Feb. 23 (Bloomberg) -- U.S. private equity firms are holding companies longer than they have in more than a decade, hurting fund returns and setting the stage for exit activity to increase this year, according to a new report.
For companies buyout firms sold or took public in 2011, the median holding period was 4.81 years, or 25 percent higher than before the 2008 financial crisis, according to a report this month by researcher PitchBook Data Inc. Private equity firms have made more than 12,500 investments since 2002 yet have realized fewer than 3,500, the company said.
“When these firms had built their original models in, say, 2005, they hadn’t factored in the size of the crisis that was to hit three years later,” Adley Bowden, director of research at Seattle-based PitchBook, said in a telephone interview. “They now have this huge inventory of mature companies that are pushing their normal exit timetable.”
Big private equity firms may be forced to search for exits this year as they seek to raise new funds. Fund returns, a measure that firms use to market themselves to potential investors, are negatively affected as companies mature in a fund’s portfolio past about five years, according to the report. Funds that began investing in 2005 have returned a median of 30 percent of their limited partners’ capital, PitchBook said.
“The longer you hold these investments, in order to maintain the return that you had promised either you have to sell the investments for more or you have to take less of a return,” Bowden said. “Right now that’s fueling a sense of urgency around exiting some of these companies.”
Buyout funds globally are trying to raise about $740 billion, London-based researcher Preqin Ltd. said last month. KKR & Co. is seeking $10 billion for its next private equity fund, two people with knowledge of the plans said in November, and Washington-based Carlyle Group LP is set to begin marketing funds, according to a person familiar with its plans.
As a result of declining exits, private equity firms may close funds before reaching their capital targets or may abandon fundraising until market conditions improve, Preqin said in a report in December.
Exit activity in Asia has proved more resilient, with sales steadily increasing since 2009, according to Preqin. Globally exits reached a five-year low in the fourth quarter of 2008 as the financial crisis sapped available capital.
Bowden said he’s optimistic that buyout firms will sell more of their investments this year. Companies looking to acquire others strategically have built up cash, and U.S. buyout firms seeking to purchase private equity-backed companies from rivals have about $425 billion at the ready, he said.
Capital Gains Tax
“You hear every day how these companies have record amounts of cash on their balance sheets,” Bowden said. “If they can’t grow organically, they’re going to need to be acquisitively growing.”
With the long-term capital gains tax rate set to increase in 2013, private equity firms may be motivated to exit investments before year-end to keep a higher portion of the profit, PitchBook said. If the U.S. decides to tax the share of investment profits that buyout firms receive -- known as carried interest -- at the higher rate for ordinary income instead of as capital gains, the firms may have an additional incentive, Bowden said.
“These firms want to make sure that they do things as tax efficiently as possible,” he said. “If a higher tax on carry takes immediate effect and you don’t have protection built in, obviously you’re going to want to sell in December, not January.”
--Editors: Josh Friedman, Steven Crabill
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