Please explain PE not exiting their investments in 2023/2024
I'm curious to understand what exactly is the issue with PE funds not exiting some of their investments during 2023 and 2024. More precisely, what benefit does the fund gain by holding the assets longer?
I want to understand the following 3 aspects:
1. LPs understand that it's a bad year for exiting, so they won't be as harsh on you if you get a lower return from the investment because such are markets and no one can time them (including the exit). Moreover, as a GP, if you exit the investment you satisfy the LP's demand and he'll be more willingly to hand you money in the future because of your integrity, so a present "cut" may translate into long-term return?
2. Because you prolong the period for holding the assets - and assuming you sell it after an additional 1-2 years at your desire multiple - then this adds years to calculating the IRR which makes it lower (?), so it makes your subsequent fund harder to sell. More so, selling it now at a lower multiple vs. selling with delay at a better multiple, doesn't make much difference in the IRR (or does it)?
3. For those LPs that pushed funds to exit their investments, wouldn't this destroy their future relationships assuming the LP may be interested to invest again with the GP in a more favorable economic climate? Interested as well to understand why would those LP push GPs to exit their investments; because realistically, what would they use the money for? Investing in "safe assets with low risk" until the market improves? Doesn't the PE fund holding the asset and awaiting a better moment to sell it already accomplishes this goal?
Some articles for further context (a bit outdated, but still somehow relevant).
https://www.ft.com/content/cf590028-d15c-4782-be2b-131fe08d703c
https://www.ft.com/content/b4a23709-9e2d-4f08-b53f-5d7d2e1dccdc
As always, thank you guys for your input.
1) LPs do not have a say in how GPs manage their investments
2) Assets that were selling for 15x Revenue in 2021 would sell for 5x today. GPs don't want that and hope multiples will improve (they won't)
There you go. No need to write a fucking wall of text.
1. You're confusing the relationship or legal aspects arising from the LPA (not my question) with LP-GP commercial/market-related relationship (my question).
2. See then my question #2, and to clarify, (a) if you exit before that, you may not get as much carry if your carry is calculated averaging the returns of all the exits during the entire fund existence, or (b) if you wait the proper exit, you may fail to materialize your investment for the total period for which the fund is set up (10/12 years). If your carry is calculated for each individual exit, then exiting faster to return the money to LPs to satisfy them may pay dividends in the long-run compared to awaiting for the best moment, which is riskier as you may not get the multiple you want because such is the market or the fund duration comes to an end befor you can exit at the desire multiple. Question: Which is the real cause and is one more favorable than the other?
Thanks. No need for further input, someone below clarified it very well.
W/r/t fundraising given these headwinds (some secular, some cyclical) and pension funds generally being tapped out on PE, how are you thinking about Middle East SWF and other pools of capital in that region? Seems like the next leg of capital growth for PE funds - but is there enough interest over there to continue fueling US and EU PE AUM growth over next 5-10 yrs?
Not enough - the hail mary is looking to create "retail" vehicles for PE (so that individuals can have PE allocations in their 401-k) but for a variety of reasons, I personally think this is a terrible idea - would you recommend your middle-class parents to put their hard earned savings into PE?
Edit:
To add a little more meat on the bones here consider this - the Norwegian Sovereign Wealth Fund (flies under the radar) but is the largest SWF in the world today - $1.6 trillion has zero private equity investments and intends to keep it that way precisely because of many of the lack of transparency / risk factors described
https://www.reuters.com/business/finance/norway-wealth-fund-should-not-…
Double Edit:
Other factor seldom talked about but in my estimation is not probability weighted correctly is geopolitics - for a whole bunch of reasons, the world is retreating from liberal democracy led globalization. World is not Hoo-rahrah and probably on balance more risk to the downside (e.g., Taiwan). Access to Middle Eastern / Asian SWFs are far from a given... Assume most of you remember when "China" was the buzz-word of its day and every PE fund was tripping over each other to build offices / access capital from that region
Agreed and I would add one more dynamic: NAV loan have made exits even harder. You have an asset base as collateral to your loan. If you try to sell and get lowball offers you might have a harder time justifying your now independently established overly generous valuation and may have to impair your asset base leading to all sorts of issues.
Equally, if you do manage to sell but for less than what’s in the books you’ll take out a lot more of your asset base than just the proceeds, so you might see very little to no proceeds as you’ll need to pay off the loan by more to keep the LTV from breaching covenants. Which begs the question - why not just hold on and let the NAV loan provider take the risk…?
In short, unless you’re confident you can get your mark (which many can’t for lots of reasons as noted) attempting to sell or selling leads to all sorts of issues despite best intentions
Point 4 shows the massive flaw that MFs and even some UMM funds have in their investing style due to size. They have nowhere to dump these assets except each other or public markets, the latter of which destroys companies who are crap very quickly. People on here clamor for these seats but reality is the best days are long behind these firms and they're just getting fat off management fees at this point.
To that point, take a look at a few of these PE-backed companies that got dumped into public markets (given the lock-up, most PE firms weren't able to realize any actual proceeds from these sales as the initial raise was used to deleverage):
Three words: bid-ask spread.
To highlight two additional motivations for GPs that others haven't mentioned:
Both of the above are things that a GP would never say motivates them but nonetheless exist. As others have mentioned, GPs generally want to preserve relationships with their LPs so they will seek to balance their short-term desires with their long-term ability to raise a fund.
Add into the excellent fund dynamic points that many have talked about above, a lot of PE assets just aren't performing in a way that they would put up a good return right now. If you bought a company in 2020 that was growing 30% (and paid an according multiple) and it's now growing 10%, you still have a long way to go to get to your target outcome. Growth has been a lot tougher to come by in a lot of sectors, and you add in the fact that your debt has no doubt gotten more expensive to service (see Pluralsight), and it's an uphill battle in portfolio management right now.
A lot of the exits that you're seeing today are from out-performers in the portfolio, which are still trading at pretty frothy multiples because so many GPs are desperate to deploy right now (at least in my segment of software growth equity).
So to your second question, your IRR is only worse if you assume little/no EV expansion in out-years. But if you get the companies back to where they were performing, selling later likely unlocks better IRR, and almost certainly better MOIC (which is ultimately what carry is paid off)
You're looking at this all wrong. PEs are dying to exit investments as LPs are putting a lot of pressure on them to return capital. However, they are not willing to adjust valuation expectations (and hence cannot find buyers) or the portfolio company is doing badly, so current trading doesn't justify the timing
They literally can't exit. They've been trying for more than a year, under immense LP pressure and they can't.
You've got some fantastic answers on why already, incl. macroeconomic factors, optics, etc
I'd like to just add that "LPs" are really just individuals who, for most part, have cushy jobs and high pay per hour (at least at the senior level, sometimes not at the junior level), especially those in the funds team & the IC. They are not rich people whose net worth is directly affected by the fund's performance.
If you were the chief decision makers (MD of the funds team / IC members who approved the investment), unless your firm desperately needed the cash (and LPs usually have more liquid assets anyway, and there's always secondaries markets for PE investments), are you really going to admit that you made a mistake? Which is what pressuring the GPs to sell at a crap valuation will be (because that's what the vast majority of them are going to be selling at), not that they can force the GPs to anyway.
And so LPs may get furious when Fund 1 tries to sell an asset to Fund 2 but at the end of the day they'd settle down and agree to it
Also, some of the hilarious things I've seen funds do to avoid a loss (before this dry spell and waaay before CV-19):
The above is most of Vista's 17 year old fund (lol that it's still around), still has like 5 assets left and none are home runs or ever will be.
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