Sixteen months ago, I wrote a magazine column about how private equity firms would eventually begin soliciting fund commitments from "regular" investors. This is opposed to their historical norm of only accepting "accredited" investors (i.e., institutions and millionaires). From that piece:
In order for private equity to truly open up to the masses, individual investors would need a way to redeem their fund stakes if necessary. For this, I'd imagine a sort of electronic secondary exchange like what currently exists for startup company stock. Or perhaps several of the firms that currently buy fund stakes from institutional investors would set up their own platforms.
So it was with great interest this morning that I read a story in The Wall Street Journal about how Kohlberg Kravis Roberts & Co. (kkr) is working with Nasdaq OMX Group Inc. (ndaq) to launch a private exchange for trading interests in some KKR funds. Moreover, other private equity firms reportedly may sign on before launch.
To be clear, this isn't exactly what I envisioned, in that the only people allowed to trade would still be accredited investors. But there always has been a chicken-and-egg dilemma when it comes to permitting retail investors into private equity funds: Regulators will continue to ban the practice until convinced that there is adequate interim liquidity, and the only way to prove the existence of adequate interim liquidity is to create a market. So I view this as a sort of interim step, using accredited investors as a proxy for the broader masses.
Equally important, such a program also could be a serious boon to private equity firms, even absent retail investor entry. In recent years, many large buyout firms have become more and more reliant on "feeder" funds, often formed by Wall Street banks for their wealthy clients. So it is in private equity's interests to make feeders even more popular, by letting their participants trade fund interests. In fact, The Carlyle Group (cg) has been operating such a program for investors in three of its private equity funds, whereby it helps manage a bi-annual auction in which five pre-approved buyers can bid on offered LP stakes.
So this is certainly an interesting development to watch. But, with that, a few caveats after speaking with private equity folks:
- Even if you're an accredited investor, don't expect access to lots of different private equity funds any time soon. A source at one firm that has been approached by Nasdaq says that such a platform would launch closer to year-end, at the earliest. Some well-known firms had never even heard of the platform, under picking up the morning paper. In other words, it's still embryonic.
- I'm not so certain that KKR itself is really the primary driver here. My understanding is that there will be a relevant SEC filing within the next week, but that it will be coming from a third party. Perhaps from an outside fund manager that would serve as the initial buy-side? I'm honestly not sure, except to say that this all may be a bit more complicated than the WSJ suggested.
But, again, it's worth watching. There aren't too many pools of untapped capital left for private equity, outside of a couple of large Asian sovereign wealth funds. And, at the same time, defined benefit plans are falling by the wayside. The industry knows it will need the masses eventually, and any baby step toward that goal is actually a significant development.
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