It can be painful for buyout pros to watch a great company that they sold produce a splashy return for the next owner. Great companies are hard to find.
Riverside Co, a lower-mid-market shop with offices worldwide, in 2009 produced a 5.1x gross return on the sale of railroad-equipment-repair company Nordco to OMERS Private Equity; it had invested in 2003. But that wasn’t the end of the company’s strong run. According to Riverside Co-CEO Stewart Kohl, OMERS also made several times its money on its 2013 sale of Nordco to Greenbriar Equity Group, and the company continues to do well.
Sure, Riverside can repurchase a company that it knows and likes. It has done so three times, a spokesman says. But that approach has drawbacks. Consider, for instance, the money lost in the fee-draining process of buying and selling. Now the firm is contemplating another strategy: raising a fund with a term of up to 20 years, double the traditional 10-year term, to accommodate longer holds.
Riverside is hardly alone. Gerry Parsky, founder and chairman of Aurora Capital, told Buyouts in a recent interview that “there’s room in the middle market for what I call long-term capital” and to “create a program to buy middle-market companies and not be compelled to sell them at all.”
Speaking at PartnerConnect Midwest this June, Craig Bondy, managing director at consolidation specialist GTCR, said the firm has talked to backers about stretching out its holding periods. Bondy added, however, that the firm has no immediate plans to raise a longer-lived fund.
At least four buyout shops have already raised or launched such funds. They include pioneer Altas Partners, which this April closed a $1 billion debut fund designed to hold companies for up to 17 years and which has been pursuing the strategy since 2012; CVC Capital Partners, which this February Bloomberg reported to be close to raising a $5 billion fund with a 15-year term; Carlyle Group, which this fall said it had held a $3.6 billion final close on its first long-dated fund, Carlyle Global Partners; and Blackstone Group, whose Core Equity Partners fund had collected close to $670 million as of this spring toward a $5 billion target, according to Pitchbook.
For decades the 10-year term has held sway as the fund life of choice for buyout firms and their limited partners. For investors, the 10-year term has a number of advantages, including the reduction of temptation sponsors might have to sit on companies just to milk management fees. So why the sudden surge of interest in long-lived funds?
Family offices have had a big hand in the trend, both as LPs and deal sponsors.
“Families are more interested in the power of compounding than they are in pretax internal rate of return as a measure of success,” said Rodney Goldstein, managing partner of Windhorse Capital Management, a firm founded in 2010 by brothers David and Richard Salem to manage money on behalf of long-term-oriented investors. “They understand that in years four through 10, compounding becomes enormously powerful in generating growth in actual wealth.”
Windhorse, which takes minority stakes in family-run businesses, raises money on a deal-by-deal basis from a pool of five to 10 families.
Other reasons for the growing popularity of long-lived funds:
1) High prices. Having the flexibility to hold a company for, say, as long as 15 years, can reduce the risk of overpaying; buyers can go into such deals confident that they can ride out a downturn in valuations.
2) Competition for deals. Not only are buyout firms raising long-lived funds, but many family offices have unlimited license on hold periods. Funds with traditional 10-year terms face the loss of deals where the seller or management team prefers a long-term partner.
3) Small population of ‘A’-quality companies. Once they acquire a high-quality company, buyout shops with long-lived funds can keep it for themselves (and away from rivals) for more than a decade.
Sponsors would be wise to approach the trend with caution. Andrew Sheiner, managing partner of Altas Partners, and before that a long-time executive at Onex Corp, observed that it’s important that his fund be able to exit companies far sooner than its upper limit of 17 years.
“When you’re presented with the opportunity to acquire a business, how in the world can you make the determination up front whether it should be a five-year opportunistic hold or a 12-year long-term hold?” Twelve to 24 months is the most that you can predict a company’s prospects “with a high degree” of comfort and certainty, he said.
That limitation in foresight, Sheiner said, creates an “inherent conflict” for sponsors managing both long-term and traditional funds. When a target with an unknowable future presents itself, which fund will the sponsor use to buy it?
The limitation also means that sponsors can’t pay high prices with impunity. Sheiner describes his deal pipeline as having been “really excellent since day 1.” And yet his firm, which has three portfolio companies, hasn’t made a purchase in 15 months, in part due to valuations that are “beyond anything I’ve seen in my career,” he said.
That said, Sheiner is “very confident in our ability to find interesting opportunities from time to time” — companies he describes as “wonderful cash machines” that can reinvest cash at attractive, unlevered rates of return.
“Those machines are very, very valuable,” Sheiner said. “If you own one of them, to sell it prematurely is kind of tragic.”
Senior Writer Steve Gelsi contributed to this column.
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