Private equity GPs ‘risk repeating 2006’ if capital remains trapped in assets – Bain & Company

(Updated to include comment from Bain & Company in paragraphs 6 and 7.)

March 12, 2024 (Preqin News) – Nearly half of the value in private equity portfolios is now in assets that have been held for more than four years, the highest proportion since 2012, according to new research from Bain & Company, raising fears that the industry ‘is at risk of repeating 2006’.

In its Global Private Equity Report 2024, the consultancy warned that ‘the trajectory of recent fund vintages is raising fears that the massive bolus of capital laid out in recent years is trapped and won’t come back to fund new allocations in a timely fashion.’

Bain said the drawdown pattern for 2020 vintage funds was mirroring 2006, the last year before the Global Financial Crisis (GFC) began to bite. Vintage 2006 private equity funds eventually recovered to deliver a median net IRR of 8.6%, one of only two vintages this century to deliver single-digit returns (alongside 8.2% in 2005), according to the Preqin 2024 Global Report: Private Equity.

However, not only were returns below average, they also took longer to be realized. Vintage 2006 funds took 10 years to return to positive territory, compared to an average of seven years for pre-GFC funds.

On a positive note, Bain said that private equity portfolios today were very different from the ones built pre-GFC, with less reliance on public-to-private deals and IPOs as an exit route. It said that despite the stalled M&A market ‘absent additional shocks, easing rates could improve exit conditions rapidly.’

Hugh MacArthur, Chairman of the Global Private Equity Practice at Bain & Company, told Preqin News that there has been a notable increase in transactions activity this year, with a near-six-month period of relative stability in interest rates giving buyers more confidence on pricing and debt finance.  

‘Our due diligence work is showing strong double-digit growth in percentage terms over last year. That’s not an explosion of deal-making by any means, but it is a meaningful increase, and the intermediaries we talk to say their pipelines are full and there are properties coming to market,’ he said. 

Bain advised GPs to devote as much focus to exit strategies as to new investments, such as setting up Exit Committees in the same way that all have Investment Committees. It said LPs would be looking for a ‘well-defined blueprint for generating near-term distributable cash – a holistic, portfolio-wide strategy that uses every tool at the firm’s disposal to boost distributed to paid-in capital (DPI).’

Among the consultancy’s suggestions were:

• Assess which assets can be sold quickly for an attractive return, including an assessment of whether LPs would rather hold out for an extra half turn of MOIC or have cash now.

• Identify companies that would benefit from defined programs to improve earnings to shore up the exit story.

• Consider formal ‘re-underwritings’ or continuation vehicles for assets that have good return prospects that will now take longer to deliver.

• Make hard decisions about what to do with companies with broken strategies and no plausible plan for improvement.

• Explore generating distributions via financing tools such as NAV loans, remaining aware that LPs are cautious about techniques that deliver cash now but create future obligations.

‘The exit conundrum is critical to fix as the market improves – the current threat to investor cash flows and the sector’s liquidity is very real,’ said Rebecca Burack, Partner and Head of the Global Private Equity Practice at Bain & Company. ‘Breaking the logjam will need GPs to take charge of their destiny in terms of how they can manage portfolios to generate increased distributions for LPs.’

_{The opinions and facts included in the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin accept no liability for any decisions taken in relation to the above.}