The largest private equity firms are capturing an increasing share of investor capital, creating a two-tier market that is setting the stage for a wave of so-called zombie firms, according to new industry data. In the first half of 2024, the top 10% of funds raised accounted for over 60% of all new capital, a concentration not seen since before the 2008 financial crisis.
Flight to Quality Concentrates Capital
The trend is being driven by institutional investors, such as pension funds and endowments, who are increasingly favoring established managers with proven track records. This “flight to quality” has left a shrinking pool of capital for smaller and mid-tier firms. Data from Preqin shows that the number of funds holding a final close in 2023 dropped by nearly 30% compared to 2021, even as total dry powder—committed but uninvested capital—hit a record $2.6 trillion.
The Rise of Zombie Firms
The concentration of capital is a leading indicator for a growing problem: zombie firms. These are portfolio companies that cannot generate enough growth to attract a buyer or go public, but also cannot fail because the general partner (GP) lacks the incentive to write down the investment. A 2023 report from Bain & Company estimated that nearly 20% of all PE-backed companies are now held for longer than five years, a key sign of zombification.
“The market is bifurcating,” said a partner at a large placement agent who spoke on condition of anonymity to discuss sensitive fundraising data. “The top quartile of firms are oversubscribed, while everyone else is fighting for scraps. This is creating a cohort of funds that will struggle to return capital to their LPs, leading to a wave of zombie portfolios.”
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Implications for Investors and the Market
For limited partners (LPs), the trend presents a challenge. While concentrating capital with top-performing managers can reduce risk, it also reduces diversification and can inflate valuations in popular sectors like technology and healthcare. For smaller GPs, the path forward is narrowing. Those without a clear specialization or a strong track record from the last cycle may find it impossible to raise a successor fund.
The long-term effect could be a less dynamic private equity industry, where a handful of mega-firms control the majority of assets and smaller, innovative players are squeezed out. This mirrors patterns seen in other financial sectors, from banking to asset management, where scale has become a decisive competitive advantage.
Frequently Asked Questions
What is a ‘zombie firm’ in private equity?
A zombie firm is a private equity-backed company that generates enough cash to service its debt but not enough to grow or provide a meaningful return to investors. These firms are often kept alive artificially because the PE fund cannot exit the investment at a profit.
Why are smaller private equity firms struggling to raise money?
Institutional investors like pension funds are increasingly favoring larger, established firms with strong track records. This ‘flight to quality’ leaves smaller or newer firms with a smaller pool of capital, making it harder for them to raise new funds.
How does the ‘winners take all’ trend affect the broader economy?
The concentration of capital among a few large firms can reduce competition and innovation in the private equity industry. It also means that many smaller portfolio companies may become zombies, potentially leading to job losses and reduced economic dynamism.
What is ‘dry powder’ in private equity?
Dry powder refers to the amount of capital that private equity firms have raised from investors but have not yet deployed into companies. As of early 2024, global dry powder stood at a record $2.6 trillion.
How can LPs protect themselves from zombie funds?
Limited partners can protect themselves by conducting thorough due diligence on a fund’s track record, investment strategy, and exit capabilities. They may also negotiate for stronger governance rights and co-investment opportunities to gain more control over their capital.
