaller funds must stay updated on these changes and adjust their strategies accordingly. This ongoing monitoring of regulatory developments and potential adjustments to investment practices can be a significant burden.
Compliance with international standards is particularly challenging for funds operating in multiple jurisdictions. Countries differ in their definitions of ESG investments and reporting requirements. Smaller funds must navigate these discrepancies to adhere to all relevant regulations.
The regulatory landscape for ESG investments is continually evolving, with new rules and guidelines being introduced regularly. Smaller funds must stay abreast of these changes and adapt their strategies accordingly. This can be a significant burden, as it requires continuous monitoring of regulatory developments and potential adjustments to investment practices
In summary, while smaller private equity funds face considerable challenges in the contemporary fundraising environment (including some of the regulatory challenges outlined above including compliance with complex regulations, detailed reporting requirements, thorough due diligence, market access challenges, evolving regulations, and international standards), strategic focus on niche tech sub-sectors, demonstrating profitable returns, and adopting innovative investment strategies may and can enhance their prospects and attract critical investor commitments in 2025.
James Klein, partner at Spencer West LLP, is a corporate lawyer with over 25 years of experience in private equity, venture capital, and mergers & acquisitions.
