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Even as the denominator effect fades, LPs are tapped out

Realizations are key this year, even for funds seeking re-ups, according to a recent survey of limited partners.

The dreaded denominator effect, which has been front of mind for LPs since

last year, appears to have lost some of its bite more recently, sources tell me.

Public markets have improved, which is relieving overallocation issues for

many LP institutions. As public market holdings increase, private equity’s

percentage of an institution’s total investment fund shrinks. This has been

occurring more recently, with the S&P 500 jumping 16 percent in the first half

and the Nasdaq soaring by 32 percent, according to a Bain & Co half-year

private equity report.

Many LPs chose to wait out their overexposure issues since last year, and that

strategy appears to have paid off. “The denominator effect is getting erased,”

an investor relations exec at a mid-market buyout firm told me.

As this pressure factor eases, the biggest concern on LPs’ minds is slowing

distributions from a lack of exits. This is a result of the tough M&A

environment, which is gummed up by higher interest rates and tighter


Venture-backed M&A has been particularly slow. Just 429 US-based start-ups

backed by venture firms were acquired in the first half of this year, putting VCbacked

M&A on its slowest pace since 2013, when only 698 VC-backed start-up

got acquired, according to a report by Crunchbase.

And there is no relief to be had in the public markets, which have been shut

since early last year.

The third big exit path is large strategic buyers, but there are only so many of

those to go around. LP concern about distributions is borne out in a recent survey from placement agent Capstone Partners. The survey found “77 percent of LPs in Asia Pacific,

72 percent in North America and 57 percent in Europe said they have

experienced lower distributions relative to 2022.” With less capital flowing

back into LP coffers, capital calls have not slowed as much, “putting further

pressure on LPs’ ability to commit capital,” Capstone reported.

“Global LPs have diverse views when it comes to their requirement for

distributions to be made in prior funds before re-upping or investing in a new

manager but in 2023, realizations are key even in established GP relationships,

with the bar for new relationships remaining very high,” the report said. “The

survey shows that this expectation is particularly high in Europe and Asia

Pacific, placing considerable additional pressure on GPs who are looking to

raise funds.” Just 18 percent of North American LPs considering re-ups for “trusted

relationships” this year expect “meaningful distributions” from the GP’s prior

fund, compared to 46 percent of LPs in Europe and 41 percent in Asia Pacific,

the report found. Some numbers around this from Capstone’s survey:

For new manager relationships, 38 percent of North American investors are willing

to commit when there have been no realizations in the prior fund, compared to 20

percent of European LPs and 14 percent of Asia Pacific LPs.

99 percent of North American participants are willing to commit to new managers if

the prior fund DPI is up to 0.5x, compared to 86 percent of European and Asia Pacific


North American investors are more willing to commit to a re-up with minimal DPI,

“as long as there is strong underlying portfolio performance (66 percent North

America versus 39 percent Europe and 28 percent Asia Pacific).”

As GPs struggle to find exits, fundraising continues to fall for both venture and

buyout funds. Venture funds worldwide raised a combined $58.1 billion in the first half of

this year, down from about $100 billion each in the first halves of 2022 and

2021, according to Venture Capital Journal‘s H1 Fundraising Report. The

number of funds has also slowed. With just 255 venture funds closed

worldwide in H1, the year is on pace to hit about 500 closed funds, down from

846 funds closed in 2022 and an all-time high of 1,322 closed funds in 2021.

The story is similar story for North American buyout funds, which collected

$228 billion between January and June, down 26 percent from a year earlier,

according to affiliate title Buyouts‘ H1 Fundraising Report. Likewise, the

number of North American buyout funds that closed in H1 totaled just 347,

down 45 percent, according to Buyouts. Sources are telling me that LPs are mostly tapped out for the rest of the year, and are requesting fundraising GPs consider them for 2024. And even then, many LPs likely have their commitment schedules for next year set, setting the

stage for another potential year of sluggish fundraising.

“It’s a traffic jam at the moment of managers, and very few LPs with money,”

the IR professional told me.

Credit: Chris Witkowsky, editor of Buyouts

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