- One quarter of private equity fund managers will fail as a result of the downturn
- One in ten private equity investors will default on fund commitments
- GPs’ transparency and risk management need to improve
Private equity investors (LPs) expect to see: the disappearance of many existing private equity fund managers (GPs); defaults on commitments by about one in 10 investors; a significant shift in the balance of power between LPs and GPs; threats to returns from regulatory and tax changes; and a further deterioration in investment conditions in the near term.
While some of this change might be viewed as an industry in renewal – a process of creative destruction – many investors are worried that regulatory and tax changes will inflict more far-reaching damage on the asset class. Half of LPs think this is likely to happen in Europe, and more than half expect the same to happen in North America.
LPs and GPs
The relationship between LPs and GPs will change strikingly over the next few years. First, the players themselves will be different: investors expect a quarter of today’s GPs (28% of venture capital firms and 23% of buyout firms) to be unable to raise a new fund over the next seven years – in other words, to go out of business. On the LP side, they think a tenth of all private equity investors will default on fund commitments in the next two years.
The balance of power between LPs and GPs is also changing fast. Around four fifths of LPs expect the terms and conditions of new buyout funds to become more favourable to them, and a majority – two thirds of LPs – expect the same for new venture funds.
Investors also want improved transparency and risk management from fund managers. Over half of investors worldwide (and as many as three quarters of LPs in Asia-Pacific) think a significant number of GPs need to improve. One in 10 investors think most GPs need to improve.
Investors themselves expect to be harder pressed in days to come. Despite the fact that a third of LPs are planning to reduce their number of GP relationships, over half of them (52%) expect resource constraints to reduce their ability to make and manage private equity investments. Different institutions are reacting to this in different ways. Those scaling back their private equity investment or retrenching organisationally (about one in 10 investors) are planning to reduce the size of their private equity teams; however, a larger proportion of LPs (almost a quarter) plan to take on additional staff to help them cope.
Valuations, exits and distributions
Economic conditions are likely to worsen in the near term, investors think. Three quarters of LPs expect distributions from their portfolios to deteriorate further over the coming year. This will be the direct result of a stagnant exit environment: only a quarter of investors expect any short-term improvement in exits (though North American LPs are somewhat more optimistic than their colleagues elsewhere). V
aluations, too, have further to fall – three quarters of investors believe valuations reported by GPs at the end of 2009 will be significantly lower than last December’s audited valuations.
PIPEs and portfolio company debt
Almost two thirds of LPs are unhappy to see GPs making private investments in public equity (PIPEs). This view is shared by investors in all regions of the world. On the other hand, LPs in different parts of the world differ on GPs buying the debt in their own portfolio companies. While 58% of European LPs are happy in principle to see this happen, only 35% of North American LPs think it appropriate. Investors in Asia-Pacific are evenly split on the issue.