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Fundraising Troubles Mean Danger for PE Funds

In spite of increased deal-flow, private equity funds are finding it harder to raise cash, according to data for 2010.

Investors apparently are still reluctant to pony up money for private equity funds.

A total of 484 PE funds raised just $225 billion in 2010, the lowest sum in six years, according to a recent report by Preqin, the London-based data expert. In the fourth quarter alone, 92 funds raised a mere $32 billion.

What’s more, the private equity funds worked much harder to close their fund.

Funds that reached a final close in 2010 spent an average of 20.4 months on the road – up from 9.6 months in 2004.

Investor disinterest is somewhat surprising, given that the PE market has been showing signs of revival of late.

For one thing, deal flow is up. According to Dealogic, in 2010 there were 593 buyouts, up 14 percent from 519 the prior year. Of course, this was way down from the peak of 2006 and 2007, when there were between 1000 and 1100 deals in each of those two years.

The dollar value of buyouts in 2010 surged nearly 88 percent, to $92.7 billion, but still down more than 75 percent from the 2006 peak.

Meanwhile PE sponsors have become much more active unloading earlier investments.

According to Dealogic, US financial sponsors announced 277 M&A exits last year, the most since 2007, when it announced 240 deals. Total value of M&A exists last year worked out to $106 billion, second highest in the decade and just slightly less than 2007. So, if deal and exit activity are picking up, why aren’t investors making new commitments?

Tim Friedman at Preqin says not everyone found things to be so challenging last year. Some firms that have done well in the past with earlier funds did not experience as much difficulty raising money.

However, he does concede that although investors did and do have money to commit for the right opportunities, aside from the top firms, fund managers have struggled to gather support as many of the investors out there are very cautious before making new commitments to such a long term asset – especially after what happened in recent years with the value of big buyout funds taking a hit following the downturn.

This said, Friedman believes the surge in the number of exits and new deals will give investors both increased confidence towards the market, and also additional capital to reinvest into new vehicles. “We’ve spent a lot of time talking to institutional investors, and their feelings towards private equity are mostly positive, and the majority will be increasing commitment levels in 2011,” he adds.

“At the same time, although 2011 is looking promising in terms of fundraising, investors are being much more discerning,” Friedman concedes. “Automatic re-ups are out, investors are looking at funds with increased scrutiny, and as a result there are going to be a lot of casualties in the market.”

He stresses that due to the nature of PE, funds that cannot raise money will not go out of business with a bang, but will basically end up winding up their existing investments and quietly shutting up shop in years to come. This could be a big group too, given that there are currently 1,600 funds on the road right now seeking $600 billion and more are planning to join them soon.

However, he expects fundraising to hit $300 billion or so next year, clearly not enough to satisfy the ambitions of all these managers. Clearly, investors still feel burnt by the excesses of a few years ago, when fund sponsors raised more money than they could spend, way overpaid for companies and investments became even more illiquid than they normally are.

Maybe they are suspicious of many of the sponsors and want further proof they have cleaned up their act and learned their lessons. But, the history of Wall Street in general is they always repeat earlier sins at the top of the next cycle.

And it looks like a significant number of PE firms will pay dearly in the next few years.

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