The market’s been starstruck this year as private equity firms have backed a series of successful stock offerings. But when the stock market doesn’t provide a viable exit, firms are also borrowing behind the scenes, using their portfolio companies to raise cash.
Many of these loans aren’t going to fund improvements at the company. They’re being used to pay out dividends to existing limited partners.
Buyout shops have issued $11.3 billion in leveraged loans for their portfolio companies so far this year, compared to $7.16 billion of stock in buyout-backed public offerings.
A key driver behind this borrowing spree is the desire to curry limited partners’ favor while the firms try to raise new funds. Many existing investors are pushing to see returns before recommitting capital to a new fund, which has helped drag out the average time to close a fund, now averaging 20.4 months up from 11.4 months in the peak in 2007.
“It’s always a push and pull with legacy investors,” said A.J. Weidhaas, a partner in the private equity practice at Goodwin Procter.
The issue of returning capital while fund raising “has come into sharper focus,” Weidhaas said— an issue that gets more complicated when the limited partner at hand has limits for how much money it can allocate to private equity. Often times, cash must be returned, in these cases, before more can be invested.
This can put private equity firms in a bind, forcing them to choose between irritated LPs or tepid returns from a public offering. There are other ways besides borrowing to find the cash to give back to investors.
Selling an existing portfolio company to another private equity firm is one option. Limited partners can also take matters into their own hands and sell their stakes to other investors in the secondary market.
“You have a fiduciary duty to your investors to be honest with them about the best possible results,” says Richard Anthony, global head of the private funds group at Evercore Partners .
If leveling with LPs doesn't work, there are always leveraged loans.
A case in point: Petco Animal Supplies, the pet company owned by TPG Capital and Leonard Green. The company this week refinanced a $1.2 billion loan it expects to close next week, and $700 million of this total will be distributed to the firms’ limited partners and various investors.
There’s no question the IPO market has been on the up, though, especially compared to a meager $1.34 billion in stock offerings it was able to digest in 2010. Companies like HCA, expected to go public next week, Nielsen , and Kinder Morgan will have raised as much as $10 billion after their private equity parents put them out to market again. And the fact that the deal sizes keep getting bigger shows further promise.
Regardless, private equity looks set to benefit from the boom. Among current limited partners, 68 percent plan to commit the same amount or more to private equity this year, and new funds should get some $350 billion in commitments this year, data provided by Prequin show.