Earlier this month, New York Times'
These firms, which include Apollo,, and the Group, are sitting on an enormous amount of dry powder that they need to put to use in the next twelve months. To be more specific, they are sitting on $200 billion of dry powder with only one year to invest it.
This presents a number of problems to the funds and highlights some of the less glamorous aspects of.
Let's highlight a couple aspects of traditionalinvesting that some of WSO's readership might not be aware of and the issues they can lead to:
- Private Equity funds have a limited time horizon for investment or the capital must be returned to the limited partners. The time horizon is typically five years.
- Private Equity firms earn a management fee, generally 2% of the total size of the fund, in addition to the fee they earn on any investment upside achieved upon a liquidity event.
- Raising new funds requires three things: successfully putting money to work in new platforms and add-on acquisitions, showing continual progress in value creation through periodic portfolio reviews, and profitable exits with above-market returns.
If afirm manages to invest wisely and produce strong returns for its limited partners, it will have no issue raising new funds. When problems seem to occur, however, is when a firm's historical investment success goes to its head and it starts to grow too big for its britches. Investment success often leads to bigger funds being raised, which leads to larger deals as well as bigger management fees.
Now, larger fund size and bigger fees sounds great on the surface, but because of the limited time horizon for investment,firms may find themselves scrambling for deals. And, unfortunately, the universe of quality deals has an inverse relationship to fund size - the bigger you are, the harder it is to invest intelligently.
This is precisely the dilemma the mega funds discussed in DealBook's article are faced with. There is no reasonable way that $200 billion can be put to work in one year's time. Fund lifecycles do not pause because of global economic uncertainty. And with so much money chasing such a limited universe of viable deals, you can bet that purchase multiples will skyrocket. The long-term effect of the next twelve months on these funds could be devastating. LPs don't want to have their money sit idly while fund managers collect fees and they certainly don't want to see their money sunk into overpriced dogs with fleas that will inevitably require write-downs. Frankly, I'm not sure how this leads to anything but smaller fund sizes in the long-term.
Speaking more broadly, the problem of too much money chasing too few good investments is endemic toat all levels. The sheer number of firms in existence is staggering. I spent two years at a truly solid lower middle market fund and was blown away by the level of competition for deals in the space. This can't last forever and I foresee a very serious contraction over the next decade.
On a broader note, I think these issues highlight some of the downsides to working in PE and should be thoroughly considered by any prospective monkeys looking to make the move. While the work in PE can be interesting, the lack of flexibility in terms of what can be invested in is very limiting. You don't have the luxury of kicking back and waiting for the economy to improve and good deals to come along, you have to grind and work on just about anything that meets the minimum investment criteria and returns threshold, often knowing you'll be outbid by some fool who has no choice but to put his money to work.
It is in this regard that I imagine Family Offices and Holding Companies to be superior to traditional. Working in a family office, meaning you invest the funds of a super wealthy family's estate, or a holding company, like Loews Corporation, definitely has its upsides. Unfortunately, these jobs are fewer and far between.
What do you think? Am I overstating the issues that mega funds and Private Equity in general face or are they even more challenging? Do you agree that PE is set to contract in the long-term? Let me know in the comments.