Private Equity and Fiduciary Risks
According to "Private Equity Investing in Trust" by Pascal Levensohn (Trusts & Estates, July 2010), professional trustees and family office fiduciaries should exercise caution in evaluating the illiquid nature of private equity and venture capital allocations. Describing initial public offerings ("IPOs") as "elusive," Levensohn urges decision-makers to "show the completion of a process of diligent review" before it's too late. For wealthy investors, sometimes referred to as angels, and institutions such as endowments or pension plans, an exit via an acquisition or public company status is often expected to occur within a few years of a first commitment. The credit crisis conditions of 2008 that still prevail have made liquidity events nigh impossible for some firms, creating stress and "syndicate fatigue."
Strained exit conditions might challenge private equity fund managers, and therefore their investors, in another way. According to a late 2007 document published by the Pension Benefit Guaranty Corporation ("PBGC"), private equity fund managers could be liable for the underfunding of pension plans that are sponsored by any or all of their portfolio companies. This reality came as a nasty surprise to the general and limited partners of a Delaware private equity fund with a controlling interest in a manufacturing company that filed for bankruptcy and was therefore no longer able to write checks to retirees, leaving the investors in said company holding the proverbial bag. Click here to read the September 26, 2007 comments by the PBGC.
Importantly, lack of immediate liquidity itself is not necessarily a bad thing. Indeed, some investors specify a slice of their portfolio for investments that are longer-term in nature with respect to the ability to convert to cash. In exchange, they want to earn a higher risk-adjusted rate of return. The key is to do enough homework so that limited partner fiduciaries - whether for family offices, foundations, endowments, pensions, college plans, sovereign wealth funds - have a pretty good sense of what might go awry and whether private equity and venture capital fund managers are backing entrepreneurs with Plan B flexibility.
Future posts for this blog, www.goodriskgovernancepays.com, will address liquidity, valuation and fiduciary aspects of private fund due diligence. The topics are critical, especially given the increasing scrutiny applied by regulators and litigators alike (in the U.S. and abroad) and the billions of dollars at stake.
