What it means
A traditional private equity fund asks investors to commit a fixed amount at the start, and the manager then calls the money as deals are found. Investors have no say over each individual deal.
A pledge fund works the other way round, giving investors a choice each time. Because the commitment is not binding, the manager must raise money deal by deal.
After finding a company to buy, the manager presents the details to the group, and members who like the deal contribute their share. Members who dislike it can pass without penalty.
This structure appeals to investors who want control. They can invest more in sectors they understand and skip those they do not, and they may pay lower fees because there is no long-term commitment.
The manager can also match deals to the investors who suit them best. The drawbacks fall on the manager.
Deals can fall through if enough investors say no, and sellers may prefer buyers with money already committed. It is harder to compete for attractive companies without certain funding.
Pledge funds are sometimes called deal-by-deal funds, and they are related to fundless sponsors, who are managers without a committed pool of capital. The terms differ from deal to deal, with fees and profit shares set separately.
Investors should read the documents for each deal rather than assuming earlier terms will apply. For finance teams and investors, the key questions are about reliability and cost.
How many of the pledged investors usually take part, how quickly can they decide, and what happens to fees if a deal does not close? Managers who can show a track record of fast, committed funding are in a stronger position.
In practice
Real-world examples.
Example
A manager of a small private equity firm finds a family-owned printing company for sale. He sends the details to 15 investors who have pledged interest. Nine decide to take part and provide the equity for the deal.
Example
A wealthy investor joins a pledge fund focused on healthcare businesses because she understands the sector. She rejects two deals in other fields and invests in a third. She pays fees only on the investment she makes.
Example
A search entrepreneur has a network of investors who have pledged to look at deals but have not committed money. When she finds a target, she gives each investor a short window to decide. The sale closes after the required funding is secured.
Formula
Calculation
Investor's share of a deal = investor's pledge / total pledges of participating investors x deal equity needed
A pledge fund has 10 investors, each pledging $2,000,000, a total of $20,000,000 of interest. The manager finds a company to buy and needs $5,000,000 of equity. Eight investors decide to participate, with total pledges of 8 x $2,000,000 = $16,000,000.
Each participating investor pledged the same amount, so each puts in $5,000,000 / 8 = $625,000. The two investors who passed contribute nothing and face no penalty. If the deal produces a total of $8,000,000, each participant receives $8,000,000 / 8 = $1,000,000 before fees.Case study
Seen in the real world.
Stonebridge Partners is a fictional investment firm, and this story is illustrative. It set up a pledge fund with 12 investors who each indicated interest of $1,500,000.
The manager found a logistics company needing $6,000,000 of equity and sent details to all 12. Seven investors agreed, which meant each had to put in $6,000,000 / 7 = $857,143 (rounded). Five declined because the deal did not suit their interests.
The deal closed, but the seller had asked whether funding was certain, and the manager had to show signed commitments before the offer was accepted. The manager realised that speed and proof of money were essential and began asking investors to give an indication of their decision within 10 days. He also kept a standing list of the investors who had joined most often, so that he could estimate in advance how much money was likely to be available. The illustrative lesson is that flexibility for investors can create uncertainty for sellers.
Watch out
Common mistakes.
- Assuming that a pledge is a legal commitment to invest, when in a pledge fund it usually is not.
- Ignoring the difficulty of closing a deal when funding is not yet secured, since sellers often prefer a buyer with committed money.
- Assuming the fee terms are the same for every deal, when they are normally set deal by deal.
Questions
People also ask.
How is a pledge fund different from a traditional fund?
Investors in a traditional fund commit capital up front, while pledge fund investors decide on each deal.
Why do some investors prefer a pledge fund?
It gives them control over which deals to back and often lower fees, because they pay only for the deals they join.
Who takes the risk of a failed raise?
Mainly the manager, who may lose time and costs if investors do not provide enough money.
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