Mid-Market Funds Asking for 25% Carry

It is of course for the good of the LPs

Buyout firms have begun horse-trading size caps and carried interest on new funds, according to Buyouts Magazine. The article which I've since confirmed independently with several LPs “ alleges that numerous firms have raised carried interest on new funds from 20% to 25% (which LPs hate), in a de facto exchange for keeping fund ceilings below anticipated subscription (which LPs love).

It may seem equitable, but it's not. Moreover, it's intellectually dishonest.

This tradeoff gimmick is mostly coming from upper-middle-market firms, which make the following argument: "We only want to raise $1 billion for our next fund. That's more than we raised last time, but it's reasonable due to market opportunities, number of partners, etc. Our concern, however, is that even a $1 billion fund will not generate enough management fees for us to prevent top talent from getting poached by the $10 billion to $20 billion mega-funds “who obviously have a much larger fee stream. So we only have two choices: Either raise our fund size substantially (which we think there is enough LP interest to support), or increase our carried interest from 20% to 25%. We opt for the latter, because it's fairer to our dear limited partners."

....

Finally, let me briefly address the crux of this mid-market argument: That such steps are necessary in order to retain key talent.

I understand the sentiment, but think it's ultimately a red herring. If a firm like Blackstone wants to poach a mid-market investor, it will always be successful if compensation is the individual's deciding/motivating factor. Raising carry on a $1 billion fund from 20% to 25% might narrow the chasm a bit, but not enough to build a bridge. The reason that most mid-market pros stay put is because they prefer the mid-market biz which is yet another argument for sticking to fund-size knitting. If your performance is strong enough, LPs will likely consent to the carry increase anyway.

Full analysis of a Buyouts article by PE Hub

Indy Mac

Indy Mac (NDE) was the biggest originator of Alt-A mortgages in 2006. Share price has fallen substantially recently but could have further to go if Alt-A blows up.

At retail (Schwab), you cannot borrow shares to short them unless you make special arrangements, so this thought is clearly in the air...

This is not investment advice

Where Does The Liquidity go?

Josh emailed me a very good question the other day about the Predictions post and asked, "if all of this happens, where do the China and petrodollars go next? Is it to Euro-denominated assets?"

I thought to myself that was an excellent question, wondered what liquidity really means, and decided that I did not have a good answer to either question.

So I am going to think about this, but I am open to ideas.

Skadden Prepares For a Wave of Bankruptcies

From Dealbook

An excerpt below:

Mr. Milmoe, who led the Skadden team that advised Refco, the commodities broker that collapsed into bankruptcy in October 2005, was asked recently about the next wave of bankruptcies. Following are excerpts from the discussion.

Q. Why has corporate bankruptcy activity been so slow?

A. It’s part of a normal cycle. Over 35 years, give or take, we see high levels of activity every five to seven years with some regularity. The deals most easily charted are the ones that are a function of economic policies: easy money versus tight money. At the moment, we are experiencing a massive amount of available cash, and that cash for investment has been available for two and a half to three years. What we’re predicting is that companies who were bailed out of a difficult situation two or three years ago are now coming up on a situation where they will have gotten in trouble again. Some percentage of those companies will continue to be rescued by available capital. But with others, people will say, “This was a bad investment, and we’re not going to throw more good money after bad.”

Q. When you look at the recent boom in leveraged buyouts, do you think of it as bankruptcy work in the making?

A. During the last cycle there was — or there used to be — a stigma associated with private equity firms’ having their portfolio companies go into bankruptcy. But if you look back at the period from 1999 to about 2002, enough portfolio companies went in that a flippant kind of remark gained some currency: “If at least one of your companies doesn’t go into bankruptcy, you’re not trying hard enough.” The analogy is: “You’re not going to hit home runs unless you strike out.” Of course, I’m a lawyer, and I bill by the 10th of an hour. There are multibillionaires out there who got to be multibillionaires by taking risks, identifying companies that had the wherewithal to load up on leverage and still make wonderful equity returns. Still, you hate to see decisions being made that are not wise.