Private equity ecosystem could be in for a shake-up

“This dislocation may lead to a clean-up of the sector. The absolute number of funds on the smaller side of the market may shrink, while the top-tier funds should be fine,” said Atul Kapur, co-founder and chief investment officer of Everstone Group, which manages more than $5 billion in assets across PE, real estate and infrastructure.

Funds managing assets of $50-400 million and investing in early stage e-commerce or growth strategies could be particularly vulnerable in this market, as these segments tend to have less liquidity, according to Kapur. Hence, these funds could struggle to secure profitable exits from their investments, he said.

“Such funds invest in smaller companies, which tend to have disproportionate problems. Every time there is a dislocation in the market, the big becomes bigger and, then, the bigger funds take away a disproportionate amount of capital from the market,” said Kapur.

It is very important that PE funds have sufficient dry powder (uninvested capital) lying around with them in this market, Kapur pointed out. “Dry powder is always helpful and if you are caught in a dislocation with no money in your fund to support your companies, then you are in a pickle. Availability of capital is absolutely critical in times such as these,” he said.

The situation could be particularly bad for first-time fund managers, which are required to clear more stringent criteria to raise capital as compared to those with long track records and deep relationships with limited partners (LPs), which are investors in PE and venture funds.

“LPs have been impacted by the turmoil in the equity and bond markets and are taking stock of their books, commitments and expected future distributions from GPs (general partners). We expect the market to consolidate towards funds with a demonstrated track record of delivering returns and three or more funds under their belt,” said Vivek Soni, partner and national leader for private equity services at EY.

During 2017-2019, 57 maiden funds had raised more than $6.6 billion from LPs, said Soni. However, he expects these first-time managers to have a tough time raising follow-on funds.

The pressure on fund managers will stem from the difficult economic environment, which will impact their ability to secure profitable exits from investments because of the depressed valuations. PE funds typically have to return capital to LPs over a fixed duration, which could range from 7-10 years. A fund nearing the end of its life could find itself in a tricky situation to exit its investments in this challenging market, with the added pressure of returning capital in a limited time period.

“In 2020, we expect PE/VC (venture capital) exits to decline by 50-67% from the 2019 levels of $11 billion on account of loss of deal momentum, weak medium-term outlook for key sectors and prevailing uncertainty over revenue and profit and loss projections for FY21 and FY22,” said Soni.

Fund managers are most likely to increase their holding periods and work through the crisis to sell in better times, as opposed to selling now at significantly discounted valuations, Soni said. “Funds that do not have the ability to extend their holding periods will be forced to evaluate portfolio sales to secondary funds at deep discounts,” he said.

Source: Livemint