Private Equity’s Capital Demand Far Outstrips Supply

Michelle Celarier of Institutional Investor writes:

According to Bain & Co., roughly 18,000 private capital funds are currently out raising money, with aggregate targets reaching $3.3 trillion. The problem is that when general partners (GPs) ask for $3, investors only have $1 they can realistically allocate. Bain described this as a “supply-and-demand imbalance.”

A lack of cash distributions from existing funds is also making matters worse, pushing some investors to the point where they are willing to accept losses (haircuts) on their commitments. According to Bain, “LPs (limited partners) are increasingly dissatisfied with partial or minority stake sales and, despite tough market conditions, are demanding full exits.” In fact, in a webinar survey conducted by the Institutional Limited Partners Association (ILPA), 63% of investors said they preferred a full exit “even at a lower valuation than recent marks.”

By contrast, dividend recaps (structures in which PE-backed companies take on debt to pay cash out to shareholders) were preferred by only 33% of respondents, and LP-led secondary transactions drew support from just 20%.

But the secondary market is no cure-all. Bain noted that “while the secondary market offers attractive bargain-hunting opportunities for investors facing fewer liquidity constraints, it remains too underdeveloped to meet the liquidity needs of the private equity industry as a whole, no matter how fast it is growing. Secondary deal volume still amounts to less than 5% of global private equity assets under management.”

Although discounts are narrowing in some secondary deals, the broader picture looks very different. Jeff Hooke, a finance lecturer at Johns Hopkins University and author of a recent report on the top 25 LBO (leveraged buyout) managers, said, “Secondary buyers are only interested in the very best managers, so for most LP interests, a sale simply isn’t possible.”

Survey results show that other types of exit strategies are even less popular. Continuation vehicles are preferred by 17% of investors, distributions financed through specialized tools such as NAV-based lending by 7%, and plain-vanilla leverage-based distributions by just 3%.

Bain’s midyear report summed it up this way: “The pressure to exit, distribute capital, raise new funds, and put that capital to work continues to intensify across the industry.”

Part of the problem stems from a slowdown in deal activity triggered by the Trump administration’s tariffs. According to Bain, deal value announced in April was 24% lower than the monthly average in the first quarter.

“The most immediate and visible impact has been in the IPO channel. An IPO market that was already subdued effectively ground to a halt in early Q2 amid tariff turmoil, with planned listings postponed or canceled,” the report said.

All of this is happening even as the stock market remains strong. Nate Koppikar, founder of hedge fund Orso Partners, said, “Stock prices have hit record highs, but IPO activity is near record lows. Today, PE managers prefer to sell to other PE firms—where they can exert some influence over pricing—rather than to the public markets.”

Buyout funds, in particular, have taken a direct hit. According to Bain, not a single buyout fund that closed in the first quarter of this year exceeded $5 billion in size—the first time that has happened in a decade.

The core issue is that there simply isn’t enough investor capital. In an April survey by Campbell Lutyens, 33% of investors said they had slowed the pace of their private markets allocations because of U.S. tariffs, and 8% said they had halted new commitments altogether.

“Given that demand for private equity capital currently far exceeds supply, it remains unclear to what extent inflows from ‘retail capital’ can help close the gap,” Bain said. Moody’s, however, has sounded a note of caution on this trend. In a recent report, Moody’s warned that “selling private equity to individual investors could create systemic risk.”

The private equity firms we are familiar with typically raise capital from LPs (limited partners) and invest it on their behalf. LPs are mainly national and state pension funds and various labor and professional associations. As the article above notes, the recent decline in private equity exit activity has reduced LPs’ capacity to make new commitments. Allocations to private equity are only one slice of LPs’ overall portfolios, and they themselves need to realize proceeds from existing investments before they can recycle capital into new ones.

The drop in exit activity is partly because IPOs (initial public offerings) have slowed, reducing exit opportunities. It is also reasonable to infer that, given Trump’s tariff policies and a broader economic slowdown, portfolio companies owned by private equity funds are likely delivering weaker operating results than in prior years.

Private equity funds frequently use dividend recap strategies, in which they lever up portfolio companies based on EBITDA (earnings before interest, taxes, depreciation, and amortization) and free cash flow in order to pay themselves cash distributions. When performance deteriorates, however, the interest coverage ratio (EBITDA/interest) falls, reducing the total amount of debt those companies can raise.

Recently, prominent investor Bill Ackman and other leaders of major U.S. hedge funds and private equity firms have been arguing that private equity should be available as a default option in 401(k) plans, the U.S. equivalent of retirement pension plans, because it is becoming increasingly difficult for them to raise LP capital.