The Rise of the Pledge Fund in Energy

As smaller GPs enter the energy market without a strong track record or name recognition, they often have difficulty raising blind pool funds. And Mark Proctor of Vinson & Elkins says these emerging managers are increasingly turning to a pledge fund structure.

Emerging private equity fund managers face many challenges, including a minimal track record or lack of name recognition. These can lead to a difficult time raising blind-pool capital. A possible solution? The pledge fund structure.

Mark Proctor, a partner in the private equity group at law firm Vinson & Elkins, says “you’re seeing a bifurcation in the market” where the larger, better-known names continue to fundraise and build their track records, while newer players in an increasingly competitive field may have trouble raising capital—especially from institutional investors—without a solid track record to show. Enter the increasingly popular pledge fund structure.

As Proctor explains it, in a pledge fund, a GP agrees to give investors a first look at deals for a certain period of time , with the understanding that the investors will evaluate these deals on an expedited timeframe.

“Instead of the GP having discretion to put the limited partners into every deal, the GP actually has to approach the limited partners with each deal, get them to buy into the deal and then those who are interested participate, while those who are not sit out,” says Proctor.  In addition, the key governance and economic terms—such as carried interest, whether investments are “cross collateralized” for purposes of determining the carried interest, management fees, and forced sale or GP removal rights—that will apply between the GP and the investor in respect of each deal are pre-negotiated.

“We’ve seen a tremendous amount of interest in these structures,” says Proctor. “And that’s going to be a trend as money keeps flooding into the industry.”

The investor base for pledge funds tends to be slightly different from that of a traditional PE fund, he explains. Investors like family offices and funds of funds are common. The more traditional investors tend to stick with the blind pools being raised by the more established firms, Proctor adds. Some sellers are wary of the pledge fund structure. Their reason? They don’t have confidence that a pledge fund buyer can line up sufficient capital in time to close an acquisition.