NAV Lending, DPI, SPACs, and Other Buzzwords: The Private Equity Cycle in Trendy Terms

As someone no longer new to the field, I have witnessed the contraction that the Private Equity industry has been experiencing over the past few years, and it is not the first time. The buzzwords circulating among practitioners and industry observers in response to the challenges currently facing the industry remind me of similar linguistic fads during previous cycles. This prompted me to write this article, where I explore the emergence of these buzzwords throughout different phases of the private equity cycle.

The main goal of exercises like this in finance is typically to identify early market shifts and capitalize on them. My objective, however, is more lighthearted. I aim to provide some context for newcomers and a trip down memory lane for more seasoned professionals.

For the pre-2010 period, my analysis is based on my imperfect memory of conversations with industry practitioners completed with what I read in the press. Not fully trusting my recollection, I conducted some research using JSTOR and Google Book Ngram Viewer (English corpus). For the post-2010 period, I expanded my research with searches on the NOW Corpus, using a dataset of 3,644 texts containing the term “private equity” in the title, totalling almost 2.4 million words.

Turning Point into a Downturn

An early sign that the peak of the cycle may be approaching is when the term “private equity” becomes 'too' popular, appearing in generalist publications. The peak usage of "private equity" occurred in 2007, just before the financial crisis of 2008. This peak—measured as a percentage of total words in analysed publications—has not been matched since. Interestingly, the peak usage of “venture capital” occurred in 1999, just before the NASDAQ hit a high mark in March 2000, which was followed by a prolonged downturn for venture capital investors.

These early indicators of popularity are akin to a taxi driver offering stock tips, signaling that the market may be overheated.

On the Way Down

A clear sign that the worst is behind us is when terms like “nuclear winter,” popular after the dot-com bubble burst, begin to circulate. At this point, there is no need to worry—things can only improve from here.

Another phrase that indicates fundraising is becoming particularly difficult is the “denominator effect.” This happens when sophisticated investors do not commit to private equity, not because their existing investments have dropped significantly in value, but because other asset classes have performed even worse!

In the quarters following a market shift from growth to contraction, the term “dry powder” reflect concerns about non-invested capital.

Currently, terms like “NAV lending” and “DPI” reflect the difficulties in returning capital to LPs. DPI (Distributions to Paid-In Capital) is today’s version of “cash-on-cash return” or “cash-on-cash multiple,” terms prevalent during the aftermath of the dot-com bubble and the global financial crisis. On the other hand, “NAV lending” is a relatively new term in the industry, reflecting a shift in the use of leverage at the fund level. Before 2008, closed-end investment vehicles had little to no leverage. The appearance of terms like “credit lines” and “NAV lending” signifies new risks emerging at the fund level.

These new risks, along with the well-identified risk of “defaulting investors” (a term most used in 2001 and 2007), represent challenges that the industry must navigate.

Across all phases of the cycle, the limitations of IRR (Internal Rate of Return) are a topic of discussion. I remember a venture capital investor in the early 2000s stating, “You can’t eat IRRs” as distributions became scarce.

The use of terms like “top quarter/quartile” and “bottom quarter/quartile” varies over time. Notably, the ratio of appearances of “bottom quarter” versus “top quarter” peaked in 2012 and 2022, reflecting the difficulty of fundraising during those periods.

Turning Point into an Upturn

The term “IPO window” was particularly popular in the early 2000s, peaking in 2004, when practitioners were wondering when the window would reopen. At that time, an IPO resurgence was seen as a strong indicator of upcoming distributions, as sales to other private equity funds were less common than they are today. Some feared these sales would damage the industry in the medium term, though history has proven them wrong.

While the term “IPO window” does not carry the same weight it once did, it still provides some indication of market direction. Interestingly, the term has been fairly popular in 2024.

On the Way Up

The term “top quarter” tends to become more frequent as the private equity cycle rises. This has been especially evident since 2012, with the term’s usage peaking in 2020. Similarly, terms like “superior returns” also gain popularity during these upward phases, though they can peak at turning points into downturns, as seen in 2022.

Remember SPACs, which were all the rage in 2021? And what about the once premature predictions about the death of closed-end funds due to their limitations?

The “retailization” of today reminds me of waves of listed investment vehicles and private equity firms over the past two decades. Back then, the idea was to give retail (unsophisticated) investors access to private markets, traditionally reserved for sophisticated investors. A similar rationale was used when PE firms began listing on public exchanges to provide access to fee income and carried interest. I have mixed feelings about these listings, as they tend to occur both at fundraising peaks (e.g., Partners Group and Blackstone in 2006 and 2007, respectively) and in more challenging environments, as seen in recent listings.

This ambiguity may arise because listings are often strategic decisions made by firms that have grown large enough to expand beyond the traditional private equity market.

What’s Next?

This list is far from exhaustive, and I may expand it in the future. As I reflect on the terms that might serve as markers for different phases of the private equity cycle, I am reminded of yesterday’s (18/09/2024) decision by the Fed to cut its target rate by 50 basis points. Actions like these may ultimately have more predictive power than buzzwords, as the era of cheap money had extraordinary effects—both positive and negative—on the industry.