Patient capital and the cost of the wrong holding period

Every investment runs on two clocks. The company's clock is set by its customers, its products and its people. The fund's clock is set by the life of the fund, and each company in it usually has to be sold within a few years. When the two disagree, the fund's clock tends to win.

What the short clock costs

Bain & Company notes that traditional buyout funds usually sell companies within three to five years, and that this short cycle creates recurring costs for the funds and their investors. It also forces managers of the fund to keep hunting for the next deal.¹

Bain lists what a longer hold avoids: transaction costs on every sale and purchase, distraction for management teams preparing for an exit, capital that sits uninvested between deals, and capital gains tax paid earlier than necessary.¹ In our experience the cost inside the company is quieter. In year three, hiring slows, a bold investment is trimmed, and the plan starts to bend around a sale date instead of the customer.

What a longer hold can do

Bain built a simple model to compare the two approaches. A long-hold fund keeps one strong company for 24 years. A traditional fund sells four successive companies over the same period. If the businesses perform equally well, the long-hold fund comes out almost twice as far ahead after tax.¹ It is a model, with assumptions, not a promise. But it shows how much the cycle of selling and buying can cost.

Large investors have taken the idea seriously. As of 2018, Blackstone had raised $5 billion for a fund with holding periods roughly double those of a traditional buyout fund. Two newer firms, Core Equity and Cove Hill, each raised more than $1 billion for holds of up to 15 years, and CVC launched a 15-year fund.²

Patient does not mean passive

Bain is clear that long holds are not for every company. They suit high-quality businesses that can keep compounding earnings, usually with strong management, steady free cash flow and a solid market position. Distressed assets, turnarounds and companies that depend on an economic cycle are a poor fit.¹ The authors also suggest looking again at each holding every three to four years, because technology, regulation and competition can change quickly.²

We agree with both points. Patience without review is just inertia. The discipline is to know why you are still the right owner.

How we set the holding period

We do not start with a number of years. We start with three questions:

• What does the plan need, and how long does the next stage of growth really take?
• What does management need to know in order to commit to that plan fully?
• When would we ask whether we are still the right owner?

We agree the answers with management at the start, so nobody is guessing about the date. If the plan needs another two years, the capital is there for it.

Key takeaway: the holding period should follow the plan. When it follows the fund, the business pays for it.

If your plan needs longer than a fund's calendar allows, we would like to talk about it.