Warehoused investments are a common tactic used by private equity firms to demonstrate their capabilities and facilitate fundraising. By making investments prior to the final closing of a new fund using their own capital, private equity firms can generate track records and dividends for early investors. This helps establish credibility and makes it easier to attract limited partners. Once the new fund reaches final closing, the warehoused investments are typically transferred over with any gains accrued. For investors, this means receiving dividends even before making their full commitments, reducing risk and increasing potential returns. Overall, warehoused investments and the resulting dividends they enable play an important role in private equity fundraising and returns.
Warehousing investments reduce risk and increase returns for early private equity investors
When a new private equity firm is raising its first fund, it faces the classic ‘chicken and egg’ dilemma – investors want to see a track record before committing capital, but firms need investor capital to generate a track record. This is where warehousing investments using the GP’s own capital or loans from early investors comes into play. By warehousing 3-5 investments before final closing, GPs can demonstrate their strategy and capabilities in action. Investors then have tangible proof that the team can source and execute deals. The warehoused investments also start generating management fees and potential carried interest, enabling GPs to pay early dividends to investors even before they have deployed all the capital. This reduces risk for early LPs since they get to see returns from the GP’s first few deals before deciding if they want to invest the full amount committed.
Transferring warehoused private equity investments to the new fund preserves early gains
Once the new private equity fund reaches its final close, the warehoused investments are usually transferred over to the fund itself. This transfer is typically done at cost, meaning the GP does not profit from the transfer. The key benefit, however, is that any increase in value of the warehoused investments is preserved within the fund rather than benefiting only the GP. So if a warehoused company has grown substantially or had a favorable exit between the time of initial investment and final closing, those gains flow through to the Limited Partners of the new fund. This helps enhance overall fund returns, bringing LPs’ net IRRs and multiples higher from the very start of the fund’s life. In essence, warehousing jumpstarts a fund’s returns before deployment is complete.
Warehoused investments enable private equity firms to provide early dividends, demonstrate capabilities, and boost fund returns, thereby facilitating fundraising and reducing risk for early investors. This tactic generates management fees, carry, and investment gains prior to a fund’s final close which benefit both General and Limited Partners.