After setting out to raise $1 billion for their fourth fund several years ago, Greg Feldman and his team at New York private equity firm Wellspring Capital Management closed the fund in six weeks. But when Wellspring passed the hat for a fifth fund in 2009, it got a very different reception. Co-founder and managing partner Feldman had a good story to tell, including a gross internal rate of return of more than 40 percent, but potential investors were strapped for cash thanks to large previous private equity commitments and huge drops in their asset values.
In the end, it took Wellspring a year and a half to close on its $1.2 billion fund. “About 99 percent of the reason was liquidity issues and not performance issues,” Feldman says.
Wellspring is not alone. The average time to close a private equity fund in 2010 was 19.8 months — double the wait in 2004, according to London-based alternative-investment research firm Preqin.
These trials underscore several challenges facing the private equity business, even as it recovers from recent setbacks. At the height of the financial crisis, as the capital markets froze, private equity funds found it all but impossible to exit earlier deals. For the year ended March 31, 2009, they lost an average of 30 percent, although they were up 21.8 percent for the 12 months through March 2010, according to Preqin.
The market appears to be turning. A total of 515 private equity buyout deals, worth $66.7 billion, were announced in the third quarter of 2010, the best quarterly period since early 2008. “Financing has come back and is quite strong,” says Chip Baird, a partner with Boston-based private equity firm Weston Presidio.
There’s plenty of cash to do deals. Worldwide in the third quarter of 2010, 83 private equity funds raised about $59 billion. That boosted so-called dry powder to $447 billion, slightly off 2009’s record $500 billion. Because funds typically have a five-year investment period to charge full management fees, a big chunk of this money needs to be spent soon. Preqin figures 2006-vintage funds still have $40 billion of dry powder, while 2007 funds have $100 billion.
Bank financing, however, is still not readily available. The standard deal today uses nearly half equity, way up from about 35 percent in 2006 and early 2007, according to PitchBook Data, a Seattle-based private equity research firm. “The access to credit and capital in the middle market is not as great as it is for the market for large companies,” says Weston Presidio partner David Ferguson.
Meanwhile, older funds feel a growing pressure to exit previous deals. “There is a lot of overhang from aging portfolios,” says Adley Bowden, manager of research operations at PitchBook.
Still, many institutional investors plan to boost allocations to private equity. In North America, private equity’s share of institutional portfolios will rise from 4.3 percent to 6.8 percent by 2012, according to a recent Russell Investments global survey of 119 large institutions.
“Investors are smarter now,” notes Stephan Breban, director of private equity with Seattle-based Russell, which provides investment products and services. For example, Breban says, many pension funds realize they can allocate as much as half of their assets to less liquid investments like private equity.
Kenneth Muller, a partner and co-chairman of the private equity fund group at San Francisco–based law firm Morrison & Foerster, says he’s seeing larger institutions commit to private equity, but with fewer individual managers. The crisis gave investors a chance to rebalance their portfolios and mix of managers, he adds.
One person who wisely held off private equity until recently is Charles Stucke, senior managing director at Chicago- and New York–based investment firm Guggenheim Partners and CIO of Guggenheim Investment Advisors. Between 2006 and 2008, Guggenheim largely avoided new private equity commitments. It began allocating again in the fall of 2008, Stucke says, making a contrarian bet: “Lack of bank financing and the closed IPO windows for many firms are two reasons private equity is a compelling opportunity now.”
