Friday Letter the wheels are coming off

Congratulations if you have just closed a private equity fund. Now you just have to sit tight and watch valuations bottom out. It is a perfect time to enjoy the summer with the kids, although you may have to spend more time with the portfolio, which will probably need a helping hand.

Well done, too, if this letter finds you on the verge of closing. The next few months are bound to be hard work as you chase those last few cheques and encourage recalcitrant investors over the line. But you probably will get there, thanks to limited partners still implementing the allocation decisions they made just before the crunch began to bite.

The latest numbers for Europe and the US – leaving aside the emerging markets where scores of private equity investors are now looking for performance – show fundraising has been holding firm. In the first quarter of 2008, US private equity fundraising was up 32 percent on the same period last year, to $58.5 billion across 81 funds, according to Dow Jones. European fundraising was also up, to $17.3 billion across 38 funds, a 24 percent volume increase. Clearly fundraising lags the market for deals, where the tumble weed has been blowing across an increasingly desolate landscape.

But for how much longer? Recently there have been signs that finally, big ticket private equity fund formation is beginning to slow. For example: Kohlberg Kravis Roberts has delayed the launch of a new mega fund, because it still has plenty of dry powder in the current one.

At the same time, limited partners are beginning to feel less cash-rich. Since the credit markets closed, the quick returns from recapitalisations have gone. Until then, LPs had been struggling to redeploy all the cash that was flooding back so quickly. Now that distributions have slowed to a trickle, investors are under less pressure to invest, and have more time to assess new opportunities.

Yet another reason why the outlook for private equity fundraising is worsening is the prospect of equity markets going down. Falling public equity valuations in their portfolios tend to leave investors over-allocated to private equity; as a result, even the most committed participants in the asset class end up having to greet the next generation of buyout funds being organised with caution. 

Whichever way you look at it: private equity is bound to have less capital coming its way in the next 12 months. A hardcore of long-term investors, veterans of the cycle, should ensure the market doesn’t grind to a halt completely. But if the wheels do come off your fundraising, be prepared to wait for road side assistance. It might take some time to arrive.