Fund lifetimes: Extend and pretend?

Gamma Capital is the latest in a series of fund managers that chose to extend the lifetime of some of their vehicles, feeling that exiting certain portfolio companies in the current climate would be ill-advised. Other players, such as Montagu Private Equity or BC Partners, were able to negotiate an extension on investment periods as they were left with sizeable commitments to draw from 2005 vintages.

Rather than applying exceptional fixes, some observers have called for a permanent rethinking of the private equity fund model, in light of the recent developments in the industry. Firms which raised large funds before the crisis, and were unable to deploy them for the last couple of years, now face the pressure to meet the investment period deadline. This capital overhang is thought to be an incentive for careless investment, and is seen as one of the drivers behind the rather high valuations witnessed on the market this year.

While this aspect is largely cyclical, the bleak economic prospects for Europe and the uncertainty of leverage coming back to pre-crisis levels may suggest longer-term changes for the private equity ecosystem. Most mid-market players expect to have to work harder and longer to create value for their portfolio companies, instead of relying on leverage and a global economic uptick to quickly achieve strong returns.

But in an already illiquid asset class, could slowing down the pace of the private equity cycle be an appealing proposition for LPs? "This is definitely not the message we are sending to our GPs" says Christophe Bavière, CEO and managing partner at fund-of-funds Idinvest Partners. "If some GPs think they can coast through difficult times while still getting management fees, avoid complicated deals and exits altogether, and wait for easier times to go fundraising, they will not get much sympathy."

The possibility to turtle up in rough times could create a false sense of security for funds that should rethink their strategy and appeal instead: "Private equity funds are slow to fold; a GP coasting his way through the crisis, holding on to portfolio companies for longer than necessary, may have the illusion that everything is fine and that he is still in the game" states Bavière.

It would seem that GPs that can make the best of a bad hand will still get the LPs' vote of confidence. "Some people chose to be dynamic and work on deals and exits in difficult times. The crisis hasn't prevented some of them from getting very nice returns; these are the ones that will still be there in the long run" continues Bavière. "You pay the best GPs to select the right investments, even when the environment is more difficult, not the ones that will "wait and see"."

Of course, it would be unrealistic to rule out the odd extension altogether, as Bavière concedes: "We can accept to renegotiate an extension on a case by case basis, if the GP has the right attitude and is being honest and open to discussion. In those cases, when putting in more equity makes sense, we may of course have to wait longer to see an exit." This individual approach, coupled with increased communication between managers and their investors, is likely to be favoured by LPs - as opposed to a "one size fits all" overhaul of funds terms and conditions.

While longer fund lifetimes could seem like a sensible solution to some of the industry's current issues, they might also encourage GPs to lose the dynamism and dedication that made private equity an attractive proposition in the first place. Moreover, they are not likely to win the hearts of most LPs - a dangerous gamble at a time when their commitment to the asset class is already put under stress.

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