No exits for private capital

Daily Data: It's getting harder to keep pretending

In today’s dispatch (which got longer than I expected):

• imagination makes illiquidity go round

• no exits mean it’s getting harder to pretend

• what if “dry powder” is really just “uncalled commits that can’t be called until there are exits”?

---

👉👉👉Reminder to sign up for the Weekly Recap only, if daily emails is too much. 

---

No exits for PE/VC

Imagination is healthy and good

Lending (and investment generally) is an imagination business.

That’s obviously true, in the sense of “imagining future upside” or otherwise seeing value tomorrow, where others only see dirt today.

Fine.

It’s less obviously true, however, in a more literal sense: when a bank lends $1M, it pats itself on the back and says “cool, now I have a $1M asset.”

The bank does that even though it just finished giving away an actual $1M, and replaced it with a mere IOU for $1M. A normal person might say, “no, you don’t have $1M—you had $1M, but now all you have is a stupid piece of paper with someone’s promise to pay you $1M.”¹

The normal person is, of course, correct, but also sorely lacking in imagination.

You see, there is plenty of good reason to treat that mere promise to pay as valuable as the thing itself (or more). In fact, it’s almost certainly true that being able to pretend, is vastly better than the alternative.² But, however good the reason and the reward, it doesn’t change the fact that a good deal of imagination is involved.

Sometimes the various imaginations are linked, such that belief in one, is a predicate for belief in the other.

Like when a private equity or venture capital fund tells their LPs that their investments are worth 20% more than last year (or whatever), they don’t actually know that. They’re imagining it.

• The funds have good reasons to believe in those valuations, no doubt, but if push came to shove, they could not actually produce the cost+20% that they claim the investments are worth.

• Eventually, they’ll have to prove it—when some other investor says “I agree, and I will pay your price,”—but, in the meantime, some leeway for imagination is a necessary part of the business.

Likewise, when an LP says “I commit to participating in your fund for $50M because it returns 20% or whatever,” they’re not actually handing over $50M.

• They’re making a promise to handover up to $50M over a period of 1-3 years. But right then and there, if push came to shove, the LP probably doesn’t have $50M lying around.

• Eventually, they’ll have it—when some other fund the LP invested in returns their $50M+20%—but in the meantime, some leeway for imagination is a necessary part of the business.

So everyone pretends, about how much their investments are worth and about how much money they’ve raised, and generally they are handsomely rewarded for their optimism.

It’s all a bit circular, because LP commits are the “dry powder” that some fund uses to realize the aspirational returns of some other fund, which is then returned to yet other LPs, so that they can fulfill their commits to some other fund, and around and around it goes.

But again, it’s worked great. It’s good to dream, and dreams can become reality.

It is getting harder to pretend

Now, however, it is getting increasingly hard to pretend.

Despite all the appreciation in fund assets, and all “dry powder” waiting to turn those valuations into reality, no one is actually returning any money to their LPs.