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The biggest regret
Traditional private equity investors asked about their biggest heartache talk about the business they sold prematurely that they knew was an absolute banger. They sold it because the firm needed to raise another fund, and raising one means putting points on the board with a short-term pop.
The rule
The opposite approach is a simple rule: never be a forced buyer and never be a forced seller. So much folly comes from having to buy something or having to sell something. A firm with average intelligence, average picking, average management, and average leadership can probably generate outsized returns compared to the market, as long as it never has to buy or sell.
The model
Opportunities to compound for a long time are so hard to find that when one turns up, it should be kept. That is the whole model at Permanent Equity, a fund with a 27-year life built so that it never has to sell to raise the next one.
Why must funds sell their investments?
Most private equity funds are structured as closed-end partnerships with a fixed life, commonly ten years with extensions. Investors expect their capital back by the end of that life, so the manager has to sell each company within the window. A manager who wants to raise a new fund also needs realized returns to show prospective investors. Investors track a measure called distributions to paid-in capital, which counts only the cash actually returned.
Why does selling early hurt compounding?
Compounding applies returns to a base that keeps growing, so the largest gains arrive in the later years of ownership. Selling early cuts off that stretch and leaves the proceeds to be reinvested at whatever the next opportunity offers. A sale can also trigger taxes that shrink the base being reinvested. Warren Buffett wrote in his 1988 shareholder letter that Berkshire Hathaway's favorite holding period is forever.
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