Posted by: Nicholas Davis | March 6, 2009

Zombie PE firms!?

A friend and I were just discussing the “bad bank” phenomenon of curiously alive yet technically insolvent financial institutions, when the subject of the difficulties facing PE firms came up.

I hadn’t realised this, but my friend pointed out that a number of Australian PE firms were essentially bankrupt, with many of their highly levered investments, bought at the top of the market last year, now worthless and in administration. The interesting aspect of this comes from two additional facts: 1) lock up periods still in operation effectively act to prevent investors in these funds from leaving, and these losses from being realised, 2) many firms have unspent capital, often in the form of new funds raised in the dying days of the boom.

What this implies is, first, that there are significant numbers of investors out there that are paying management fees on funds that are essentially worthless – for example, a $400m fully invested fund, locked up to 2012, where the vast majority of investments are currently in administration or almost worthless. Some PE firms are therefore collecting 2% on the full value of the funds raised; money which they have already lost.

To add insult to injury, the additional capital is presumably being touted as the way out of the mess for these firms who will undoubtedly claim they can buy new assets at bargain basement prices and thereby make up for their previous mistakes. But, particularly for young firms, having unrecoverable funds dating to 2006 or 2007 means that track records will suffer and new capital will be very tough to raise – and so the effect of new, unspent funds will simply be to prolong the death throes of the firm, who must face the end of lock-up periods with a morbid fascination. Meanwhile, of course, investors are also paying management fees on this next tranche of cash, which is being invested by firms with effectively no future that have technically lost already (often the same) investors enormous sums of money. Zombie PE firms!

Now I’m told that in many funds there is a clause that allows a certain percentage (80%?) of investors by unit trust value to dissolve the fund or transfer management, which apparently happenend to ABN Amro at one stage. Perhaps it’s time that investors who are paying management fees on non-existent investments did the same to their other funds… I wonder, how widespread is this phenomenon, and who knows about it?



  1. Ouch, that is harsh.

  2. Amazing, hey? Now I need to go and verify this… šŸ™‚

  3. Just a few thoughts:

    – Usually no (or very low) fees have to be paid on cash sitting in an account. Alternatively, the fund can only drawdown cash once an investment is due.
    -If (fixed, noticeable) fees are due, it’s usually a percentage of the value of the investment/ shares. If the investment is valued at zero (due to being in administration), no fees are due.
    – Losses of the investor are realised on the investor’s balance sheet by writing down the investment. The effect of the lock-up period is that the investor can’t get back liquid assets from the fund itself and may be subject to drawdowns.

    However, in general, I expect a lot of mergers among PE firms in the short/medium term. Anything below EUR 100m is (apparently) not competitively manageable.

    • Thanks Daniel, that’s helpul information! So my above post could be at worst part of anti-PE firm propaganda, at best an exaggeration of the situation of investors locked-up in failing firms. I’ll go back to my source and continue the debate.

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