The Clock Keeps Ticking On Investment Periods

The last five years was marked first by a period of fulsome fundraising followed by one of depressed deal-making. By extension, the next period may well see buyout firms running out of time on their investment periods with cash still left to invest.

Statistics on the phenomenon are hard to come by, but an analysis of fund data from seven public pension funds and a university endowment suggests that some buyout shops have indeed fallen behind the pace. Several caveats attend the data. One is that the fund data we’ve collected dates from the first half of 2009, with much of the data current through March 31, 2009 (for more on the sample see page 29 of the Nov. 16 edition of Buyouts). Second, the data, though well-populated with buyout funds, also includes venture capital, funds of funds and other kinds of private-equity funds.

Assuming an investment period of five years, one would roughly expect vintage 2005 funds to have reached the 80 percent drawn-down mark in 2009, and vintage 2006 funds to have reached the 60 percent drawn-down mark that same year. In fact, more than half (56.3 percent) of the 133 vintage 2005 in our relevant sample do appear to be on track, having reached the 80 percent drawn-down threshold. However, another one in four (24.8 percent) sits between the 60 percent and 80 percent mark, and another one in five (18.8 percent) has yet to even reach the 60 percent plateau. Many vintage 2006 funds in our database also appear to be off the pace—although not as many as you might expect given the credit crunch that took hold in 2007.

Well over half (60.1 percent) of the 185 vintage 2006 funds in our relevant sample had reached the 60 percent drawn-down mark by the first half of 2009. Another three in 10 (28.1 percent) sit between the 40 percent and 60 percent drawn-down mark. And more than one in 10 (11.9 percent) has yet to even reach the 40 percent threshold.

Running out of time before deploying all committed capital doesn’t have to be a major trauma for a buyout shop. In times of low liquidity, limited partners may even welcome the chance to reclaim some of their commitments for other uses. (Last year, Candover, Permira and TPG all offered to reduce the sizes of funds already raised.) The sooner you cut your fund size, however, the better, so that LPs don’t end up paying management fees on more capital than actually gets invested. On the other hand, not investing all committed capital can throw a wrench in the carefully-wrought cash flow models of LPs. And buyout firms that cut their fund sizes or end up with uncommitted capital at the expiration of their investment periods could have trouble convincing LPs that the next fund target they set is the right one. That’s particularly so if they took a big jump in fund size with their previous funds.

Of course, the threat of running out of time on investment periods could become moot if we see a big pick-up in deal pace this year, which isn’t out of the realm of possibility. And while five years is a common investment period, some LPs do grant their general partners more time to make investments. It’s also important to bear in mind that even after the end of the investment period, typically defined as the time when the GP can add portfolio companies at its own discretion, the GP can usually still draw down money for follow-on investments, and to meet other expenses. Below are some additional findings on the subject from the first edition of PE/VC Partnership Agreements Study 2010-2011, recently published by Thomson Reuters.

• Five years is the investment period for three-quarters (75 percent) of the U.S. buyout funds in our study sample, while 18.8 percent have six-year investment periods, and 6.3 percent have four-year investment periods. In most cases (62.1 percent) the clock starts ticking on the investment period at the initial closing of the fund.

• More than eight in 10 (83.3 percent) U.S. buyout funds in our study sample have fund terms of 10 years with the possibility of extensions. The most common formulation for those with extensions is to allow up to two one-year extensions, and in most cases taking extensions can be done at the GP’s discretion.