Friday Letter mid is the new mega

Why many LPs are far less enthused about large buyout funds, and what that means for the private equity industry.  

Coming out of the recession of 2001 to 2002, many large buyout firms experienced a kind of perfect storm of economic conditions. It was a perfectly benevolent storm. Prices were down, strategics were knocked out of the market, debt became increasingly cheap and plentiful, and a rising stock market meant exits galore were on the horizon.

On the fundraising side, another (good) perfect storm was brewing. Limited partners around the world began drastically increasing allocations to private equity, cognisant as they were of the relative outperformance of this asset class and emboldened to throw old stock-and-bond recipes out the window. The chief beneficiaries of this capital gusher were the very largest buyout firms, who by 2007 were receiving individual capital commitments of $500 million, $750 million, $1 billion or more as GPs attempted to outdo each other in raising dizzyingly large funds.

But the buyout opportunity targeted by these superfunds did not hold its momentum. And now, according to many sources within the fundraising market, the enthusiasm among limited partners for very large funds is on the wane.

You’d be surprised the kinds of big names to whom LPs are saying “no”, a placement agent tells PEO. The alternatives head of a major retirement system tells us the pension is currently not committing to mega-funds. Why? It’s near impossible to put together debt for very large deals in the current market. And now that the stock market has cratered, will corporate boards really entertain going private?

Many LPs are now focusing on the deal-size range in which many of today’s Goliaths built their track records, and this can broadly be defined as the middle market. (They are also focusing on distressed and secondaries strategies, as an upcoming special report in Private Equity International will detail).

This news will be met with subdued cheers by true middle-market GPs. Subdued, because there still isn’t enough cash for anyone but the most seasoned, impressive deal teams.

Clearly this new focus on smaller deals does not spell the end of super-sized private equity – witness the recent $13.7 billion Carlyle close. But it portends a massive retreat from the $20 billion frontier, headed back to a market that looks a bit more like it did in 2002. The big difference, of course, is that there are many firms that are going to find it quite painful to cut back from the glory days of early 2007, and not all of them will survive the amputation.