News analysis: The extend is your friend

As seen last week with BC Partners, GPs increasingly need to extend investment periods in order to deploy dry powder that languished during the economic crisis.

Private equity firms that raised capital in the fundraising boom from 2005 to 2007 are at or approaching the end of their five-year investment period, but many still have significant amounts of undeployed capital.

As the end of these investment periods near, many GPs have decided to go back to LPs and ask to extend the investment period in order to take advantage of what many believe to be a more promising and liquid investment environment.

Extensions must be approved by the LPs. Private equity firms typically raise fund with the obligation to invest it over a certain number of years. Securing permission to extend this period can be tricky.

However, in the current market, some funds still have significant amounts of capital, and many are loath to return this to investors, given the challenge of raising fresh commitments in the current market.

When approached by general partners about investment period extensions, LPs need to consider the impact of an extension on their timing expectations and management fee step-down.

This article is the second of a two-part series that explores the phenomenon of “stale unfunded” commitments and what general partners can do to change this from a challenge into an opportunity. In the first article, we explored the investor relations benefits that can come from relieving LPs of “stale” commitments that will never be drawn down.

Without LP permission, there is little wiggle room for extensions, according to a New York-based fund formation lawyer. “The terms do not generally permit the extension of the investment period unless an amendment to the agreement is sought, which normally requires approval by a certain percentage in interest of LPs,” the lawyer said.

Winning LP approval is often based on the way in which the private equity firm communicates the matter.

“The [private equity] firm needs to think about how they approach investors. The case must be clear [for why the extension is necessary],” the lawyer said.

Extensions of the investment period may be difficult to come by as many LPs currently find themselves over-allocated to private equity. In fact, some firms with new fund offerings have tried to sweeten terms by offering shorter, not longer, investment periods.

One firm that was successful in convincing LP to extend the fund was BC Partners, which this month won an extension to the investment period in its €6 billion eighth fund, stretching the investment window to June 2011 from November 2010. BC Partners was also granted a two-year extension of the hold period in its €4.3 billion seventh fund.

GPs like BC will welcome an extension because it eases the pressure to complete deals and gives the GP more time to raise its next fund.

To get the extension, BC Partners needed more than two-thirds of its investors to approve the change in its investment period. It was ultimately supported by 90 percent of investors, according to a source with knowledge of the situation.

BC’s Fund VIII has about $1 billion left to invest, according to the source. The investment period extension was not necessary, the source said, but takes some of the pressure off the firm to get the capital invested right away.

LPs that invested in BC Partners’ European Capital VII fund include the California State Teachers’ Retirement System, the Ford Foundation, Maryland State Retirement and Pension System, and the Pennsylvania State Employees’ Retirement System.

There are various reasons why GPs have been slow to commit capital.

In BC Partners’ case, the firm held back on investing the fund during the credit bubble from 2006 to 2008, the source said. The firm then deployed 30 percent of the capital in the fund after Lehman Brothers collapsed in 2008.