In 2022, private equity firms will continue to find new and interesting ways to capture the vast sums of capital that institutional investors have amassed from favorable market returns, says Todd Boudreau, a Boston-based partner with law firm Morrison & Foerster.
Thanks to percent returns in the high 20s and low 30s for their portfolios, large institutional investors are finding it challenging to reach their allocation targets in private equity, says Boudreau, who represents institutional investors, including pension funds, as well as advising PE firms.
“They have to write bigger checks; they have to do bigger deals; they have to deploy more capital. The process of finding interesting managers is difficult,” he says.
PE firms will help relieve the institutional investors of this burden with more co-investment opportunities, offering lower fees than the standard 2 percent of assets and 20 percent of returns for a direct investment by the investor alongside the PE firm’s investment in a given target.
The pre-negotiated terms might include no fees at all. The incentive for the PE firms? They can do larger deals with the help of the co-investment capital–also known as sidecar deals—than they could on their own.
A sidecar deal could help, for example, a middle-market PE firm that’s limited by its investment documents to investing no more than 5 percent of its fund’s capital in any one deal, Boudreau says. With the co-investment capital, that firm might double its investment capital and acquire a larger asset. A sidecar deal is when a PE firm allows institutional investors to invest directly alongside the PE firm’s own investment.
Look for 2022 to also bring more continuation funds, Boudreau says, where a PE firm offers to roll over investments in a fund that’s nearing the end of its lifecycle, into a new fund that carries on some of the same investments from the old fund. This allows PE funds to hold on to companies beyond the standard 7- or 10-year life of a fund instead of selling prematurely. It also allows investors to capture returns from those longer-life assets as well.
Another trend that may pick up in 2022 is the formation of cross-over funds, where PE firms launch funds that mix PE investments with other types of investments, like public equities, Boudreau says. A high-profile example of this is Sequoia Capital Global Equities, a $12 billion fund by the venture capital behemoth that invests in both public securities and private companies.
– Keith Button