The Private Equity Exit Now Takes Twice as Long

Twenty times larger in twenty-five years. That is what has happened to assets under management in private equity, and investing in the asset class has become much more common for a wide range of investors. The past three or four years slowed the pace. Guillaume Vuillemey, Associate Professor at HEC Paris and academic director of the Executive MSc in Finance, puts that down to interest rates. The long-term trend has held. 
 

Growth like that does not leave the plumbing alone. “We really think that private equity is at a turning point”, Vuillemey told during an HEC Paris masterclass. What has turned is the calendar (a company that once left a fund's portfolio after three years now stays six), the way returns are read, and now the credit side of the same market. One question runs under all three: when, and at what price, can anyone actually get out?

Why exits have become the industry's binding constraint

A private equity fund is a closed-end vehicle with a finite life, ten years or a little less, and a promise with a date on it: capital called down over roughly five years, three to seven years of ownership, a sale, cash back.

The J curve everyone has seen in a fund presentation is that promise drawn on a chart. It is also where the trouble now shows up. Vuillemey puts one difficulty above all the others. “At the moment, probably the single largest challenge facing the industry is the one of exits or liquidity.” Deals kept going in. The ways out stayed where they were.

IPOs, trade sales, secondary buyouts are all narrowing

Take the public market first. IPO windows have been cold for years, and the recent flurry (the SpaceX listing, the large AI offerings expected to follow) says less than the long series does. Four decades of American listings slope one way: far fewer companies list today than thirty or forty years ago, and Europe slopes the same way. Fewer listings, more portfolio companies queuing to be sold.

Trade sales work differently, and their limit is easier to see. Microsoft, Cisco, CVS and a handful of others have been among the largest acquirers in trade sales in recent years, industry leaders buying companies that came out of a buyout in good shape. Their appetite runs out. “Maybe they can acquire a few of them every year, but cannot absorb hundreds of them every year”, he notes.

Which leaves the third route. In a secondary buyout, one fund sells to another through a fresh leveraged buyout, and the company never leaves the asset class. Vuillemey calls it “not fully satisfactory.” His reason: “it's just about postponing a bit more the exit from PE as an asset class.”

All of it shows up in a single number. 

In the early days of private equity, a typical firm would stay for about three years in the portfolio of a fund. Today, it stays for about six years.

 These figures relate to funds that were closed two or three years ago, not the ones currently being raised, and “there are major concerns that they may actually have to keep their firms in their portfolio for even longer.”

That gap is what limited partners are really pricing. Committing money for five years and committing it for ten are not the same decision, and nobody signing today knows which one they are making. Money is moving accordingly: fundraising is concentrating on the larger funds, better connected, likelier to be able to take a company public or place it with a strategic buyer. Size, in this market, is being bought as an exit option.

Continuation funds split the industry

Two responses to the liquidity squeeze are growing fast (nobody much objects to the first, the second divides the industry):

LP-led secondaries often come at the initiative of the limited partners themselves. An investor wants out, finds another investor, sells the stake. Vuillemey sees little to object to, and notes something almost circular about it: “it's actually somehow a return to what public markets used to provide, which is the ability to resell in a liquid market.”

The second type of vehicle used to provide liquidity to investors is GP-led continuation funds.

Those who defend them argue about timing. A good asset may still have room to run, and the market either sits in a weak patch or has not yet worked out what the company is worth. Sell into that and you hand away the value that waiting would have captured.

The objection starts from the same facts. An asset that finds no buyer may be telling you something: good assets always find one. Fees carry on while the manager holds it. The bidding process between the selling fund and the continuation fund, both run by the same firm, may never become competitive. And the investor left holding the risk may be the least equipped to price it. Put end to end, that is the scenario the critics describe: weak assets moved into a vehicle and sold to the least sophisticated buyer in the room.

Vuillemey will not call it. “I think it's almost impossible to say who is right, who is wrong. There is just not enough data.”

Why IRR flatters private equity returns

The internal rate of return, IRR, won because everyone understands it. Fifteen percent a year over five years can be lined up against a bond, an equity index, gold, a building.

Four reservations:

The first is the wait: capital has to sit ready for the call, often for two or three years, kept liquid and parked on low-yield assets. None of that drag reaches the figure the fund reports.

The second is the clock. IRR moves sharply with the length of the period it is computed over, what the industry calls the IRR clock, and that period can be shortened. Subscription lines, equity bridge facilities: the fund borrows for a few months and puts off calling capital from its investors. One recent study Vuillemey cites puts the average gain at close to two percentage points, for a return that has not changed at all. “You make the funds riskier”, says Vuillemey. “You don't give more to investors, but you communicate a better performance.”

The third is the benchmark, or its absence. Fifteen percent reads well against an S&P 500 at zero and poorly against an S&P 500 at thirty. “IRRs are very meaningless unless you really compare them to what would have been the performance in the market”, Vuillemey argues. Hence the case for public market equivalents, or PME. Risk sits in the same blind spot.

The fourth is maturity. Early private equity picked the low-hanging fruit, the investments that returned most. Whether the asset class can hold those numbers as it becomes much bigger remains an open question.

Private credit's exit problem is just better hidden

A couple of years ago, private markets meant private equity and little else. They now run on equity and credit together, with Blackstone, KKR and others operating credit desks that pick up business syndicated bank loans once handled.

Regulation did much of the pushing. After 2008, banks came under much heavier supervision, and lending grew costly for them in regulatory terms, leveraged loans to riskier companies above all. Banks pulled back. Funds, under lighter constraints, moved in.

The last few months have been rough, and the constraint is the one from the first section wearing different clothes. Investors asking for redemptions have sometimes found their money hard to retrieve, which is the exit problem transposed to the credit side rather than a separate story. Competition during the boom probably loosened lending standards, especially before 2022, when borrowing cost almost nothing, and the funds that lent in 2020 and 2021 are the ones now winding up. Valuation makes it harder to see. These loans have no market price; they are marked to model. 

It's very hard to know whether the models are correct or not, in particular in the context where there may be incentives to delay recognizing losses.

 The incentive is built in, since the next fundraising rides on the performance the last fund shows. Further out stands a refinancing wall, money borrowed cheaply and coming due at much higher rates.

Building the skills these markets now demand

One demand runs through all three problems. Value an asset that has no price. Read a return with an eye on who chose the window it was measured over, and look at a valuation model wondering what could ever prove it wrong.

In practice, that turns into three questions worth putting to any manager, none of which requires a view on the market. Was a subscription line used, and what does the IRR look like without it? Against which public market equivalent is this track record measured, and over which window? For anything marked to model, what would have to happen for the mark to move down, and when did it last move down? A manager who answers all three easily is telling you something. So is one who does not.

Technical work of that kind, not market opinion, is now part of the ordinary job of anyone sitting across the table from a private markets fund. It is the ground the Executive MSc in Finance covers, under the academic direction of Guillaume Vuillemey: fund structures and fee mechanics, leveraged buyouts and non-recourse debt, deal valuation, free cash flow to equity, carried interest and cash sweeps, with venture capital, asset management and corporate valuation alongside. The degree is built from stackable certificates and open to candidates with five years of experience in finance.

Talk to a program advisor.