Math behind the size of PE fund’s investment

During my time in private equity, I was often investing as a minority investor alongside larger PE firms. One very important consideration was how much does that investment matter to the majority investor.

Today I want to walk you through a topic that all of us from private equity know; but most founders, operators and sport executives don’t – what the math behind size of fund’s investment signals.

Specifically, how large each investment is relative to the fund itself explains why some investments are big bets and others are call options or rounding errors.

During first 4 years of the fund (so called investment period), large buyout fund will typically invest in a portfolio of 12 to 15 investments. The largest investment may be ~10% of fund’s size (in mid-market funds ~15%), and smallest ~4%.

Note that a PE fund will typically invest ~80% of committed capital (i.e fund size), and use 20% to pay itself management fees and cover costs over fund’s life (10 years).

If a fund writes a check into a company that represents 15% of the fund – the outcome of that one deal will meaningfully move the fund’s overall returns. The fund will dedicate serious resources, and lose sleep over quarterly results.

If that same fund writes a check that is 1% of the fund (which is unusual, as it is too small). Even if the investment returns 10x, which is exceptionally rare in PE, that would barely impact fund’s total return.

The smaller a check is relative to the fund, the less it will matter to the fund’s returns, no matter how well the investment performs.

CVC is one of the first and largest private equity investors in sports. Last year CVC consolidated its sports investment under Global Sport Group, but we can still look at these investments and do some math.

CVC Capital Partners Fund VII is a flagship €16 billion buyout fund raised in 2017/18.

The fund has invested heavily in pharmaceuticals, consumer healthcare, IT software, and regional European services, with ticket sizes ranging from €500 million to over €1 billion.

Since 2018, CVC has also invested heavily in sports. Notable sports investments from Fund VII are:

• Rugby, £700m in 2018 – 2021: deployed across three competitions Premiership Rugby (£200m for initially 27%), PRO14 (£120m for 28%), and Six Nations Rugby (£365m for 14.3%)

• Volleyball World, $100m in 2021: 33% stake in the commercial subsidiary of the Fédération Internationale de Volleyball (FIVB)

Now let’s look at the size math:

• €1.6 billion investment into portfolio company is 10% of the fund

• €800 million in three Rugby investments is 5% of the fund

• €90 million investment in Volleyball is ~0.5% of the fund

While for volleyball executives a $100 million cash injections may have felt like a transformational bet, for CVC it was almost a rounding error.

I am not implying that CVC was doing something cynical, to the contrary CVC was buying a strategic foothold in a growing sports market. But the math is such that for Fund VII that investment cannot move the needle. Even if the volleyball investment returns 5x, an amazing outcome for a PE investment, that would make a marginal contribution to total fund value.

A large buyout fund targets to return ~2x Net MoM to its investors (LPs) over a 10-year period. Yes, I know you are probably thinking that is not world beating… but actually only ~1/4 of large buyout funds achieve that!

2x Net MoM means net of 20% carried interest (performance fees), 2% annual management fees over 10 years (which eats 20% of the fund), and quite a few other expenses paid by the investors. That means that fund needs to generate ~2.5x Gross MoM to return 2x Net MoM.

For CVC Fund VII it means that for €16 billion fund, fund’s investments need to generate €40 billion (€16bn x 2.5) in proceeds, so CVC’s investors get 2x Net MoM.

In practice, a PE fund’s returns follow a power curve. Maybe three or four investments return 3 – 5x and drive the bulk of the profits. A few return 1 – 2x. A couple go to zero.

Even if CVC’s Volleyball investment returned 5x, it would be barely 1% of proceeds required to return 2x Net MoM to their LPs.

Small positions serve real purpose. They build relationships, create option value, and provide market intelligence. But they won’t make or break a fund.

Not every character on the stage is Hamlet. There is Yorick too. In PE portfolio the math will tell you who is who.

Thanks for reading,

Nikola