The value of permanent capital has never been clearer. Surging deal valuations are creating a narrower path for private equity to achieve desired returns. This increasingly competitive deal environment could be the push needed to send permanent capital vehicles into the mainstream.
Middle market private equity firm 3i largely invests its own capital rather than fundraising from limited partners, an approach that’s provided optionality on recent deals, co-head of North America private equity Andrew Olinick tells Mergers & Acquisitions. The private equity firm invested in discount retailer Action in 2011, for instance, but chose not to dispose of the asset on a normal fund cycle to reap further benefits. Action’s operating earnings before interest, depreciation, and amortization more than doubled in the five years through 2019 to €541 million.
Few private equity firms play in the permanent capital space due to investor demands for liquidity, Olinick says. Limited partners want either a term-limited investment horizon or equity issuance in a firm. That explains the rise of perpetual vehicles chiefly amongst large, publicly traded PE firms like KKR and Blackstone.
As more middle-market PE firms go public, they may be freed from some LP demands for short-term exits and other constraints. Middle market financial sponsor Bridgepoint announced IPO plans last month. The use of proceeds include boilerplate language on retiring debt and funding growth, but it could also point the way for other middle market funds to provide investors with the liquidity needed to pitch permanent capital vehicles.
The industry already embraces the concept of raising funds for deployment in acquisitions of “indefinite” duration: funds save on costs to raise, close, and dispose of assets in their portfolios, while earning higher (eventual) fees on commitments they hold for longer time horizons.
The idea is not new, but the rate of adoption is. And Credit Suisse analysts say it’s accelerating. We are approaching a tipping point when the composition of the largest private equity players’ fee-related earnings (FRE) derived from perpetual capital vehicles is so substantial it can offset the periodic FRE declines between flagship fundraisings. The analysts noted after Q1 earnings that Blackstone’s increasing share of permanent capital-derived fee revenue has several upsides: “high management fees (which also compound with appreciation), superior incremental operating margins, no net redemption risk and robust client demand given [Blackstone]’s strong brand/track record.”
Perpetual capital also provides a strategic edge in auctions. All else being equal, founders prefer to sell to a long-term investor who might be driven less by near-term exit considerations, Olinick says.
As private equity competes in a more crowded market for deals, the extra time and founder-centric sales pitch provided by perpetual capital vehicles could spur wider adoption.