The Wall Street Journal today points out (subscription required) that KKR's latest efforts to raise $1.5 billion in an Amsterdam listed fund that will basically act as a public "front-end" funnel for cash into all of KKR's funds, are a "precursor" to publicly listed buyout funds.
Quoth the Journal:
"This is a precursor to public [corporate]-buyout funds," says the head of one major financial sponsors group, who cited Securities and Exchange Commission rules in declining to comment by name. "They are testing the waters. Every private-equity firm will figure out how much and how quickly they can follow. It is an important evolution."
The Journal goes on to point out, rightly in my view, that valuing a private equity firm (if, just say, they one day wanted to list themselves on a public exchange) is difficult without more consistency in the management fees. Locking in management fees removes a big valuation issue as the stability of those cash-flows makes the firm's revenue structure much easier to model.
Still, the structure strikes me as a bit backward. One of the major advantages of private equity funds is the ability of the general partners to ignore short-term thinking in their investments. Leveraged buyouts in particular require a long horizon (5-7 to even 10 years )and patient approach. While KKR's Amsterdam funnel fund (a "fund of KKR funds"?) doesn't appear to adversely impact the the ability of KKR to remain long-term focused, a publicly listed sort of approach (particularly if we start seeing the partnership broken into a more traditional share and option based compensation strategy a la Goldman Sachs after its IPO) suddenly aligns the incentives of the partnership with short term fluctuations. This defeats the structure of a buyout firm, which is nearly entirely about avoiding short-term temptations.
Features in limited partnership terms for buyout firms, like lock-in periods, 7-10 year fund life and such are designed to give long-term focus to the general partnership. But there are rational limits.
The Journal argues that the effect of a "funnel fund" like this enhances long-term focus, quipping that:
Because private-equity funds have limited lives, often firms are forced to sell portfolio companies to return money to their investors. With this new structure, though, KKR can keep its portfolio companies for longer if it so chooses.
I think there are limits though. If you can't turn the firm around sufficiently in 4-7 years to hit your IRR, should you be hanging on to it for longer? Isn't the purpose of an LBO firm to take advantage of the incentives that debt creates in order to restructure the business and then send it back on its merry way as a nice operating unit? The steep part of the growth and efficiency gains curves should be immediately after the acquisition. If you're still hanging onto the firm after that then you will have to be growing revenues. How you can push those up quickly enough to meet a target IRR of 20% or more (remembering that even the same growth figures later in the IRR calculation counts for less) is a suspect analysis to me.