This change can mean much to your Mid-Market company.
Reports indicate that more than 50% of Limited Partnership Groups see the potential value in having the option of a longer life fund. And it looks like private equity firms are picking up on the hint. The lifespan of the median fund rose from 11.5 years in 2008 to 13.2 years in 2014, according to Palico.
Some funds can now last anywhere from 10-20 years and investors can expect General Partners to assume a more operational role, focusing on company growth over the very long term. They can also expect lower annual returns as profits are spread out over more years, extended periods of illiquidity, paying fees for longer, and the challenge of making sure the deal teams are goal-oriented. So where’s the upside?
The investment style of many of these funds can mimic how more permanent forms of capital, such as family offices, might invest. A longer life fund might be an option for investors wanting access to companies who don’t meet required return rates for the main fund but have the potential for impressive growth.
With many funds failing to produce the knock-out returns that once defined private equity, expectations from LPs are shifting and firms are adjusting. Even large private equity powerhouses such as Carlyle and Blackstone have introduced funds with longer lives, lower fees, and a mandate to consider such investments as minority stakes, family businesses and lower middle market and middle market companies.
Holding periods reach their peak
Since 2008, the average holding period for private equity portfolio companies has been on the rise. Pre-crisis, most private equity firms kept companies in their portfolios for about 3-4 years and this has been trending up in the years since.
Part of today’s dynamic M&A environment is a result of portfolio companies finally being exited from the last cycle. Many of these companies were held long past initial expectations as investors waited out an uncertain market. “Holding periods have gotten longer due to the financial crisis in 2008 and the continued softness in the US and global economy,” says Axial Member George Stelling of Quadrillion Partners.
The latest data, however, does show the lowest average holding period since 2012 (5.5 years) so we may see this trend reverse.
Ernst & Young’s most recent market update indicates a longer term investment strategy is likely a necessary response to the changing industry. “In the last 18 months, many exits have occurred as demand has revived, interest rates remain low, and valuations have gone up,” said Stelling.