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Will mega-buyouts return in 2013?

October 2, 2012: 11:50 AM ET

Private equity firms have too much money, but that doesn't mean they'll rush to spend it.

FORTUNE -- Ever since the financial crisis of 2008, private equity firms have been stuck with more capital than they can reasonably invest. The industry jargon for this dilemma is overhang, and Pitchbook Data reports that it currently stands at $432 billion. Of that, nearly half technically needs to be invested by the end of 2013 -- based on private equity fund terms that typically require initial disbursement within the first five years of a fund's life. And most of that expiring capital is in the hands of funds that are $5 billion or larger in size.

This is the topic Andrew Ross Sorkin discusses today in his New York Times column, suggesting that the overhang will result a revival of mega-buyouts. Fairly logical conclusion: Private equity firms have to quickly unload billions of dollars, and it would be easier to do so in a few large chunks than in dozens of smaller ones.

But here's the thing: Logic and private equity aren't always the best of friends. For example, does it stand to reason that a "buy high/sell low" industry invested record amounts of capital in years like 2006 and 2007, but sat on its collective hands in 2009 and 2010?

Private equity execs will tell you that Sorkin's thesis is off base, because it implies that firms would knowingly overpay in the pursuit of filling up a fund. Such a thing, they argue, would be in breach of their fiduciary responsibilities to limited partners.

And they're right, to a point. Private equity executives are unlikely to seek out a $10 billion transaction, prompted by a pending fund deadline. But it's not usually because of high-minded fiduciary concerns. After all, the right solution in that case would be to retroactively cut the fund size, like many venture capital firms did after the dotcom crash in 2002 and 2003.

Instead, they won't do the deals because they can simply insist that their limited partners give them more time. Sorkin touches on this briefly, but it deserved more prominent mention.

When it comes to find life extensions, most private equity firms have their investors over a barrel: If LPs fail to extend the fund life -- thus shutting off the fee-stream and signaling a lack of support for follow-on funds -- then the private equity executives can effectively threaten to turn their attentions elsewhere. Sure they'll officially continue managing out the existing portfolio, but it may no longer be their full-time job. And, without fees, you often can say goodbye to the junior staff that often does much of the heavy operational lifting.

Limited partners always have the right to fire a general partner but who would they hire as a replacement? There are a few boutiques out there for small funds, but nothing for multi-billion dollar portfolios.

That's why LPs almost always approve the fund extension. Or, as we've seen recently, have grudgingly agreed to sell their fund stakes via secondary recaps that lets PE execs continue to collect fees on funds that should be dead and buried.

In other words, don't necessarily expect a bumper crop of mega-buyouts in 2013 based on the overhang issue. Private equity is a long-term asset class by nature, and can be an even longer-term asset class by necessity.

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Dan Primack
Dan Primack
Senior Editor, Fortune

Dan Primack joined Fortune.com in September 2010 to cover deals and dealmakers, from Wall Street to Sand Hill Road. Previously, Dan was an editor-at-large with Thomson Reuters, where he launched both peHUB.com and the peHUB Wire email service. In a past journalistic life, Dan ran a community paper in Roxbury, Massachusetts. He currently lives just outside of Boston.

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