Private equity recaps (no, not that kind)

August 13, 2012, 6:25 PM UTC

FORTUNE — Nearly twelve years ago, Behrman Capital raised $1.2 billion for its third private equity fund. By the end of this month, it is expected to have raised around $1 billion for… its third private equity fund.

That’s right, it’s a private equity recap of a private equity fund. Not because Behrman Capital III is in the red and LPs are fleeing, but because the fund is actually in the carry and its general partner has refused liquidate the fund’s five remaining portfolio companies. Some limited partners are pleased that they’re getting bought out, while others are livid. All of them are practically powerless to do anything about it.

Here is what has been previously reported about the Behrman situation: The New York-based firm hired Cogent Partners to find buyers for the remaining portfolio, which is being valued at approximately $750 million. The remaining $250 million or so would be used to fund new investments by Behrman – an equal amount to what Behrman raised for its fourth fund in 2007 (despite having targeted $1 billion). Canada Pension Plan Investment Board agreed to serve as cornerstone investor for the deal by making a $644 million commitment, beating out a rival offer from Goldman Sachs.

Here is what is new: CPPIB has since bumped up its commitment by approximately $100 million due, in part, to early syndication difficulties. There had been talk that both Goldman Sachs and Coller Capital would help fill out the remainder, but word is that Coller later bailed. Not sure about Goldman, or how much rollover is coming from existing LPs. Either way, a source familiar with the situation now says that the entire offering is oversubscribed. The firm itself is declining comment.

What’s fascinating (to me) about this situation is that Behrman (or Cogent) has figured out a way to keep generating fee revenue for a fund that should be dead and buried by now. Moreover, its general partners are getting around half of their carry paid out, while the rest will just wait for eventual liquidation. Why request more fund life extensions when you can just find new LPs to buy out your old ones? Why close out a fund in 10 years – as the original LPA required – when you can sit and hold indefinitely?

I know what some of you are thinking: Wait a minute. Can’t the LPs just refuse to let this happen?
Technically yes. Pragmatically no. Imagine the LPs refused to accept this deal. What is their next move? Hire a new GP or consultant to manage out the remaining portfolio – one that is less familiar with the underlying companies? Simply refuse to keep paying fees to Behrman GPs – ok, but what incentive do Behrman GPs have to show up at work rather than the beach?

To be clear, I’m not suggesting that limited partners are getting a terrible deal here. Each one of them – particularly some secondary players like AXA Private Equity – will book Behrman III as a gain. But there also is a fair case to be made that, if Behrman’s marks are correct, they could make even more money by Behrman selling off the remaining portfolio companies right now. No explanation yet from anyone as to why that isn’t happening. All I can figure is that by doing it this way, Behrman also gets to raise new primary capital (which generates brand new fees) without a formal fundraising process (like the one that largely failed in 2007).

In short, it’s just another example of how general partners hold almost all the cards, no matter how the original agreement is written.

Here is how one Behrman investor put it: “We’ll make money, but I still hope they can’t fill the deal. It’s not the optimal outcome for us, and it may set a bad precedent.”

Anyone disagree?

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