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Weekend Analysis

Zombie funds could rise again, but there are antidotes

As valuations fall, fund managers are left struggling to exit while funds extend beyond their natural lifespan. Could we face a renewed proliferation of so-called zombie funds?

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With exit totals in Q1 on the decline for funds globally, private markets are facing a new liquidity crisis. As more vehicles extend beyond their typical 10-year lifespan, and LPs wait longer for returns, so-called zombie funds could make a comeback.

Fund managers will still have means of generating liquidity for their LPs, chiefly through the secondaries market. But the blockage could be more severe for managers that find themselves overexposed to companies backed at peak valuations that they are now struggling to exit.

The situation echoes the global financial crisis of 2008, when private markets saw a glut of funds loaded with overvalued assets they couldn’t sell. While some managers rode out the storm, many struggled.

As such, the period saw a proliferation of zombie funds: vehicles holding assets past their expected holding period with no way of liquidating these assets or raising a successor fund, effectively imprisoning capital in a non-performing fund while still collecting fees.

The concern is that a worsening of current market conditions could precipitate a new wave of zombie funds. But there is hope that slowing inflation and a break in the interest rate cycle will allow valuations to recover, or that today’s more mature—and perhaps more sophisticated—secondaries market will provide the antidote.

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PitchBook’s most recent US PE Breakdown paints a grim picture for liquidity. Exit count and exit value both fell for the third quarter in a row in Q1 as GPs continue to hold on to their investments instead of exiting at lower valuations.

The slowdown is even more acute among VCs. In Q1 of 2023, US VCs closed just $5.8 billion in exit value—less than 1% of the total exit value of 2021, when exits peaked, according to the Q1 2023 Pitchbook-NVCA Venture Monitor.

The picture isn’t much better in Europe. PE Q1 exit activity plateaued in the region at €70.7 billion (about $77.6 billion) while VC exits in the region significantly deteriorated to €1.6 billion, a 69.6% decline over the previous three months.

Exits are just part of the picture but go some way toward explaining the current liquidity crisis.

The average lifespan of private market funds in the wake of the tech bubble and the post-2008 recession grew as funds came to the end of their traditional 10-year cycle with limited refinancing and exit options. PitchBook data shows that the average lifespan of PE and VC funds grew to around 13.1 years. Our data also shows that over 70% of funds now between 10-to-15 years old—meaning with a 2008-2013 vintage—remain active.

Under similar conditions today, funds could take longer to return capital.

Currently, some areas of the private markets are showing more warning signs than others—in particular the VC industry, which was massively impacted by the collapse of Silicon Valley Bank earlier this year.

Even before the collapse, VCs had struggled with low returns or losses, more expensive debt, and fewer exits hampered by the closing of the IPO window. However, with fewer financing options available, small- to mid-sized VCs in particular will struggle to exit their existing investments and raise further capital.

The extent to which any would-be zombies are able to generate liquidity for their investors will depend partly on the secondaries market’s ability to absorb lingering assets. It is a market which is much larger than it was 15 years ago.

In the wake of the last crisis, the secondaries market rejuvenated struggling PE portfolios via a spate of GP-led secondaries involving PE firms. Such transactions have since been repurposed as a means for PE fund managers to hold on to their most prized value-generating assets. These kinds of transactions could yet be called back into action for ailing fund managers looking to return capital to LPs.

Featured image by Julia Midkiff/PitchBook News

  • andrew-woodman.jpg
    Written by Andrew Woodman
    Andrew Woodman is PitchBook’s London Bureau Chief and oversees news coverage of Europe and the Middle East. Andrew has been reporting on the private markets since 2012. He was previously an editor with Private Equity International and with the Asian Venture Capital Journal. A Japanese speaker, he spent the best part of a decade in Asia, living and working in both Japan and Hong Kong.
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