Borrowing Against Spreadsheets
Our CEO Brent slacked me a chart recently without comment. What it showed was private equity distributions to partners falling off a cliff following the 2016 vintage. What’s more, if you’ve invested in anything in the asset class since 2020 (and that’s five years ago now), you’ve seen almost zero return.
“Wowsa,” I wrote.
“This should be in our deck,” he wrote back.
Because apparently unlike many of our peers, Permanent Equity has sent money back to our Limited Partners since 2020. But this isn’t about us or our funds’ liquidity (you’re welcome, Compliance), but rather about the fact that not long after I received that from Brent, I read about Limited Partners – because liquidity is hard – increasingly borrowing to meet new private equity capital call commitments. And what are they borrowing against? The reported net asset values (NAVs) of those same non-distributing funds. In other words, Limited Partners who made capital commitments expecting some level of liquidity from previous capital commitments, have turned to NAV financing because they are not getting the liquidity they expected. So they need some other source of capital to make sure they don’t become Defaulting Partners (a status that typically comes with pretty onerous terms).
Uh oh.
The good news is that the fine folks in Private Credit providing this liquidity in the face of illiquidity are reportedly doing so for around SOFR plus 600 (or a 10% cost of capital). Since Private Equity returns are always so much higher than that, this is easy money for everyone all around.
The rub is that reported NAVs are numbers in spreadsheets and not numbers in the real world and that there is a difference between spreadsheet value and real world value. Further, if the real world value were the same or more than the spreadsheet value in this case, then I suspect that Private Equity writ large (not us!) would not have distributed so close to zero since 2020. Follow that to its logical conclusion and it would seem to be the case that LPs are borrowing against levered assets (secured by nothing more than a number in a spreadsheet somewhere) to buy more levered assets.
If that makes you queasy, it should. Putting leverage on leverage because of a spreadsheet is historically not an investment approach that’s worked out well for anyone. But, like the situation we talked about with Meta debt earlier this week, maybe this time will be different here, too.
– Tim
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