The CFO of a mid-market buyout fund recently told me how disillusioned he was with the secondary sale process. He had spent hours on diligence calls to help an investor sell his position in the fund, only to later discover that the sale had collapsed. He felt that he had wasted his time and was suffering from “secondary fatigue.”
Would you be surprised to learn that buyout funds have over $40 billion hidden in off–balance sheet debt?
Limited partners in private equity funds can be a skeptical group when it comes to unrealized returns. And that can be a problem for the many general partners looking to come back in 2011 to replenish their war chests.
The increased focus on cash-on-cash returns became apparent to me at the annual meeting of a well-known growth equity fund. One of the fund’s star portfolio companies presented a detailed account of how it had grown revenue and EBITDA in a very difficult economy. The fund had already distributed roughly half of its cost basis in the investment and had written up the value of the company by threefold. During cocktails, while speaking with the representative from a mid-sized college endowment invested in the fund, I remarked that the company was still quite conservatively valued. The LP responded, “I’ll believe the valuation when I see the exit.”
When governments embark on large asset sales there are often opportunities for smart investors to profit in unexpected ways. With the U.S. government currently liquidating a $2.9 billion private equity portfolio we believe that such an opportunity may exist. In order to appreciate the opportunity, you must first understand some history of the federal government’s […]
Three years ago, at 4am on the day after Thanksgiving, I rushed my pregnant wife to a Best Buy in Westchester, hunting for a laptop selling far below cost. Expecting to be among the very few crazy enough to shop on Black Friday before sunrise, I was shocked to see a line stretching around the block (including other pregnant women). By the time we were finally allowed into the store, all the best deals had all been snapped up, leaving laggards like us to scavenge through baskets of bargain-priced junk. Determined to have some sort of compensation for our lost hours of sleep, I purchased a deeply discounted DVD— the Arnold Schwarzenegger classic Total Recall. Since this event, I have taken to calling the purchase of a good or service to justify one’s effort “Black Friday Syndrome.”
Now, just a week after Black Friday 2009, I have been asked by several investors in private equity if Black Friday Syndrome might be entering the secondary market for private equity LP interests. Since late summer, we have seen prices increasing in the secondary market. This has been reported by numerous sources and nicely summarized at peHUB by Erin Griffith.
Are secondary investors starting to buy private equity LP interests to justify their fund-raising efforts or is there a more rational explanation? Will buyers be left with the private equity equivalents of Total Recall DVDs? At a secondaries conference I participated in several weeks ago, Dan Primack even speculated that secondary funds will be unable to find investable opportunities and return some of the capital they raised.
There has been a great deal of recent press regarding the gulf between buyers and sellers of private equity interests. The disconnect is usually attributed to some analytic model—the vagaries of FAS 157, a lack of information, uncertain outlooks, etc.
As a buyer of private equity interests, I believe that there is validity to many of the commonly-cited explanations. Nevertheless, focusing on the financial metrics alone imagines a world in which price is the only driving force in markets. It is important to remember that institutions never sell private equity. People within institutions sell private equity. Many of the individuals tasked with managing private equity portfolios have recently suffered through traumatic professional experiences. Buyers of private equity need have patience and understand the personal nature of private equity partnerships.
At a recent private equity conference, Stephen Schwarzman was asked why he thinks Blackstone’s share price has fared better than those of the investment banks (see Erin Griffith’s summary here). Schwarzman attributed Blackstone’s relative resilience to the fact that it has long-term capital and is not subject to the daily money-market pressures required to support trading operations. Indeed, a key benefit of the private equity business model is that you can afford to be patient with your portfolio companies. However, the long-term nature of private equity capital is often overstated. Private equity funds have commitments from investors to call capital as needed to make investments. Most funds hold just minimal cash or other assets that could be considered actual long-term capital.
While skeptics may wish to dismiss as semantics the distinction between commitments for and actual long-term capital, in periods of economic stress this difference can be highly problematic. Individual investors are often the first to default on capital calls. In the Internet boom, many of the founders and early employees of recently IPOed startups made commitments to venture capital funds with ten-year partnerships. When the market value of their stock options collapsed, many of these investors were unable to meet their capital calls—so much for long-term capital.
When I won the PE Wire NCAA tournament pool last year, no one was more surprised than me. I grew up in New York City as a rabid Knicks fan with minimal interest in college basketball. Despite my lack of experience, I accurately forecast the final score of the 2007 National Championship with an 84–75 […]
Every year an increasing number of funds reach the end of their planned ten-year term. In 1997, 309 private equity funds were raised, meaning that all those that have not already been liquidated will reach the decade mark this year (source: VenturExpert). At the end of a fund’s term, the General Partner has two basic […]
These are turbulent times for investors in private equity. The Dow can be down 300 points by lunch only to rebound an hour before the close of market. Debt markets, which once showed an insatiable appetite for risk, are becoming more conservative by the day. Spreads on announced public-to-private transactions have widened as investors question […]
In my last post (Searching for Alpha), I commented on how applying hedge fund metrics to private equity fund performance creates unique complications. Recently another phenomenon in the convergence of alternative assets has emerged as a hot topic—hedge funds making investments in illiquid private companies. In a large buyout deal announced earlier this year, KKR […]
I was at a private equity conference last week focused on issues of interest to Limited Partners. One of the things that struck me was several Limited Partners who described investing in private equity as “the search for alpha.” While in the past I have heard many Limited Partners talk about alpha, I have found […]
In a recent article in The Financial Times, Harvard Business School Professor Josh Lerner closed his discussion on the performance of portfolios of private equity partnerships by noting: But a large portion of the differences [in the performance of private equity portfolios] seems due to simply superior decisions about funds to invest in, and which […]
My employer, VCFA Group, was the first firm formed to purchase private equity interests on a secondary basis and has raised approximately $750 million over the course of its 25-year history. At a time when other secondary firms are closing on multi-billion dollar funds (Goldman’s latest secondary private equity fund was in excess of $3 […]