Professor Glenn A. Okun
Private equity’s waning opportunities for its portfolio companies to be sold or go public has led general partners to employ can-kicking tactics to defer realizations into a hopefully brighter future of elevated liquidity and valuation multiples. Now, private equity is getting kicked by the can.
While the M & A and IPO markets are providing a much lower number of exits since the peak, private equity general partners have been reluctant to transact in an environment of more conservative valuation multiples. Exits, where available, would lead to disappointing portfolio company investment returns.
The can-kicking
General and limited partners have been managing this problem by using can-kicking techniques. Continuation funds, secondary sales of limited partnership interests and NAV loans effectively postpone the day of asset realization reckoning.
Can-kicking is costly. Diminished distributions from funds, the natural result of can-kicking, have damaged the private equity fund raising environment. Many institutional investors recycle their cash distributions from funds into new commitments to the asset class. Fund raising is also hampered by track records of performance that lack a sufficient number of realized portfolio company returns that are required to appear credible to investors.
Getting kicked by the can
Funds are also getting kicked by the can. Some limited partners have made subscription to a general partner’s new fund contingent on the realization and distribution of portfolio company value from that general partner’s existing fund.
Limited partners’ liquidity mandates can damage portfolio investment returns. In the current environment, only the most attractive portfolio companies can be sold or taken public, albeit at disappointing prices.
The effect of suboptimal exit values is magnified in venture capital and private equity because a small percentage of portfolio companies must be relied upon to supply the funds’ overall return. These untimely portfolio company exits doom fund performance.
Can-kicking and being kicked by the can both damage venture capital and private equity capital markets. Barring a resurgence in attractively valued exit transactions, these industries will shrink in size. Actionable entrepreneurial opportunities will become more limited as a result of a diminished supply of capital.
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