May 25, 2024 - Business

Private equity's tangled fundraising knot

Illustration of a rope with a knot in it surrounded by abstract shapes and money elements.

Illustration: Gabriella Turrisi/Axios

Private equity has a problem.

Why it matters: The industry is failing to exit investments at a pace that keeps up with limited partner demand, creating a tension that could have broad impacts.

By the numbers: Private equity firms are sitting on $3.2 trillion worth of unsold assets, Bain & Co. says. Levered up, sponsors have an estimated $4 trillion of dry powder. Normally, that would be a decent balance.

Yes, but: Exits aren't really happening, and neither are sponsor-to-sponsor deals. GPs are stuck in an IRR model and clinging to companies for dear life.

  • "I think you have GPs in love with assets," Hamilton Lane co-CEO Erik Hirsch said at an Axios event this week.
  • "If they own a great business that's compounding at double digits, they're reticent to sell it, because trying to find a new asset that they can acquire today that they're going to grow at double digits" is going to be tough.
  • That reticence is what's driving the tension: Why would an LP commit more capital to a GP who hasn't distributed money? (A similar dynamic is playing out in venture capital.)

Friction point: "There's a big backlog in terms of both deployment and exits after two years of much weaker activity," said Rob Pulford, the Americas head of the Financial and Strategic Investors Group at Goldman Sachs.

  • The recovering IPO market is a key solution to the exit problem, Pulford notes. Follow-ons, block trades and other ECM products can help too.

Between the lines: Thanks to the two-year-long dearth of deals, DPI is the new IRR.

  • Distributed to paid-in capital is the dominant industry conversation. Gone are days when GPs would routinely hit a 2X home run for investors. Now, they can barely get to 1X, and LPs are asking: Where's our money?
  • In fact, the global DPI average for funds raised in 2019–22 is at 0.12X, according to Goldman. Getting to 1X, and doing so early, is usually the goal — LPs are paid back and rest is gravy. That isn't happening.
  • "If a sponsor hasn't returned enough capital to their LPs … relative to their peers, I think that's the catalyst for more exit activity," Goldman's Pulford notes.

What's next: Private equity buying is on the upswing. The ECM market is there for the taking. But with LP distributions still rare, GPs continue to scramble for extensions and continuation funds.

  • "I've never seen a fundraising logjam like what we're seeing today," said Hamilton Lane's Hirsch.
  • "There's a real gapping that's occurring. So there are some ultra-successful firms that are raising a lot of money. And then I can show you right now the other 1,500 folks that are kind of in the queue that are nowhere near their target."
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