While raising capital, private equity funds get commitments from investors such as pension funds, university endowments, hedge funds, fund of funds and high net-worth individuals. These commitments are drawn down as and when the fund makes an investment.

This means that till the capital is deployed, its control rests with the investors, collectively referred to as limited partners (LPs).

Because of the huge erosion in the market value of their fixed income and equity exposure, many of these LPs, especially the pension funds and endowments, could suddenly find themselves overexposed to private equity, an asset class that is not marked to market.

If they decide to reallocate assets, private equity funds may find themselves in a situation they last faced during the dotcom bust, when many LPs pulled out and funds were left with little capital to “draw down". Another problem could arise from hedge funds or institutions who have been taken over by larger institutions.

A case in point is Bear Stearns and Companies Inc., which had invested in some India-dedicated private equity funds. It’s still not clear if JP Morgan Chase and Co., which took over Bear Stearns, will honour these commitments. Otherwise, these funds may well be left with a gaping hole.

The third and most vulnerable group among the LPs is the high net-worth individual. Many domestic funds had recently raised huge capital commitments from this segment, and may again find themselves unfamiliar terrain.

Of course, there are penalties for not honouring commitments, its extent depending on the agreement signed between the investors and the fund, which in turn depends on the degree of bargaining power the fund enjoys.

In some cases, it could mean LPs having to forfeit the “drawn down" capital, if they fail to honour the whole commitment.

The alternative for distressed LPs is to find a substitute investor. These investors, referred to as secondary purchasers, specialize in buying a commitment from an existing LP.

It may well be the right time for global secondaries specialists such as Coller Capital, Paul Capital Partners and Lexington Partners Inc. to mark their presence in India. Or maybe cash-rich Temasek Holdings Pvt. Ltd, the Singapore government’s private equity arm, could step in.

As Manish Kejriwal, senior managing director and country head (India) for Temasek, admitted at a recent conference: “A lot of LPs have approached us regarding secondary purchases."

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