Private Equity Keeps Inventing New Ways to Give Cash to Investors

Private equity firms are increasingly employing innovative strategies to distribute cash to investors amid a persistent three-year deal drought. These methods include leveraging portfolio companies with new loans, utilizing continuation vehicles to extend holding periods for assets difficult to exit, and further rolling assets into newer 'CV-squared' structures. This reflects PE's adaptation to a challenging M&A environment, focusing on alternative liquidity solutions for limited partners.

Analysis

Private equity firms are contending with a persistent M&A and exit market slowdown, now extending into its third year, which is compelling them to devise increasingly sophisticated financial structures to generate liquidity for their limited partners. The industry's response involves a pivot from traditional asset sales to alternative capitalization strategies. These include leveraging portfolio companies with new debt to fund distributions, as well as shuffling assets into 'continuation vehicles' to extend holding periods. The emergence of even more complex, second-generation structures, dubbed 'CV-squared', signifies the depth of this liquidity challenge. While these innovations demonstrate adaptability, their defensive nature underscores the ongoing weakness in the dealmaking environment, forcing fund managers to prioritize interim cash returns over waiting for optimal market conditions for exits.

Key Decisions for Investors

• Investors in private equity funds (LPs) should conduct enhanced due diligence on distributions originating from continuation vehicles or leveraged recapitalizations, assessing the fee structures and potential impact on the long-term value of the underlying assets.
• For those invested in publicly-traded PE managers, the increased reliance on these alternative liquidity solutions serves as a key indicator of continued pressure on the M&A exit market and may signal a delay in realizing more profitable performance fees from traditional asset sales.
• Credit investors should closely monitor the balance sheets of PE-owned portfolio companies, as the practice of taking on new loans to fund investor payouts could increase leverage and elevate credit risk within those specific operating businesses.