Private Equity Companies/Partners/Owners are Engaged in Standard and Exotic Loans

Over the last three or four decades executives of private equity companies ruled the roost where investors from all over the world would beat a path to their front door looking to invest in their next big fund. However, times have changed, declining valuations and much higher interest rates have made it harder to sell assets, raise new money for investments and fund distributions to their investors. 

Today the biggest investors or backers of these private equity funds have turned the tables and are demanding more from private equity owners/directors, such as if we invest you now have to invest more of your own money. Throughout the private equity industry, company directors/owners /partners are having to take on debt and pledge their personal assets (homes, paintings, yachts etc) in order to appease their larger investors.

In 2023, contributions to equity from the private equity sector was circa 2% and in 2024 is circa 5%, and according to analysts, in some cases as high as 20%. In order for some of these executives to raise the requisite amount of cash, they have been taking out high interest loans where the rate is anywhere between 10% and 20%, and some banks, so experts advise, are demanding collateral of all personal assets. Such is the need for more cash in the private equity sector, some money managers are now scrambling to get cash, and  private lenders such as Oak Capital Management are making funds available. 

Apart from the personal loans the industry has seen loans that have been rarely used before. Below are a few examples.

*Manco Loan – This is a relatively new loan where appetite is going through the roof. Taken by the entity or management company that oversees the private equity investment, the collateral consists of cash flows such as equity returns or fee streams. This loan is usually used for funding an individual partners’ equity stake in a private equity fund, succession planning (focuses on maintaining a company’s talent and ensuring a smooth transition should existing leadership leave) and seeding new strategies. Currently there is no data available for the size of outstanding loans, but experts suggest that deal sizes range from USD50 Million to USD350 Million.

*Net-Asset-Value or NAV Funding- This form of finance is usually backed by a pool of portfolio companies within a fund, where the funds are utilised by private equity companies to help return money to investors. However, experts in this area advise that this form of finance is likely to dilute returns at later dates and effectively leaves the fund paying an interest rate that is not to everyone’s liking. Estimates from analysts and experts alike suggest this form of financing will increase circa 700% by 2030 to USD 700 Billion.

*Collateralised Fund Obligations – This form of finance bundles stakes in funds holding private equity owned companies, which are then packaged into one security. Risk categories go from senior to equity tranches and coupons are paid from the cash flows generated by the companies. If the investment goes south the equity tranche takes the first loss, but as it is the riskiest tranche interest payments  according to experts are 20%.

In an industry sector that has been used to cheap money from 2010 to 2021, this scrambled rush for loans sees a marked reversal of fortunes. The industry has been facing geopolitical and economic uncertainty plus much higher interest rates which in 2024 has seen takeover volumes down by 50%. Indeed, cash on hand at private equity companies is, according to recent data released, at its lowest mark since 2008 (Global Financial Crisis). Furthermore, experts advise the more influential investors (e.g., state pension providers and sovereign wealth funds) have said they will only commit to new funds if capital in the old funds are released first. 

The private equity industry is valued by analysts at circa USD8 Trillion and has undergone a real cultural change with the balance of power shifting away from the private equity companies to the Limited Partners or LP’s (investors). It is suggested that before too long, these LP’s could cut out the middleman and set up their own in-house private equity companies. This will leave the current players in the market struggling to find the best investment deals to offer a smaller number of investors.