Friday Letter Milli Vanilli

Bargain-basement deals for outdated, out of favour music albums bear a striking resemblance to a growing segment of the private equity market.  

Scattered abundantly amongst the cultural detritus of the last century are many, many used, bargain-basement copies of Milli Vanilli’s 1989 CD, “Girl You Know It’s True”. Reason:  No one who bought this cringe-inducing collection of songs wants to keep it.

What does this have to do with private equity? As a tidal wave of “used” fund interests begins to wash through the secondaries market, pay close attention to which GP names are most often for sale. It’s a powerful indication of LP appetites and opinions, and could signal a Milli Vanilli-esque fate for certain GP franchises.

For its upcoming September issue, the editorial team of Private Equity International magazine is working on a special report about the private equity secondaries market. Here’s a preview – while the participants in this fiercely competitive market take pains to differentiate themselves from each other, they all agree on this: deal flow is booming.

Some sellers just need cash – and fast. But others, such as CalPERS, want to pare back their relationships with what they deem to be mediocre GPs in order to commit more with fewer, better GPs. While professional buyers of secondary interests sometimes agree to commit on a primary basis to the next fund as a condition for doing the secondary transaction, it is not necessarily the case that they are in love with the GPs they buy. Many simply believe they are buying an asset at an attractive price, with risk carefully factored in. They probably won’t be committing to the GP´s next fund. And neither will the seller.

To be sure, having an interest in your fund put up for sale is by no means cause for shame or alarm. As secondary pros have long proselytised, sellers have many reasons besides revulsion for wanting to transfer their LP interests to others. That said, if interests in XYZ Capital funds suddenly and simultaneously go up for sale from all kinds of LPs all over the world and change hands for discounts to NAV that are well below the market par, it’s safe to say that LPs are having an allergic reaction to XYZ Capital, and that its future is in question.

It is astonishing how many unworthy GPs survived through the last down-cycle of 2002. But there were some notable tech-related franchise implosions. Many market participants are predicting that the current turbulence will lead to even more GP extinctions, and good riddance. Private equity firms that invest poorly should become extinct while strong performers should be rewarded with further and bigger capital commitments.

The secondaries market has many utilities, but one may be as a prism through which the future health of private equity firms can be viewed. We will soon witness early signs that the pretenders out there are going the way of Milli Vanilli. You know it’s true.