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Capital Markets

Private equity caught between rock and a hard place

Buyout firms struggle with first closes; exits remain tricky, extending holding period of portfolio assets.

In May, Warburg Pincus became the latest private equity firm to close a new buyout fund, following similarly successful fundraisings by Silver Lake and Advent International Corp earlier this year.

But although Warburg’s $11.2 billion fund is one of the largest to be closed since 2008, it fell short of the $12 billion the firm was targeting.

According to Preqin, a provider of data on the alternative investment industry, private equity funds that closed in 2012 secured on average 44% of their target capital by the time of their first close – the lowest proportion in the period since 2006.

In the first quarter, 129 private equity funds reached a final fundraising close worth a combined total of $67 billion, compared with 203 funds that raised $79 billion in the first quarter of 2012, says Preqin.

In addition, those private equity funds that closed in 2012 took an average of eight months to reach a first close, compared with five months in 2006.

The bright spot in this is that evidence from last year shows that reaching a first close quickly can increase the chances of overall fundraising success.

Preqin says some 58% of the funds closed in 2012 that held a first close within three months went on to meet or exceed their fundraising target, compared with 36% that took over a year to reach first close.

Private equity sponsors tend to offer investors who invest before the first close lower management fees or co-investment rights as incentives.

However, on the other side, private equity firms are also struggling to realize investments made in the buyout boom. This is adversely affecting the amount of capital returned to investors.

Preqin says that the average holding period for private equity-backed portfolio companies sold so far in 2013 is 6.2 years – up from just 2.1 years in 2008. The average holding period for companies sold last year was five years.

As a result of this increase in the holding period, the amount of paid-in capital to investors has fallen substantially.

Preqin says that after six years, 2001 vintage buyout funds had distributed 95% of paid-in capital to investors, compared with just 33% of paid-in capital after six years for vintage 2007 buyout funds.

Furthermore, some 63% of portfolio companies purchased in 2006 and 73% purchased in 2007 have yet to be sold, according to Preqin.

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