Private equity is changing slower than you’ve heard
There is a burgeoning narrative about how private equity is reconsidering its traditional model, with eyes toward raising long-dated funds that would allow them to hold portfolio companies for 20 years or more. Basically moving closer toward a Berkshire Hathaway (BRK.A) structure, albeit not always with publicly-traded shares.
Some of this talk is based on reported experimentation with such funds by large private equity incumbents like The Blackstone Group (BX) and CVC Capital Partners. Some was prompted by a February speech by TPG Capital co-founder James Coulter, in which he talked about the private equity industry experiencing “titanic shifts.”
In general, however, this “evolution” is overblown.
The reason for interest in long-dated private equity funds is that certain institutional investors believe that private equity fees are too high relative to performance. This is largely because private equity charges fees up-front on uncommitted capital, slowly ratcheting down the fees (in terms of hard dollars) as capital is called down (and then often paying them back once investment returns are generated). Or, as Coulter put it in his speech: “That fee drag in the early years of a fund actually becomes difficult.”
But if you create a long-dated fund, you can charge lower annual fees. Not only because fees would be charged for more years, but also because overhead can be reduced. After all, it should be cheaper to run a fund that has 20 years to invest its money than one that only has five years to invest. And the same goes for hold periods (i.e., longer to turn companies around).
The only problem, of course, is that private equity firms already have begun to lower fund fees. Not only “sticker prices,” but many firms are abandoning old rules that said any cost break enjoyed by one limited partner would be enjoyed by all. Today, larger investors can get added discounts for buying “in bulk” — plus are being encouraged to participate in co-investment vehicles that often do not include any management fees on uncalled capital.
And the reductions have proved success, with U.S. private equity fundraising having rebounded from its 2009-2012 lull (average of $95 billion raised annually) to average nearly $180 billion over the past two calendar years. I can think of only a couple of long-dated funds being raised in that more recent crop, and those were for firms that implemented such models long before they became rhetorically trendy.
Even Coulter’s TPG is in the midst of raising a new flagship fund that has… you guessed it, a traditional time structure.
To be sure, private equity firms will try to innovate in their quest for better performance. But when it comes to fundamental structure, few firms will deviate sharply from what has worked for them for decades. If there is movement, it will be glacial.
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