Last week, PitchBook, one of the global authorities on all things private investing, brought up a fascinating point. We hear all the time about how few deals are going on now. The reason we hear about this is because it means that a lot of investors who are used to collecting hefty fees, haven’t seen a paycheck in a while. But what is often forgotten is just how many deals were consummated in the last several years. Many of those would normally be up for another round of capital raising or transition of ownership to investors who are looking for something incrementally more mature. But, with tightening lending standards, and increased interest rates, has come a screeching halt in exits as well. Frankly, if current conditions persist, this backlog will only increase because unless they have to, no investor or entrepreneur wants to let assets go at any sort of discount.
However, for many private equity investors, the fund structure forces their hands. What happens in certain structures is that there is a requirement for capital returns after a certain amount of time. PitchBook calculates that, as a result, there would be between 20% and 26% of invested capital that may be due back to investors. This is a big deal for investors in legacy funds because some companies will not have the ability to cash out at their initially conceptualized rates of return. Further, in some cases, there may be no bid at all from traditional sources.
There has been a fair bit of news lately about the secondary market because IPOs have been all but shut off. But where the secondary market may be heading is toward the concept of continuation funds. The idea here is not new, but given the size of what may be coming, it would appear that many PE firms will look to the secondary market and “continuation funds” to offer liquidity to investors in cases where the asset is either not mature enough to stand on its own, or for some other reason is unsaleable. In some cases, many PE firms will buy assets out of their own funds. Obviously, there is some inside knowledge in these cases which may give investors confidence, but in other cases, the perception of self-dealing could be problematic. As the wall of overdue exits approaches, there will be great opportunities for investors and investment managers alike. We’ll be searching for the right assets, and we’re getting more excited with each passing day.