There is pain in the portfolios as earnings weaken. For owners that creates some clear priorities, such as making sure your portfolio managers have the right strategy in place to deal with the unprecedented challenges of the day. A second is being certain to devote enough time to deal with your LPs. They need plenty.
Pondering the situation, however, most general partners of private equity funds should also reassure themselves that, relatively speaking, the situation is still ok. Look at hedge funds for example: vast losses being made and capital cascading out like a tsunami in reverse. People now ask: were hedge funds ever even an asset class? That's how bad things have become.
Private equity's asset class status on the other hand has not been called into question, and firms can take comfort from the fact that their investors can't easily take flight. The beauty of the private equity funding model is that investors make an upfront commitment to stay the course. This normally means ten years or more, for better or worse. A limited partner may opt to sell its interest in a fund, but cannot simply redeem.
It's the industry's definitive contractual agreement, and therefore sacrosanct. By the same token, the prospect of LPs defaulting is one of the industry's greatest fears. This is especially true in the current crisis, because private equity's relative strength rests almost entirely on its continued access to capital.
That is why the recent news of UK funds of funds manager SVG Capital's inability to service its funding obligations to buyout firm Permira had such great impact.
Thus far, LP defaults have been few and far between, and despite the severe cash flow problems facing some of the world's foremost institutions, no sharp increase is expected at the moment.
Speaking at a seminar in London in December, Nigel van Zyl, a fund lawyer at law firm SJ Berwin, confirmed there haven't been many defaults yet. But he also warned that more will come, and reported that many GPs are now busy reading those sections in their limited partnership agreements spelling out what happens if LPs balk at capital calls.
You couldn't help thinking that most of these GPs must be reading these default provisions for the very first time.
Neither is it just fund managers paying attention to the problem. Business owners looking to sell assets might also have some doubt over private equity's ability to finance acquisitions.
Consider a vendor eager to complete the sale of an asset. On the table are two identical offers, one from private equity and one from a corporate. If certainty of closure is the vendor's main priority, even a small lack of confidence over the private equity bidder's ability to draw down the requisite equity capital may swing it in favour of the corporate. Likewise, one buyout fund might prevail over another in spite of making a lower bid – provided the vendor believes the low-ball is the one more likely to be good for the money.
Of course, given the stalemate in the credit markets, worries over capital calls for equity are not the main obstacle to a resurgence of private equity deal-making. The lack of leverage is. But the last thing general partners need right now is holes opening up in their equity funds.
Forward-looking managers are discussing the issue with their clients now. What is needed is a strategy for dealing with defaults before they actually happen. A year ago, GPs would have dismissed this as a waste of time. But now, in the midst of the market meltdown, it's a sensible precaution.
In some cases, action has been taken already: The Carlyle Group has urged its investors not to default and offered support in case funding calls come at an awkward moment. Permira has thrown SVG a lifeline by allowing it to reduce its commitment. TPG has also given investors the option to cut back.
Similar measures at other firms are a distinct possibility, and some may already have agreed them behind closed doors. In the meantime, capital call uncertainty will remain a concern for as long as it takes limited partners to return to business as usual. When this will be no-one knows.