- Capital Call by OneFund
- Posts
- The Approaching Maturity Wall within Private Equity
The Approaching Maturity Wall within Private Equity
Capital Call - a bi-weekly newsletter from LPs for LPs, covering the latest and greatest from across the private markets
Calling all LPs! Thanks for joining me (John Bailey, Co-Founder at OneFund) for another edition of Capital Call. A bi-weekly private equity newsletter from LPs for LPs.
The mission of Capital Call is to deliver concise, top-notch insights and updates from the private markets tailored to what matters for LPs.
This week we will be looking at:
The Approaching Maturity Wall Within Private Equity
Fundraising updates and VC/PE reports
GP Perspectives from Chamath Palihapitiya & Harvey Schwartz
About OneFund
OneFund is democratizing access to Private Equity and Venture Capital for everyday investors. We partner with the world's top PE & VC funds to offer investment options without the million-dollar minimums.
If you would like to follow what we are doing, get more regular updates directly from the team, or access to the platform, schedule a call!
Industry Insights
PE exit figures are down 75% in Q2 2023 from the highs of Q2 2021, according to Pitchbook’s Q2 2023 Private Equity report. This creates both opportunities for those investing today and challenges for older funds working to return capital to their LPs. As some funds reach maturity, many have reluctantly marked down some portfolio assets and resisted selling to protect fund IRRs however they will eventually need to produce dividends for investors. This can present ripe opportunities for funds deploying capital to pick up assets at attractive valuations.
Pressure is mounting to return capital to LPs in mature funds (think fund 5 years or older) and it is forcing some GPs to sell assets. This could cause an impending “maturity wall” for deals made during the COVID-fueled M&A boom and earlier as well as create opportunity for LPs investing today. In this week’s capital call, I’ll dive into the consequences of the maturity time wall on the private capital industry and the trends LPs should be most aware of.
The Growing Need for Exits
Funds holding onto assets has resulted in a record $2.8 trillion in un-exited assets, over four times the level held during the financial crisis, according to a recent Bain report. Over half of these assets have been held for four plus years and nearly a quarter have been held for six plus years. This will only serve to mount pressure on GPs managing their funds that are over five years old to sell and produce dividends for their LPs.
For GPs, this also makes it challenging to raise new funds as LPs who may be increasingly tied up in older vintages and need liquidity may be hesitant to increase commitments. This can be seen in recent fundraising numbers which dropped to $517 billion in the first half of 2023, a 35% decline compared to last year.
DPI is the New IRR
Since many LPs are feeling cash-strapped, distributed to paid-in capital (DPI) is becoming a more important metric than IRR. DPI measures the dividends returned to LPs over the amount of money that has been paid into the fund. a DPI of 1 means that as much money has been returned to LPs as paid-in. Over 1 means more cash has been returned and under 1 means less cash has been returned. A DPI under 1 is not bad and even to be expected in newer funds still in their investment period. However, as a fund matures that DPI number should go up as the fund sells assets and returns cash to its LPs.
When surveyed over whether liquidity concerns left LPs more inclined to cash out of investments or roll it over into a GP-led secondary fund, over 60% of LPs indicated they prefer cashing out. LPs now prioritize liquidity over waiting to earn higher multiples upon exit and fund managers should take note.
For LPs, evaluating GP performance, using both IRR and DPI can provide a more comprehensive assessment in today’s environment.
What does this mean for LPs?
With this potential liquidity crisis in private capital, LPs should assess whether their GPs can implement liquidity solutions effectively, whether through exits, continuation funds, GP or LP-led secondaries, recaps, or other liquidity solutions. Continuation structures, typically known as GP-led secondaries, have picked up and now represent more than half of all secondaries volume.
Another liquidity solution gaining traction is NAV financing, where banks provide borrowing based on the portfolio net asset value (NAV) allowing sponsors to accelerate distributions to LPs. NAV financing increased by over 50% in 2022 and further gained traction in the first half of 2023 as firms continued navigating the tough exit and credit environment.
The current environment is not all bad news for LPs, however. Investing today may present an opportunity to take advantage of the flood of portfolio companies that could hit the market as GPs seek liquidity.
Updates from Across the Ecosystem
Fundraising
Reports
GP Perspectives
Chamath discusses the interesting phenomenon where many software companies with 80%+ gross margins and minimal marginal costs tend to become unprofitable in the long-term. This is because high-margin businesses typically have a strong marginal advantage in the industry, but this also produces more opportunities for well-funded competitors to enter the market and compete aggressively.
On the other hand, businesses that can prudently navigate the J-curve and understand pricing dynamics are able to build long-term profitability with fewer competitors as a result. Chamath summarizes, “Huge GMs are your friend if you have them, but they aren't a substitute for growth at all costs and indeterminate periods of unprofitability.”
Carlyle’s new CEO, Harvey Schwartz, believes the private equity firms can compete with banks in securing loans for portfolio companies. Schwartz wants Carlyle’s capital markets unit to bypass banks by arranging financing and placing the debt with private lenders on its own. This would facilitate deal financing and help recoup investment banking fees typically paid on these types of transactions.
Schwartz believes more firms will do this as banks rein in lending and shield balance sheets from the slowing economy. It would also mitigate the issue of regional banks pulling back lending as new regulations are imposed on them.
About OneFund
OneFund is democratizing access to Private Equity and Venture Capital for everyday investors. We partner with the world's top PE & VC funds to offer investment options without the million-dollar minimums.
If you would like to follow what we are doing, get more regular updates directly from the team, or access to the platform, schedule a call!
Reply