Grant Thornton has new survey results out, showing that nearly 20% of British private equity firms have discussed investment period extensions with their limited partners. Bloomberg reports on the news breathlessly, saying that such firms “are running out of time to invest.”
For the uninitiated, private equity funds typically only have five years to build their portfolios (although often reserve some “dry powder” for follow-on deals). So there is indeed a time crunch for many firms that raised new funds in 2006 or 2007, but which have not yet spent most of the money (perhaps due to the recessionary deal slowdown of late 2008-2009).
But requesting an investment period extension is not the only option available to such firms. Instead, they could give the extra money back to investors!
I know, I know. I’m promoting private equity heresy. Just imagine the fees that could be lost…
But there is precedent here. Many venture capital firms ran into this exact same dilemma ten years ago, after raising massive dotcom-era funds that couldn’t be responsibly invested once the boom turned to bust. Dozens of them chose to give money back, rather than requesting extensions or irresponsibly playing out the string.
Any time I bring up this comparison to private equity pros (or their investors), the response is that “private equity guys would never do that.” What I never understand, however, is why.
You can’t tell me that it’s an ego thing, because some of Silicon Valley’s most self-important VCs were among those that cut fund sizes. And I also don’t think it’s a fee-driven greed thing, because the same similarity applies.
All I can come up with is that private equity firms are displaying a startling lack of self-confidence.
The VC firms that cut fund sizes did it, in part, because they believed there would be another fund around the corner. Why hog old fees today when you can generate new fees tomorrow? And, as a bonus, fund size cuts would make it easier to raise future funds, since it’s seen as an LP-friendly move.
The current crop of PE fund extenders, on the other hand, basically are saying: “If you’ll just let us do one or two more deals, we’ll be sure to pick you winners that make up for all the losers we’ve already done.”
That’s not an exhibition of confidence in future deal-making, but rather a desperate plea from folks who know even a blind squirrel occasionally finds a nut.
It will be very interesting to see how LPs respond to these requests. There is an inherent danger in saying “no,” because it can spark an exodus of the denied firm’s younger professionals (i.e., the people who often do most of the work). After all, there still are legacy investments to manage.
But that risk is usually preferable to throwing good money after bad. Well, unless the limited partner also is suffering a crisis of confidence. And, judging by median private equity returns lately, that just might be the case.