The European-focused firm, which closed its fifth buyout fund in September 2015 after hitting its €2.75 billion hard cap in just eight months, is trying to change the fund’s documentation so it can borrow money against the vehicle for up to 190 days, according to people familiar with the matter. It needs 75% of investors to agree to this change, one person added.
Most private equity firms have overdrafts on their funds that enable them to do a deal during a holiday period without having to contact investors with capital requests.
However, firms have realised that they can boost returns if they borrow money for longer. By using debt instead of investor cash when purchasing a business, before replacing it later on, investor capital is used for a shorter period of time. This makes the returns appear higher because the performance of most buyout funds is measured by its internal rate of return, which is a metric that factors in both timing and performance.
Montagu has historically not used debt for longer periods of time, but has been asked by its investors to consider the option, given the fact that many other fund managers are now using overdraft facilities to enhance returns, another person said.
Boston-based Advent International increased its overdraft from 90 days to 195 days in its latest fund, one person said in May, although another person said this was a provisional term that had since been taken out. London-based Cinven can use bank debt for up to 365 days in its newest fund, also an increase on its prior fund.
Montagu is likely to get investor approval for the change in fund documentation, one person said. However, some investors don’t like the method, he added.
Private equity investors are divided on the use of overdrafts. While it boosts the IRR, the overall fund return – which is known as the money multiple – does not improve, but actually decreases slightly because the fund is charged interest on the debt that is used. The overdraft facility also helps fund managers to get to their own returns quicker because it increases the fund’s IRR above the 8% ‘carried interest’ threshold after which managers begin to share in profits — which is usually 20%.
Some investors like the technique because their own remuneration is also linked to internal rate of returns, while others feel it is a way of artificially boosting performance.