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Liquidity improving for private equity investments

Liquidity is improving both in entering private equity investments and coming out of them, according to a report by Neuberger Berman.

Going in liquidity may be characterized by the increased availability of financing for well-capitalized transactions; more equity for transactions; co-investment equity in leveraged buyouts; and the potential for formation of follow-on funds from general partners seeking to embark upon a new vintage year fundraising cycle.

Neuberger Berman says that by no means does improved liquidity for adequately financed companies usher back in the era of the financial sponsor-led megacap buyouts, which may remain dormant during 2010 and not see available financing until future vintage years.

Going out liquidity may increasingly be characterized by an increased number of initial public offerings, available financing for dividends or recapitalizations to provide a return of capital to LPs in private equity sponsored deals, and the potential to see an increased number of sponsor-to-sponsor transactions, where one private equity fund purchases an investment from another.

According to the report, sistressed private equity should also be highly active in 2010, with a continued robust supply of investment opportunities, given a large number of over-leveraged companies operating in a restrained economic environment.

Specifically, distressed debt, restructuring and turnaround funds may be well-positioned for outsized returns over the next one to two vintages. With some of the large and highly liquid credits having experienced a significant run-up in pricing in 2009, credit selection, restructuring and operational expertise will be more important in these vintages than was true last year.

In terms of fund structure, it is likely that the formation of shorter-duration types of private equity funds will wane, and that more normal-term funds will be in the offing, says Neuberger Berman. Shorter-duration funds were created recently to take advantage of temporary dislocations in various parts of the capital markets by distressed investment funds that were providers of liquidity.

Two areas that may see greater sustained activity in 2010 are Asian private placements and US distressed commercial real estate. Higher Asian public equity valuations may encourage private market capital raises for issuers seeking flexibility pertaining to timing and liquidity. Meanwhile, lower valuations in the US commercial real estate sector are likely to continue to make debt refinancing more difficult and the distressed investing opportunity for that asset class more robust.

Neuberger Berman believes the historical rigidity in place for management fees associated with some private equity funds will be out in 2010. One legacy issue remaining in the private equity market after the heady vintage years of the 2000s is the mending of fences between GPs and LPs regarding both management and incentive fees. This dynamic may continue to be felt through increased GP equity contribution to funds, as well as new fee equations regarding management, transaction and incentive fees designed to provide LPs with terms they require, the report says.

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