Private equity funds: From obscure strategy to industry

  • Matt Williamson

    Matt Williamson

 
By Matt Williamson
American Private Equity Group
Updated 10/19/2020 11:52 AM

For the last 50 years private equity has grown from an obscure strategy used by Wall Street mavericks to an industry that manages vast amounts, employs hundreds of thousands of employees and attracts some of the best human capital. The question is, are we approaching cataclysmic changes in the PE industry and has the investment community been paying attention?

Furthermore, will PE funds continue to be a vibrant investment option in the next 10 to 15 years? As you look ahead, you might be wondering what the future has in store for the large PE firms.

                                                                                                                                                                                                                       
 

The industry has come a long way since KKR & Co. started applying their niche strategy after its founders left Bear Stearns, inspiring founders of Blackstone, Carlyle, and others to start and grow their businesses, shaping today's established private equity industry. Some call PE an asset class and some, like Warren Buffett, call it a compensation scheme.

Nevertheless, what we call PE today is not any different from what successful families have been doing for hundreds of years -- holding private equity stakes in businesses and real estate assets for long periods.

Using relationships with bankers to finance these businesses and assets is a standard tactic for family holdings. In fact new or existing partners taking each other out is the usual exit strategy, while expanding to other businesses and industries has been their diversification strategy. Private owners don't diversify because they're unsure about the future of their current business. They add to their existing holdings where they see profit opportunity.

This contradicts what business schools are teaching today -- to invest in many businesses and in many sectors -- because you don't know which ones will perform. The question is, has today's PE industry reached maturity stage? Have the PE firms' owners invested their own money in these funds? Are PE firms taking themselves public an indication that the owners are ready to exit? Are they exiting because the industry will not be profitable in the future, or are they unsure how the organization will perform once they exit? If the founders are uncomfortable, why would the limited partners be confident?

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Is this the reason small private investors will now be allowed to invest in PE via their retirement accounts? They should have been able to do that 30 years ago when university endowments started investing in PE. If the founders want out, will they stay around for a while to make sure the C-suite is ready to run the show without them?

Will family offices and high-net-worth individuals keep investing in private equity funds or have they seen that they can do better by having their own analysts in-house and investing in their own deals? Will they keep control of their capital and partner only as part of a joint venture in club deals with the PE firms, negotiating the terms for each deal? Even more, have the family offices developed the deal flow they need to satisfy their appetite for investing? They answer is yes; the family offices have satisfactory deal flow.

Interestingly, some of the large PE funds don't get this deal flow because their minimum requirement for equity investment is so large that it disqualifies them from most deals today, both in real estate and in corporate deals. This is because the size of the funds they manage are so large that they have to deploy their equity in very large amounts. They compete with other large PE funds for a few large deals, resulting in fierce competition that pushes prices to higher levels.

For these reasons, we believe there is a good chance large PE funds will disappear in 10 to 15 years, or they won't play the same role as they have for the last 50 years.

• Matt Williamson is an author, speaker and CEO of American Private Equity Group and American Private Water Group in Naperville.

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