Private Equity (PE) funds offer access to various investment opportunities. However, the liquidity profile of these funds is inherently different from funds holding listed equities. In this short piece, we look at breaking down the liquidity dynamics in PE funds.
1. Illiquid Nature of Investments
PE funds are inherently illiquid. This means that once capital is committed to a PE fund, it cannot be easily converted back into cash or redeemed like shares of a publicly traded company. Instead, investors must wait for distributions from the fund, ordinarily generated by specific liquidity events, such as the (part) sale of a portfolio company, or from dividends. Liquidity may be available via the secondary market (See below)
2. Investment Period
The investment period refers to the initial phase, typically lasting 3-5 years. the fund manager identifies, evaluates, and makes investments in target companies. During this period, committed capital may be drawn or “called” by the fund managers as investment opportunities arise.
3. Capital Calls
Capital calls, also known as “draw-downs”, are requests from the PE fund to its investors to provide a fixed proportion of their committed capital. These calls finance the fund’s investments in portfolio companies, operational expenses, and sometimes follow-on investments in existing holdings.
4. Distributions
Distributions refer to the amounts that are returned to the investors following a realisation from a portfolio company sale (to trade, another PE Fund, or a listing), or from dividends received. These distributions are ordinarily in the form of cash. Distributions typically occur later in the fund’s life, during the harvesting or realisation period (often a number of years after the initial investment). The timing is a function of both internal and external factors, and depends on the success and strategy of the fund.
5. Fund Lifecycle
A typical private equity fund has a life of 10, sometime with the ability to extend by another year or two. This duration reflects that timing of entry and exits from portfolio companies. While a PE fund ordinarily starts making distributions mid life, some investments might take until year 10 (or later) to be realised. The latter part of the fund’s life is usually focused on the harvesting of assets through realisations.
6. Secondary Markets
While private market investments are illiquid by nature, a secondary market is evlving where investors (i.e. limited partners) can sell their interests in PE funds to other investors. However, these transactions can be complex to value, may require the fund manager’s approval and may have an associated cost (eg a discount to the underlying value).
Example
To better understand the liquidity profile of PE funds, let’s walk through a hypothetical scenario of an investor named Jane, who commits £100,000 to a PE fund with a 10-year lifecycle through the Treble Peak platform.
Year 1-3: Initial Investment Period
Initial Commitment: Jane commits £100,000 to the PE fund through the Treble Peak platform, but does not transfer the full amount immediately. Instead, she is informed she will be called upon to provide portions of that amount over the coming years.
Capital Calls: Over the next 3 years, the fund identifies promising companies to invest in. Several capital calls are made via Treble Peak during this period. By the end of Year 3, Jane has contributed 60% (£60,000) of her commitment to support these investments and pay for fund costs
Year 4-5: Further Investment Period, with some realisations
Further Capital Calls: The fund continues to make further investments and calls another 20% (£20,000) from Jane.
Recycled cash: The fund receives dividends and other distributions from their portfolio companies. This cash can be used to invest in further companies, as long as still within the investment period. Such investments could be funded from recycled cash rather than new capital calls.
First Distributions: In Year 5, one of the fund’s early investments is sold. The fund decides that it does not require the cash or liquidity at this time, and distributes the proceeds to its investors. Jane receives a distribution of £40,000 in Year 5.
Year 6-9: Maximising Value and More Exits
Further Distributions: Further fund investments are sold. From these exits, Jane receives distributions totalling £160,000.
Year 10: Final Exits and Closing of the Fund
Final Distributions: The fund sells its remaining holdings and distributes the final proceeds to its investors. Jane receives an additional distribution of £60,000.
Total Outcomes : Over the 10-year period, Jane had contributed £80,000 to the fund. In return, she received distributions totalling £260,000, representing a significant return on her investment.
Conclusion
Jane’s journey with the private equity fund offers a more nuanced perspective on liquidity in the private market world. While it is common to view private equity investments as highly illiquid, the structure of capital calls means that the entire commitment is not tied up from day one. Instead of paying the full amount upfront, investors like Jane provide capital in stages as the fund identifies and pursues opportunities. This approach offers a degree of cash flow flexibility to investors.
Furthermore, as investments within the fund mature and exit, capital is returned to the investors, providing a cash return before the end of the fund’s lifecycle. In Jane’s case, she received a distributions in Year 5, approximately halfway through the fund’s term.
While the long-term nature of private equity does require patience and a commitment to keeping capital invested, the phased approach to capital calls and the potential for earlier distributions highlight that private equity, while distinct from public markets, offers its own set of liquidity dynamics.
This content is for information illustrative purposes only. Treble Peak does not provide investment or tax advice, and information on this website should not be construed as such. Potential investors should seek specialist independent tax and financial advice before investing in any alternative investment. Past performance is not a reliable guide to future returns. Your capital is at risk.
