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Each buyer made more than the last
The chain of owners
Each firm in the chain sold at a profit, and the next owner made more. The fund model pushes firms to channel capital in and out, because fees, the next fund, and money to return to investors all call for sales. A firm that held on through all three stages would have captured everything the chain earned.
A recent case
A recent case shows the same pattern with an unnamed firm. It sold a business for many billions of dollars to a publicly traded strategic buyer, after owning it for ten years. Five years before that sale it had sold 80 percent of its stake to return money to its shareholders at a nice profit. The 20 percent it kept was later worth more than the 80 percent had sold for.
The arithmetic
The arithmetic of chaining shows why this matters. If each of three owners earned five times its capital in turn, one owner holding the whole stretch would have turned 5 times into 25 times and then into 125 times. That is the case for an owner built, structurally and temperamentally, to hold on.
Why do private equity funds sell after a few years?
Most private equity funds are set up as limited partnerships with a term of about ten years, and the first several years are for buying companies. Investors expect their money back, with profit, within that window. The managers earn carried interest, typically 20 percent of profits, only when investments are sold and gains are realized. A fund also needs a record of completed sales to raise its next fund.
How do continuation funds help firms keep winners?
A continuation fund is a new vehicle that buys one or more companies from the manager's older fund. Existing investors can cash out at a negotiated price or roll their stake into the new fund. The manager gets more time to run the business while the older fund closes on schedule. Such deals, also called GP-led secondaries, became a large part of the private equity market in the 2010s.
Why can permanent capital hold businesses longer?
Permanent capital has no end date, so it never has to sell to return money to investors. Berkshire Hathaway, led by Warren Buffett, is the best-known example, and it has long said it buys businesses without plans to sell them. Closed-end private funds, by contrast, have fixed lives set in their partnership agreements. Holding companies and family offices use the same logic.
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