11/01/2011

Colony, Divco Attract Equity Via ‘Sidecars’

Fund shops Colony Capital and DivcoWest Properties have bucked the tough fund-raising market by setting up “sidecar” funds alongside commingled vehicles.

Colony has lined up about $400 million of equity via sidecars, supplementing nearly $600 million for the main vehicle, Colony Distressed Credit Fund 2. DivcoWest has amassed about $400 million of pledges for a vehicle that co-invests with its DivcoWest Fund 3, which also has about $400 million of commitments so far.

Sidecars are nothing new, but they could be an especially effective option for raising capital at a time when market volatility has left institutional investors wary of making equity commitments. Co-investment vehicles typically carry lower fees than the main funds and give investors greater control of investments. They are akin to a separate account attached to a commingled fund.

After seeing the success of Colony and DivcoWest, other investment managers might follow suit, said one placement agent who didn’t work on either fund. “Anything that

works will get replicated,” he said. “It’s so hard to raise capital, if something worked, it will be tried.”

A sidecar fund usually focuses on a single investment or sector and is often broken out from the main fund to avoid excessive concentrations of a specific investment type. Sidecar vehicles can invest in the same transactions as the main fund, although they can also invest independently, perhaps pursuing deals with a different yield goal than the main fund.

While such funds are often backed entirely by the limited partners in the main fund, those investors aren’t required to participate in sidecars. However, operators will usually push backers to make pledges to both. Sidecars can be set up after a fund has started investing or during the original marketing campaign.

Also, as foreign investors like the Abu Dhabi Investment Authority become bigger players in the fund sector, sidecars offer a way to stay within accounting limits. Sovereign wealth funds typically are prohibited from contributing more than 50% of the capital for a single U.S. fund.

With sidecars, managers can offer nervous investors a hybrid model. The limited partner allocates discretionary equity to the main vehicle and nondiscretionary capital to the sidecar. If the investor later decides it doesn’t want to deploy all of the money, it can decline to sign off on sidecar investments.

The advantage to investors, according to a placement agent, is that “if one day you wake up and say you don’t want to fund that sidecar, you may have [an angry general partner], but your boss will be happy with you.”

Colony has been soliciting up to $1 billion of capital for Colony Distressed Credit Fund 2 since early last year. The vehicle shoots for a 12-15% return by acquiring distressed commercial mortgages and mezzanine debt. The Santa Monica, Calif., fund shop doesn’t use a placement agent.

DivcoWest set out earlier this year to raise $800 million of equity, split evenly between DivcoWest Fund 3 and a co-investment fund. It will likely exceed that total by the time it holds a final close next month. The San Francisco sponsor, which is working with placement agent Greenhill & Co., is kicking $10 million of equity into each vehicle. DivcoWest is seeking a 10-13% return via value-added plays on office, industrial and multi-family properties.

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