The long game: running beyond the 10-year fund life

Private equity has rarely wavered from the standard 10+1+1 year model for fund lifespans, and while a fundamental shift away from that timeline is unlikely, some GPs are seeing value in vehicles that run for as long as 15 years.

Last year Nordic outfit Altor closed its fourth fund, a vehicle with a 15-year fund life, and in August this year Luxembourg GP Castik Capital closed its European Private Investment Club I (Epic I) on €1bn, pledging to stay invested in its portfolio companies for up to 10 years.

Altor partner Stefan Linder believes there is a tendency among GPs towards longer-term fund lifespans, but points out not all firms may prioritise lifespan when negotiating with LPs, saying: "They may have other battles to fight."

His view is supported by Sunaina Sinha, managing partner of placement agent and secondaries adviser Cebile Capital, who says she is seeing more funds with extended lives, though not enough to suggest it will become a new standard. "It really is only being done by high-performing GPs, as a reaction to investor demand. It is not something that has become the norm among the majority of GPs yet."

While there has not been a broad push for extended lifespan funds from investors or GPs, rather the few cases of uncommon fund time horizons are a result of managers leveraging strong LP relationships and performance to deviate from the cookie-cutter fund structure. "It's very much on the basis of established GPs with great track records and oversubscribed funds, which means they can dictate terms and decided to use that to increase the life of the fund," says Sinha.

Good for GPs
For GPs, a few extra years on the tail-end can mitigate misunderstandings, not least of which is the perpetual accusation from critics that the private equity ownership model is too short-term.

As longer-term funds are usually the preserve of very successful managers, the extended fund lifespan perhaps favours GPs over LPs. "A longer hold with attractive IRRs year-on-year at the later end, and creating the time and the opportunity for us to really, really change companies, build them strong and make them international is very favourable for us," says Altor's Linder.

Says Linder: "Extending the fund for a number of years and adding the opportunity to invest in existing portfolio companies throughout the life of the fund were two aspects that were very important to us. These elements are very valuable in our day-to-day value creation work, and also in positioning us in the market and attracting partners, managers, co-owners and entrepreneurs that the structure appeals to. It has been a very positive experience for us."

While extended holding periods may assuage company owners' fears in regions where private equity's reputation is lacking, the key benefit of a longer-term fund is the opportunity to continue to develop and build portfolio companies, and capture more value on the tail-end.

"We saw good opportunities to continue developing some of our portfolio companies in the earlier funds, for a range of reasons," says Linder, when asked about the reasoning behind Altor's decision to launch a 15-year fund. He mentions situations such as buy-and-build investments with unrealised potential, as well as companies that run into problems where the team would need time to recover and deliver.

Altor's reasoning is also a hint as to what type of GPs are more suited for extended-term funds. Those funds operating in the mid-market, versus the large-cap market, generally invest in businesses with more potential for strong growth over a decade or more.

Buy-and-build investments, cases with heavy consolidation and local-to-regional-to-global expansion opportunities, often favoured by the aforementioned GPs, are not necessarily achievable ambitions in the space of a standard 3-6-year holding period. Turning a local player with potential into a global powerhouse can take much longer.

"The lower-mid-market and mid-market funds are leading the trend of longer-term lifespans," says Sinha. "I haven't seen a large buyout fund extend their lifespan yet. It's very much done by the mid-market so far."

Furthermore, evidence of this is also being seen in the venture space, where more venture-backed companies are raising large amounts of capital in later funding rounds, as investors see opportunities to capture strong long-term value at advanced stages.

Draper Esprit CEO Simon Cook's view of the situation in venture capital also provides a key insight to the tendency in private equity: "What's going to come out of this is a challenge to the 10-year LP structure. I think we've seen the peak of it, because investors are holding on to these funds as long as possible to capture that value."

Patience is a virtue
In addition to requiring a strong GP/LP relationship, long-term funds are not suitable for all investors. Funds-of-funds with classic lifespan funds could run into conflict with their own LPs, if the pay-out horizon of fund commitments exceeds the lifespan of the fund-of-funds vehicle itself.

Endowments and foundations – LPs with investment horizons beyond even 20 years – will carry less risk if exposed to long-term funds, and though some pension funds and family offices may also have suitably long horizons, others will need liquidity to cover ongoing liabilities.

The increased liquidity risk and additional years of management fees to be paid in a longer-term fund would seem unappealing to LPs, yet Altor IV hit its €2bn hard-cap after just three months of fundraising, suggesting some investors are willing to take the added risk when committing to high-performing managers.

However, recent years have seen liquidity improvements at nearly all levels, as the secondaries market offers LPs a great deal of mitigation when it comes to liquidity risk. "The secondaries market is a huge driver of why this trend has come, and the reason investors are happy for this trend to exist in the first place," says Sinha. "What has changed is the liquidity being generated by the secondaries market: eight years ago the secondaries market was in the $5-10bn range; in 2014 the market was $45bn in volume."

Fee, Fi, Fo, Fum
While LPs may worry less about liquidity risk, fees are as hot a topic as ever and some expectations of management fees being adjusted due to the extended run-time could be warranted.

Five extra years of 1-2% on a €2.5bn fund could easily become a point of contention between GPs and LPs, but terms and conditions do not seem to strongly differ from the standard fund fees and carry. "There is no compensation to LPs for extending the fund life," says Linder. "It was agreed upon as an attractive aspect that should be attractive to both parties. It was seen as a win-win."

His comments reflect what Cebile's Sinha believes is common for this type of fund: "What I have seen with longer funds is that during the commitment period the fees are, say, two and 20, and after the commitment period the management fees halve."

Though the tangible downside of long-term funds seems to fall more heavily on the LP-side, Linder suggests they may see some industry-wide advantages as a result of the trend. He says part of the discussion when speaking to LPs about extending the new fund's lifespan centred around benefits to investors from a macro-perspective. "To force the industry to recycle assets after three-to-five years (and certainly the shorter, the worse), adding a number of percentage points worth of transaction costs in each iteration, is not perhaps ideal. Macro-wise it is a sound development that doesn't just pass fees along to others," says Linder.

As with nearly all investment options, the viability of longer-lifespan funds will ultimately come down to one thing: returns. "The jury is out on whether investors are being compensated for the increased liquidity risk in these longer-term funds," says Sinha. "We'll have to wait and see what the returns are like, but we haven't seen any hard numbers and won't for a while yet."

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