Smaller is beautiful

Private equity: Giant private equity funds won’t be back for a while. New research shows many investors have lost interest in multi-billion dollar funds. That will make it tougher for big buyout shops like Blackstone and KKR to raise money in the amounts they are used to. Some may even have to relearn smaller-scale methods of investing.

The best-regarded firms can still raise plenty of money. BC Partners is set to start raising a new fund and is hoping for around 6 billion euros. And Blackstone has already gathered about $9 billion for its next fund. But firms may not be able to raise as much as they have in the past. Even if Blackstone’s total rises further, it will probably end up only around half the $21.7 billion fund the firm raised in 2007.

Most big buyout firms will have to set their sights lower still. According to a recent survey by Preqin, 37 per cent of buyout investors will be avoiding funds with more than $4.5 billion after previously investing in them.

By contrast, just 5 per cent of investors said they would avoid small and mid-market funds.

Investors are shying away from giant funds partly because, with far less accommodating debt markets, the big deals these funds need are tough to pull off these days. For some of the same reasons, private equity managers are having trouble exiting larger investments profitably. Partly as a result, large funds are posting lower returns than mid-market funds, according to Preqin. That gives investors just one more reason to look elsewhere.

Even if they can still raise funds in the billions, most private equity firms will have to revert to pre-boom types of deals.

Rather than undertaking giant leveraged buyouts of public companies, the more typical investment used to be buying smaller private businesses and units from public companies.

Going back to that kind of business may require more work for each smaller deal. That means that as their funds shrink in size, the big firms could find their profits — and payouts to their people — deflating, too.