Zombies in Private Equity: An Empirical Study of Fundraising Impact on Fund Performance

Abstract: In a maturing private equity industry with more players, larger funds and importantly more data at researchers' disposal, new issues can be both identified and studied. One of these issues surfaced when the sharp drop in fundraising volumes in 2008 rendered many of the General Partners (GPs) unable to successfully raise a follow-on fund, which is considered vital for efficient functioning of the GP's organization. This has created an increasing concern among Limited Partners (LPs) who are stuck with underperforming and disincentivized GPs that are postponing divestments just to "milk" the fund for management fees. Regardless of the increased media attention on these zombie-like situations, relatively little is still known about the phenomenon. Using an extensive dataset of 2,824 private equity funds from Preqin, we identify 436 zombie funds with performance information among vintages from 1996 to 2008. We take a look at the fund performance patterns and observe from regression analysis that zombie funds are providing less value to their LPs over the course of the fund life. More importantly, we note that the performance deterioration of zombie funds is equal to 12% of the initial paid-in-capital compared to non-zombies once the failure to raise a follow-on fund has become clear. This is indicative of both misaligned incentives and that LPs would be better off by taking active measures to find a solution. Furthermore, we identify that zombie funds are slower in making investments as well as report to have more residual value left near the end of the fund's life. Our findings are both statistically and economically significant.