'We're now undergoing a real cultural change,' says expert
Investors in private equity firms have made demands regarding their continued commitment to upcoming fund raises, as reported in an article by BNN Bloomberg.
Sources who have asked to remain unidentified have revealed that sovereign wealth funds (SWF) and state pension providers were some of the investors that would only be committing in fund raises if their capital that had been tied up with old funds were released.
There were also additional requests such as fee discounts, more opportunities for co-investment, greater information rights, representation on committees, a cut of the fund’s management fee, and an opportunity to buy a stake in the fund manager.
“We’re now undergoing a real cultural change. It’s the first time we’re seeing LPs being so straightforward and linking a distribution from one fund to a new commitment in another. They’ve never been so precise with their asks,” said William Barrett, managing partner at Reach Capital, a private market fundraising firm.
Notably, large fund managers are unable to scale their platforms without financial support of limited partners while they would need managers who can accept large capitals. However, as private equity buyout funds have a hard time paying back investors due to corporate valuation disagreements, investors are now given more power in dictating their terms.
“It’s a tough market and LPs are using the leverage they have, particularly the largest investors of private credit, such as the sovereign wealth funds, and state pension plan funds. Fund managers have to fight for their dollars now and investors know this,” said Barrett.
With many fund managers being slow in selling fund assets into the current market, many have been using leverage in order to release funds. There is a significant increase in the use of net-asset-value (NAV) financing, a loan backed by portfolio companies. However, these are costly and may possibly dilute returns in the long run.
David Philipp, a partner at Crestline Investors, has stated that there were more limited partners who have been requesting the return of their capital and asking for general partners to explore NAV lending. He said that this often came from sponsors soliciting LPs to “re-up” in an upcoming fund before giving back their money from previous vintages.
There were also some private equity firms who have been taking out loans at management companies in order to meet fund commitments. These loans were usually backed by assets that have the potential of a future fee income and have the capacity to charge high interest.
With more sovereign wealth and pension funds raising their concerns and demands to private market firms, there was an increase in investors who were lending directly to their borrowers as well as cutting out direct lending giants.
“LPs are generally becoming more and more educated in private markets investing,” said Barrett.
“The next question will be when will some of the biggest backers of this sector begin building their own in-house origination teams and start cutting out the middleman,” he added.