The meeting was earlier this year. Employees of New State Capital Partners, a private-equity firm in New Rochelle, N.Y., were told they might never see cash from the firm's second fund. Word spread fast to the people who weren't in the room. In the past year, about a third of the staff has left, Mark Maurer reports in Wednesday's Journal. Two of the three founding partners are among them.
Here's the machinery. Private-equity staff earn a base salary and bonus from management fees. The big money is carried interest, a share of a fund's profits. New State's second fund began investing in 2018. Its companies, which include a clearance-goods distributor and a healthcare recruiter, underperformed. Higher borrowing costs make them harder to sell. The next buyer has to finance the purchase at today's rates and needs a higher return to make it work. So a fund can clear its hurdle, the return it must hit before the firm takes profits, and still have no cash to hand out.
A small-firm problem, mostly
The firm says its head count is roughly flat counting new hires, and that it keeps returning capital. All four of its funds, it says, are above the threshold to pay profits. It raised $700 million for a fourth fund last year. Bloomberg ranked its third fund a top performer among funds under $500 million that began investing in 2021. That ranking uses net IRR, a yearly return figure. Maurer notes net IRR can mislead, because it rests on the firm's own valuations rather than cash in hand. Chris Wood of Huntington Bank says midsize firms are "pretty close to a period of reckoning." Firms under about $15 billion with no other business lines are the most exposed.
The squeeze shows up in fundraising. U.S. private-equity firms raised $222 billion through Sept. 30, against $330 billion for all of last year, per PitchBook. That's the worst pace since at least 2020. Aterian Investment Partners, another $2 billion firm, won't raise a fifth fund. Funds that bought companies at peak prices from 2020 to early 2022, when rates were near zero, are hurt most. As Christopher Sheaffer of Reed Smith put it, "It's not free money anymore."
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This is Investments and Risk (IN04), and the lesson is about how private assets are measured. A public stock has a price every day. A private fund has a mark its own manager sets, and IRR is built on those marks. New State's third fund ranks as a top performer by IRR, while its staff worry it's headed the way of the second fund, which may pay them nothing. Both can be true, and the cash is the one that pays bills. The practice owns no private-equity funds and holds none of the firms named. The nearest things in the books are two public lenders, Main Street Capital (MAIN) in 3 books and Ares Capital (ARCC) in 1, held at weight, nothing added. Private markets have a place in some plans. A paper number nobody has cashed doesn't.
The connection to your plan is any private fund you've been offered, or already own. Private-equity, private-credit and interval funds are pitched to individuals more and more, and the pitch usually leads with IRR. The check this week is to find the fund's own report and look for two other figures. First, how much cash has it actually paid back to investors compared with what they put in. Second, what are the rules for getting your money out. Many of these funds limit withdrawals to a small slice each quarter. If the sales deck doesn't show cash returned, ask for it in writing. Ask on a calm day, before you need the money, and bring the answers to your next plan review. An umbrella you can't open when it rains isn't one.