For years, private equity executives across the globe called the shots when they met with prospective investors for their next big fund raise, many of whom had traveled thousands of miles to meet them for the privilege.
Now, the tables have turned.
The biggest backers of buyout firms are wielding their ever-growing bargaining power to drive increasingly tough deals. The latest in a string of investor demands is this: If you want our money, put more of yours in first. As a result, some private equity executives — at both big and small firms — are loading up on more debt and pledging personal assets to appease them. This includes their homes and other valuables as well as traditional collateral such as fees and stakes in other funds.
The equity contributions from buyout firms into new funds has jumped to an average of 5% from 2% last year, and in some cases as much as 20%, according to people familiar with the matter. It’s leaving some managers scrambling to find significant amounts of capital in often short time frames, the people said, asking not to be identified discussing private agreements.
To raise cash, some are taking out high-interest loans that can charge rates into the mid-to-high teens, and are often backed by holiday homes, cars, second businesses and art collections, the people said. Some banks are demanding that executives pledge the bulk, if not all of their personal assets, some of the people said.
Investec and J.P. Morgan Chase & Co. are among banks providing such loans, according to people familiar with the matter. The industry’s need for more capital has also given rise to several private credit lenders such as Ares Management, Oaktree Capital Management’s 17Capital and Pemberton Asset Management, who have raised, or are raising funds to lend out.
“The question of ‘how much are you personally putting into the next fund’ is definitely a discussion on the table and it’s often the first discussion,” according to Jean-Philippe Boige, managing partner at Reach Capital, a private-market fundraising firm.
During the past decade, private equity firms had little trouble keeping their investors happy: Rock-bottom interest rates helped spur an unprecedented flow of profits that kept investors happy and made many in the industry fabulously rich. But as economic uncertainty disrupts the pace of asset sales, and the cost of financing those assets soars, many private equity fund managers — known as general partners — are now struggling to return cash to their backers. As a result, investors — known as limited partners — are turning up the pressure when asked to part with capital.
The demands are the latest indication of a power shift in the $8 trillion market since the end of the easy money era. In exchange for their continuing investment, money managers have been ramping up their requests, which span fee discounts, co-investments, as well as the release of capital tied up in old funds.
“The question from limited partners now is how much skin in the game do you really have?” said William Barrett, managing partner at Reach Capital. “But these loans are not cheap, so you have to be careful with what you’re asking. You don’t want to put so much pressure on your private equity firm that it buckles.”
For some investors, it’s not just about the percentage of fund equity that a buyout firm is supplying but what portion of a manager’s personal net worth is being contributed. Unless it’s a meaningful amount, it could be argued that it’s not real alignment, according to Imogen Richards, a partner in Pantheon, an investor in private markets.
“It’s one thing to have 3%, 4%, 5% of equity in a fund, but how much of your net worth does it represent, it may only be a fraction, in which case limited partners could be asking those questions and demanding more,” Richards said.
Given the kind of collateral needed to get loans, the main applicants tend to be from mid- to large-sized buyout firms, according to Richard Sehayek, managing director in Ares Management’s credit group.
For managers at smaller firms, lenders tend to be private wealth banks, who charge more and demand more collateral, including personal assets and real estate, according to several people familiar with such deals.
“Some of the larger banks are not willing to lend to a general partner if the loan size is below $300 million, so it’s forcing general partners to go to smaller lenders, who are more expensive,” said Jason Meklinsky, chief revenue and strategy officer at Socium Fund Services, a firm that helps administer private equity portfolios.
With cash paid out from funds tumbling, investors are now less able, or willing, to allocate new money to the asset class.
Last year, the rate of distributed capital to investors fell to 11.2%, the second-lowest rate in the past 25 years, according to a report by wealth management firm Raymond James, citing data compiled by Hamilton Lane Cobalt.
That means there is less money available to commit to new funds, further heightening the competitive nature of the fundraising market, according to Darius Craton, a director at Raymond James.
That lack of liquidity is rippling through the market.
“Everyone assumes that it’s limited partners that are facing liquidity crunches in private equity funds, but we’re also seeing one forming at the management level too,” according to Stephen Quinn, senior managing director at 17Capital.
