Investors gain upper hand as private equity weakens

BERLIN Feb 4 (Reuters) - Private equity firms will lose the upper hand to the powerful pension and endowment funds which invest in their funds, as they struggle to raise cash from sparse reserves.

Private equity heavyweights at the industry's SuperReturn conference [ID:nL3166441] in Berlin on Wednesday said investors in the funds, known as limited partners or LPs, would have more power to dictate fees and fund sizes.

"Going forward, the LPs will be heard much more and their concerns on deal fees, size of funds ... will have to be addressed," said Carlyle Group [CYL.UL] co-founder David Rubenstein.

"The pendulum will have swung ... for the next few years, they have the balance of power."

It would be a marked deviation from the boom that lasted from 2004 to 2007, when private equity executives, or general partners (GPs), were raising cash hand-over-fist and could dictate their terms to investors.

Private equity companies are looking for alternative ways to spend roughly $1 trillion of unspent investment capital as the market for leveraged buy-outs has virtually halted, but investors often question those strategies.

They also face trouble in many of the companies they have invested in, which are struggling under heavy debt piles the private equity companies have loaded them with.

The interests of private equity firms and investors had not been aligned in the last few years as the buy-out houses sold stakes in companies to each other, said Guy Hands, the chief executive of Terra Firma.

Rather than cashing in through IPOs or trade sales, investors now sometimes ended up being exposed to both the buyer and the seller when assets changed hands.

"The LPs essentially remained the same and just paid more fees with no true exit," he said.

Many exits made this way in 2005 and 2006 looked great on paper, and had helped a new wave of LP allocations to private equity in 2006 and 2007.

"My guess is that much of the money allocated to private equity in 2006 and 2007 will probably get negative returns," he said, making it harder for the industry to raise new capital.

Rubenstein predicted that "very few new firms will be able to raise money at all".

But the few that would, would receive an "enormous amount of attention," he said.

BEATEN-UP

The mood has been gloomy at the industry's main conference, which borrowed its name from the industry's earlier heady days, as executives stressed their focus on keeping portfolio companies above water.

"You have to accept the fact that transactions will be smaller and have far less leverage -- that's a fact," said Henry Kravis, co-founder of New York-based private equity giant Kohlberg Kravis Roberts & Co. on Tuesday.

"That means all of us have to adapt. We have to change the way we'll do business. If we don't, we'll be left out."

The year ahead would be difficult but successful deals could have high returns and he predicted that banks will lend more in the latter half of 2009, Rubenstein said.

Relatively few buyouts will be completed this year, he said, and he didn't expect to see many exits from deals already completed in the first six months of the year.

He added that a lot of deals done in the last couple of years would not survive. But there was still some hope, as companies that had landed in financial trouble as the credit crisis rages might look for capital.

"Clearly the need for private equity capital is greater than it ever has been and that will increase," he said.

Any deals that get done in this period could make spectacular rates of return, he said.

That there would be no better time for investors to allocate money to private equity than once the current overhang of capital in private equity funds had been invested, Hands said.

While banks will not be lending much in the first half of the year, he predicted that in the latter half of 2009 and 2010 there would be more leverage available to buyouts.

He predicted more deals in minority stakes, because they require less leverage, or borrowed money.

"The theory of evolution applies to private equity as well as animals and we need to evolve," he said.