Preqin Says PE Funds Face Challenging Environment

(March 23, 2011) — According to data provider Preqin, first-time vehicles coming to market looking to attract investors face a number of significant challenges in the current environment.

While the amount of private equity funds successfully raised last year dropped to its nadir of the decade, first-time funds have also made up their lowest proportion of the total since Preqin began tracking such information. Tim Friedman, head of communications at Preqin, told Financial News: “It is very difficult to raise a first-time fund now despite evidence showing their performance is very good. Investors are being very wary about where they are putting their money and want to see a track record.”

Britt Bentley, vice president of consultancy LCG Associates, agrees that first-time funds face a challenging environment, yet he said that with less money flowing in, investors have more leverage and greater influence over terms. “Investors are demanding that new organizations have institutional-level infrastructure on day one. They’ve been able to be pickier,” Bentley told aiCIO.

Bentley noted that a trend among larger endowments has been an attempt to lower the number of private equity relationships they have. “If they’re allocating fewer dollars, they want to make those dollars count,” he said. He added: “We still think private equity for long-term investors makes a lot of sense. Firms that weathered 2008 well are going to be the firms that have the most success raising capital going forward.”

Private equity as a whole suffered in 2008 and beyond, as managers scaled back their allocation to this strategy due to factors such as illiquidity, high fees, and suffering performance. Management consulting firm Bain & Company, surveying the private equity landscape, recently revealed that it foresees a lot of dry powder, or unused capital – and warns that the urge to put it to use may cause firms to overextend. Looking at the large buyout space, investment consultants note that the large amount of unused capital that is not put to work within recommended investment periods will cause some funds to make acquisitions more aggressively.

In its Global Private Equity 2011 Report, Bain predicts that the “nearly trillion dollar stockpile of un-invested capital” makes it likely that private equity firms, looking to put capital to work, will increase deal-flow in the coming months. However, in a release, the firm stated that the “positive trend is somewhat tempered by the fact that approximately one-quarter of the $434 billion of the dry powder targeted for buyouts is ‘pressured capital’—committed capital in the hands of GPs with powerful incentives to return profits to limited partners (LPs) and extend the life of their firms—which may cause some pressured firms to overreach in their deal-making efforts and potentially drive up deal prices as a result.”

Some groups are attempting to better align GP and LP interests, however. The Institutional Limited Partners Association (ILPA) has aimed to restore and strengthen the relationship between the endowment and pension funds that invest in private equity funds (the limited partners) and the private equity firms that invest and manage the capital (general partners). The ILPA, which represents investors, has introduced guidelines surrounding fund structures, which contains best practices relating to the alignment of interest between general partners and limited partners, fund governance, transparency and reporting. Earlier this month, the famed private equity firm Kohlberg Kravis & Roberts (KKR) said that it endorses private equity best practices guidelines issued by ILPA.

“We are pleased to formally endorse the ILPA principles,” KKR’s Henry R. Kravis and George R. Roberts Co-CEOs and Co-Founders wrote in a statement. “We believe that the entire private equity industry – limited partners and general partners – will benefit from increased focus on the three basic tenets…For KKR, we believe the principle of alignment is at our very core, as evidenced by the fact that we have a meaningful amount of capital, more than $6 billion, from our executives and our balance sheet, at work in our private equity investments.” KKR further noted that while the firm’s existing and future funds will not adhere to each and every term outlined in the Principles, its endorsement reflects a general support for the efforts of ILPA and other industry supporters with the mission of improving the private equity industry for the long-term benefit of all of its participants.