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Zombies of the Private Equity Industry Pt. I

Private equity funds have begun to slowly show the positive results of fundraising efforts – the capital raised in 2013 is up 20% compared to what was raised in the same period in 2012.1 Although the results of industry fundraising are improving, the amount of time needed to raise those funds is continuing to grow. In 2009, the average time period to raise capital was approximately 7 months while it has grown to 18.5 months in 2013.2 Why? A significant contributor is the growing period of time in which investors have capital sitting in unprofitable investment vehicles from which they have limited exit options.3

As of June 2013, approximately $116 billion in assets is sitting in almost 1,200 zombie funds with assets from over 1,700 companies.4 Zombie funds refer to private equity funds, hedge funds, or venture capital funds that contain illiquid assets that have become stagnant in the market in terms of generating returns for its investors.5 The results of a recent study by Prequin, a research and consulting firm specializing in the private equity industry, reveal that the median distribution to paid-in-capital of zombie funds was significantly lower than that of their non-zombie peers: 39% for zombies and 99% for other funds.6

Although the funds no longer produce satisfactory returns for the investors who supplied the original capital necessary to fund the acquisition of assets, they find themselves locked into the funds while they continue to accrue management fees.7 The difficulties in selling their shares in the funds stem from illiquidity of the assets, difficulty in valuing the assets, and the “expected term” provided in the original agreement (often 10 years).8

Apart from the damage done to the individual investors, lack of returns in an equity fund can be especially detrimental to an entire economy. For instance, of the $116 billion in assets in zombie funds, 10% of those assets is found in Asia.9 India in particular has had difficulty in the private equity market as limited partners are increasingly discouraging general partners from investing in Indian funds.10 As of this year, approximately 20% of the pre-2009 funds have gone inactive; there remains 219 active funds in the country and 41 funds have become zombie funds – for every 5 funds, 1 is zombie.11 It is a common practice that investors tend to shy away from geographic locations until their prior investments in that region have shown some return – this has resulted in a lower investment allocation in India.12

Once a fund begins to perform poorly, a domino effect begins to emerge and it is extremely difficult to change the direction of unprofitability. In most cases, the raising of capital for private equity funds is attributed, at least in part, to the track record of the fund and the general partner(s). In cases where seemingly profitable funds make the transition to zombie funds, the reputations of the funds and managers have already been damaged. Rather than make efforts to improve returns for the investors, many managers write off the fund as a lost cause and just sit back and watch the management fees roll in.13 While the general partners fail to take an active role in trying to turn profits, the original investors, who invested as limited partners for tax benefits, have no further recourse in changing the management of the fund.14 The only leverage available to them is to threaten refrainment from investing in future funds. However, this threat is often ineffective as most funds and managers will already have taken their past performance in the zombie fund as indication that the investors will not be investing with them again.15

In previous years, investors have had few options available to them in terms of how to exit from these unprofitable investments. However, there have been many efforts in recent years to both mitigate and resolve issues with stagnant funds. In the public sector, the SEC has fortified the scrutiny given to investment advisors and the private equity industry.16 The asset management unit in the Enforcement Division has taken interest in private equity funds because of the possible harm that can be done to investors given the long lives of the funds, the illiquidity that investors experience as a result of their investments, and the rapid growth of the industry.17 The Commission is taking notice of any suspicious activity, including funds with few remaining assets that hold potential for managers to maximize their own compensation.18 Specifically, the concern is that managers are not only passively failing to increase returns for investors, but rather that they are “actively delaying the liquidation of their holdings because the income derived from these assets is their only source of revenue.” [govt3]. Although managing a zombie fund is not unlawful on its own, the SEC believes that the incentives for managers to generate management fees for themselves will likely cause “some problematic conduct and possible violations of the law.”19

The government is only one of the actors taking action to reform the zombie fund business. Apart from implementing preventative measures before investors have suffered losses, the private sector is responding proactively with solutions to either help investors obtain cash for their investments or to attempt to revitalize the zombie fund. Some ideas that have been implemented include restructuring economics of the fund, recapitalization, and the expansion of the secondary market. These concepts and their effects on the investment market will be further explored in a future blog post

Click here for Part II

  1. Jason Karaian, Private Equity Funds Aren’t Nearly As Attractive As They Think They Are, Quartz (Oct. 2, 2013),

  2. Id. 

  3. Id. 

  4. Clare Hutchison, More Than $100 Billion Trapped in ‘Zombie Funds:’ Industry Data, Reuters (June 13, 2013, 1:00 PM),

  5. Cameron E. Cook, Zombie Funds: Alive and Well, Accuval (Nov. 2012), 

  6. USD 116bn of Private Equity Assets Locked in Zombie Funds, Prequin (June 14, 2013),

  7. Cook, supra note 5. 

  8. Id.; Susan Pulliam & Jean Eaglesham, Investor Hazard: ‘Zombie Funds’, Wall St. J. (May 31, 2012, 10:09 PM),

  9. Deepti Chaudhary, PE Industry’s Latest Challenge: Zombie Funds, Live Mint (Aug. 19, 2013, 11:49 PM),

  10. Id. 

  11. Id. 

  12. Id. 

  13. Zombies At the Gates, Economist (May 23, 2013),

  14. Id. 

  15. Id. 

  16. Randolph Walerius, SEC Focus On Examining Investment Advisors Raises Stakes for Private Equity, CQ Roll Call, June 4, 2013, available at 2013 WL 72402959. 

  17. Expect More Private Equity Cases, Kaparti Says at Industry Gathering, Alternative Investment L. Rep.: Bloomberg BNA, Jan. 30, 2013, available at

  18. Walerius, supra note 16. 

  19. Alternative Investment L. Rep.: Bloomberg BNA, supra note 15. 

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Jessie Chen

Vol. 3 Associate Editor