Dequity
Dequity.
That’s the new name being used for rescue financing for private equity firms.
Longtime readers know the existential struggle private equity is undergoing right now.
Here’s what we said back in March:
“Last year, private equity funds returned the lowest amount of cash to their investors since the financial crisis 15 years ago). That’s according to Raymond James Financial Inc.
Distributions to so-called limited partners totaled 11.2% of funds’ net asset value, the lowest since 2009 and well below the 25% median figure across the last 25 years, according to the investment bank.
Hedge funds and private equity depend on returning capital to their investors. That’s what allows them to launch new funds. And get their LPs to recycle that cash back into their new funds.”
These private equity firms need liquidity. They need the capital to raise new funds.
The inability to return capital has forced firms to launch “Continuation funds” and “NAV Squeeze” — both major red flags for the industry.
Another creative way to get liquidity is through “dequity.” Here’s Bloomberg with the context (emphasis added):
“As private equity firms struggle to sell the companies they own and return cash to investors, their counterparts in the world of private credit are offering special loans to tide them over.
Direct lending arms at shops from Ares Management Corp. to Neuberger Berman Group and even private equity titan KKR & Co. have all launched what some are calling “dequity” funds — to convey the presence of both debt and equity — to the tune of $30 billion industry-wide since 2023, according to data compiled by Preqin.
Demand for this type of stopgap financing has soared even more lately as cash-strapped private equity firms face a prolonged deal drought...
It might not be the most attractive option since it is more expensive, but in many cases, it’s the option that is on the table,” said Matthew Schernecke, a partner at Hogan Lovells.
Still, demand for the funding is only expected to grow. Private equity funds tend to hold companies for five to seven years before moving those assets and paying investors. But after years of sluggish deal activity, there’s as much as $3.2 trillion of unsold private equity assets sitting in funds, according to a 2024 report from Bain, leaving sponsors in need of liquidity.
“There’s an eagerness to get money back to LPs, particularly given a recent slow down in realizations,” Neuberger’s Munch said.
The increased need for rescue capital could set the stage for clashes between creditors, a normal occurrence in the broadly syndicated market that has appeared less frequently in the clubby, relationship-driven world of direct lending. But loan agreements have become more permissive as the competition in the sector has increased, meaning that some existing investors risk being superseded in the capital structure by fresh hybrid financing.
Existing lenders usually “welcome this type of capital, because it protects their investment, and comes in below them,” said René Canezin, managing partner at Evolution Credit Partners.
“However, sometimes the capital can take out the existing lenders, or strip them of collateral, and that’s where the tension begins.”
These “hybrid loans” are effectively rescue financing.
A desperate way for these private equity companies to get liquidity for their LPs. It’s a clever way to pay something to their limited partners. And claim it’s a “win.”
However, firms like Ares and KKR are the real winners. They have all the leverage.
They know these private equity firms are desperate. So they get to dictate the terms. Getting debt and equity. They buy at significant discounts to the most recent valuation and get to sit at the top of the capital stack should anything go wrong.
This is bullish for the stock prices of Ares and KKR if you’re looking to invest and/or trade off of this.
Good investing,
Lance
DISCLAIMER: This is solely our opinion based on our observations and interpretations of events. This should not be construed as personal investment advice.
Interesting writing, Lance. It sounds like this "new" form of debt financing is primarily short term. Do you have a sense of how long the term are, or does this borrowing is structured as revolving?