Business has stopped dead for secondary private equity managers, who were in the midst of their busiest season just three weeks ago.
Stock market volatility is making it impossible for managers to price the limited partnership interests and cast-off portfolio companies they want to buy. Indeed, some of the largest private equity managers moved to the sidelines despite a cornucopia of private equity interests up for sale.
“In the last couple of weeks we could not close one (deal) because of the (market) volatility,” said Byron T. Sheets, general partner at Paul Capital Partners, a San Francisco-based private equity secondary fund management firm.
Public companies are used as a proxy for private company values, but that can be challenging when the stock market has wide swings in a single day.
When the markets settle a bit, firms taking a long view of valuations expect to see bargains from the growing array of sellers offloading interests in private equity funds. Troubled banks like Citigroup Inc., Lehman Brothers Holdings Inc. and Wachovia Inc. and insurance companies such as American International Group Inc. — many either merging or being bailed out by governments around the world — are selling off their private equity portfolios to get liquidity.
Banks invested in private equity funds to get the lending business of their portfolio companies, Mr. Sheets said. “If you wanted to be on the call list of Blackstone, you had to make a pretty big commitment to its latest fund.”
Banks now are looking in every corner of their balance sheets for liquidity, he said. One side benefit for banks selling illiquid investments like private equity is that taking a loss does not count against them because Wall Street analysts do not include profit and loss of private equity activity, Mr. Sheets said. On the contrary, analysts view these sales as a positive move.
Banks are also spinning off their in-house private equity teams in sometimes-disguised management buyout deals. These deals have accounted for about 30% of the current deal flow in the secondary markets, Mr. Sheets said. Last year, Bank of America's venture capital team spun off to form Scale Venture Partners, removing the bank from the financial picture. Some deals are disguised so they don't look or feel like a distressed sale, Mr. Sheets said. Some transactions are being structured as joint ventures, where the seller gets a partial payment upfront in exchange for giving the buyer future distributions.
Another popular strategy used by Paul Capital is paying capital calls for an unfunded portion of the limited partners' commitments in exchange for an ownership interest in the entire portfolio. This eliminates selling the private equity stakes at a discount. The strategy has been popular with public pension funds wanting to reduce the risk from their 2006 and 2007 vintage buyout funds, Mr. Sheets said.