With liquidity in short supply, power in the ongoing struggle between LPs and general partners has clearly shifted to institutional investors who still have capital to commit to funds. And they’re flexing their muscles in ways that have implications for how fast buyout shops will be able to invest in new deals over the next several months.
Some would like buyout shops to ratchet back fund sizes on pools already raised. Buyout funds managed by
When confronted with new funds, meantime, LPs have started asking for caps on the amount of capital a GP can inves over a given period of time. Popular in the late 1990s, investment caps became a non-issue when the market got rolling in the last upswing, said Jose Fernandez, a managing director at La Jolla, Calif.-based
Added Greg Kulka, director of private equity at the
Needless to say, institutional investors across the board have become far more sensitive to the issue of how fast buyout firms spend their money. Many are victims of the denominator effect, in which rapidly falling public equity valuations have their private equity portfolios well above target allocation. Others have no available cash to fund their capital calls at a time when selling assets to generate cash is far from an attractive option. The buyout shops themselves have been no help: Capital distributions today are between 25 percent and 35 percent of what they were a year ago, while capital calls are approximately 80 percent of what they were at that time, according to New Mexico’s Kulka.
The upshot? Yet more cold water tossed on a deal market already at a near-standstill due to frozen debt markets and reluctant sellers. And it’s likely that we’ll see more commitment reductions down the road. Between 2007 and 2008, U.S.-based buyout shops raised approximately $475 billion, suggesting enough firepower to buy well over $1 trillion worth of companies. By contrast, buyout shops are on pace to close a total of 568 deals with a disclosed value of $28.4 billion (represented by 128 deals) this year, based on an annualization of Q4 2008’s closed deal total. “There is concern among LPs as to whether [GPs] can manage such a large increase in capital, particularly in this environment,” said StepStone Group’s Fernandez.
Fund Size Reductions
It wouldn’t be the first time that private equity firms have cut their fund sizes. After the dot-com bubble burst, some venture firms found themselves with $1 billion-plus pools to invest but no obvious way to generate a decent return given the lifeless M&A and IPO markets at the time; as today, many investors short on liquidity were pressuring GPs to ease up on the gas pedal. One result was a slew of fund size reductions from such well-known firms as
At the time, some venture capitalists actually believed their investment model was broken. On the one hand, they faced high valuations on fresh investments given the competition for deals; yet they had few opportunities for blockbuster exits. With little leverage available in the market today, the LBO model is arguably broken as well, at least temporarily. And once again we’re seeing GPs and LPs respond with fund size cuts.
It was global buyout firm Permira that kicked off the recent run of scale-backs. In November, the firm gave investors with liquidity concerns a chance to cap their commitments to
In late December the concessions hit the U.S. LBO market, when TPG sent letters to investors outlining an optional commitment reduction plan for its $19.8 billion
And just last month, London buyout firm Candover began conversations with LPs about dialing back the size of its
Buyout professionals like to point out that past downturns produced some of their best investment opportunities. If so, LPs may later regret that they threw lassos around buyout shops at exactly the wrong moment.