Private equity firms have long operated like a methodically revolving door: they take in struggling businesses, improve them, and then sell them at a profit a few years later. No company stays in the metaphorical building for very long; given that a private equity firm’s intention is always to sell, the walkaround, as it were, rarely stretches for longer than five years.
Recently, however, some private equity firms have opted to slow their revolving doors beyond the typical five-year span and consider the benefits of holding onto businesses for a decade or more.
These “permanent capital” vehicles offer fund managers a means of maintaining their financial resources indefinitely — without the constant and costly dealmaking that short-term buyouts typically require. The extended timeline can lead to more stable and better-managed businesses, as well. Because buy-and-hold investments don’t need to adhere to the strict short-term and capital-raising benchmarks that typical private equity investments require, long-held assets have more of an opportunity to implement long-term strategies for business growth and development.
For some firm executives, permanent capital isn’t just a promising trend in private equity finance, but a necessary correction for the sector as a whole. As Cranmere Chief Executive Jeffrey Zients comments in a Wall Street Journal article on the matter, “There is excessive short-termism in our economy. That creates an opportunity for long-term owners to make disciplined investments in areas like R&D that make sense and have strong returns when you plan to hold companies, not sell them.”
He isn’t the only person to see that opportunity. The shift towards permanent capital has been wholeheartedly embraced by several high-profile organizations. Apollo Global Management is one. As of 2017, the firm held over $100 billion, or about 41% of its total AUM, in permanent capital. This is a far leap from the comparatively slim $11.5 billion (7% AUM) that it kept in 2014. The Blackstone Group underwent a similar shift; today, long-term investments have been responsible for 90% of Blackstone’s revenue over the past year. In 2018, the firm held $64 billion in permanent capital, an increase of over 700% since 2013.
Of course, permanent capital vehicles do have their drawbacks. Long-term investors tend to buy relatively stable companies that already have steady cash flows. As a result, these investments tend to be more expensive than the fixer-uppers that more typical private equity firms might buy. They also may not be as immediately lucrative as short-term buyouts; according to estimates published by the Wall Street Journal, permanent capital assets tend to see annualized returns of 12% to 15%, rather than the 20% a conventional vehicle might bring.
Some investors, however, may prefer to trade immediate gains for a higher long-term profit. A recent analysis published by Bain & Company found that a firm selling an investment after a 24-year holding period could outperform a conventional buyout firm selling four successive companies nearly twice-over on an after-tax basis. The difference, researchers suggest, lies in the transaction costs. Because a long-hold company does not have to engage in costly buying and selling practices that a typical buyout firm would, they can preserve far more in profit when they finally sell a permanent asset. The potential for greater long-term gain may appeal to larger investors — i.e., insurance companies with long–term liabilities and considerable financial resources — or smaller offices that may not need the liquidity that shorter-term deals provide.
All this isn’t to say that the sector as a whole should be moving towards long-term investment vehicles. These methods are still very much in development and should never be considered a one-size-fits-all solution; after all, not all businesses will be profitable as long-term investments. Firm managers may find it challenging to profitably sort short-term assets from long-hold ones. Given some fine-tuning, however, the trend towards permanent capital could be the one that comes to dominate the private equity sector in the future.