Much tougher partners

Private equity fund investors are refusing to be lenient with managers who are not showing the expected results, writes Christopher Witkowsky.

U2 frontman Bono famously mourned: “I still haven’t found what I’m looking for”.

Today, Bono may be able to sing a new dirge lamenting that the limited partners of his private equity firm, Elevation Partners, haven’t realised the returns they were expecting.

Elevation’s LPs recently denied the firm’s request for an extension of its debut fund’s investment period. The investors told Elevation it “needed to concentrate on the portfolio, get some realisations and return cash to them and hopefully in a year if that all works [the firm] would be able to go out and raise capital and have a Fund II”, Kevin Albert, Elevation’s former fundraising chief, told PEO in an interview this week.

Elevation is not alone in its illiquid travails. LPs in general are demanding results before they agree to make concessions, or dig into their wallets for fresh capital.

This has been the fundraising situation for some time now, since the downturn of financial markets in 2008. The example of Elevation, and another firm, ArcLight Capital, is fresh evidence of the changed stances of LPs, from once-compliant partners during the boom years to sharp-eyed examiners of performance today. A firm like Elevation just doesn’t get a free pass from investors anymore, even with the outsized presence of a star like Bono.

Christopher
Witkowsky

Elevation has had two exits since its fund closed in 2005 on $1.9 billion. The firm made a small profit on its investment in smart phone maker Palm, investing a total of $460 million in the company, which was later sold to HP for $485 million. The firm also exited video game developer VG Holding to trade buyer Electronic Arts in 2007. Elevation reaped a 2x return on the investment, selling the company for $620 million after paying about $300 million in 2005. To better these results, Elevation will have to work hard to turn more investments into realisations.

Meanwhile energy-focused firm ArcLight is finding fundraising tough going as LPs also demand more distributions before committing capital to the new fund.

ArcLight raised about $2.1 billion for both its third fund in 2006 and its fourth fund in 2007. The firm hauled in $1.6 billion for its second energy fund in 2004 and $950 million for its debut fund in 2003. It’s not clear how much ArcLight has raised for its fifth fund, but sources tell PEO the firm is switching placement agents amid the fundraising. MVision, which was helping ArcLight raise the fund, is off the assignment, sources say.

As of 31 May 2010, ArcLight’s Fund IV was generating a 5.45 percent internal rate of return; Fund III was producing a 3.19 percent IRR; and Fund II was carrying a 14.6 percent IRR, according to performance data from the University of Texas Investment Management Company.

Both cases make very clear that limited partners want to see results before placing more capital with firms they’ve backed in the past.

As LPs refuse to pony up more cash for new funds, and as investment periods run out, management fees for certain GPs will start to dwindle. This will mean serious belt-tightening for some. Those GPs that can’t produce distributions can no longer rely on a fresh fundraise to keep the lights on.