The Last Levered Dance: How Private Equity's Mega-Funds Are Feeling the Squeeze
All Carry, No Exit: PE's Midlife Crisis
Hello Muppet Capital readers,
Before we dive into today's private equity malaise, let's take a quick stroll down Leveraged Memory Lane.
From Financial Alchemists to Middle-Aged Middlemen: A Brief History of PE
Modern private equity was born in the 1980s, when financial cowboys like KKR's Henry Kravis and TPG's Jim Coulter (before they were Sir Henry and Sir Jim with their matching billionaire islands) pioneered the leveraged buyout. The basic recipe: find a sleepy, cash-generating business, buy it with minimal equity and maximum debt, slash costs mercilessly, and sell it a few years later. The seminal moment was KKR's 1988 takeover of RJR Nabisco for $25bn (that's "billion" with a "b," kids), immortalized in Bryan Burrough and John Helyar's "Barbarians at the Gate."
The 1990s saw PE mature slightly—it was no longer enough to just cut costs; you had to actually make the business better. Revolutionary concept, I know. By the 2000s, with interest rates plummeting after the dot-com bust, PE funds ballooned in size. The 2005-2007 "Golden Era" witnessed megadeals like Blackstone's $39bn acquisition of Equity Office Properties and KKR's $45bn takeover of TXU. Then the financial crisis hit, and suddenly loading companies with crushing debt didn't seem so clever.
But PE is nothing if not adaptable. When the Fed slashed rates to zero after 2008, the industry rebounded spectacularly. Cheap debt and a rising market created the perfect environment for financial engineering to shine. PE firms became less hands-on business improvers and more financial arbitrageurs—buying with cheap debt, riding multiple expansion, and selling to the next eager buyer.
Which brings us to today, when private equity's mega-players are suddenly discovering that buying companies with lots of debt, doing some PowerPoint-based "value creation," and selling them at higher multiples isn't quite the magic money-printing machine it once was. Turns out trees don't grow to the sky—even when watered with limited partner money and fertilized with management fees.
According to Bain & Company's 2025 Global Private Equity Report, PE returns declined to a measly 3.8% in 2024, marking the third consecutive year in which public markets outperformed the asset class. While buyouts returned 8.5%, the S&P 500 trounced them with a 36.3% return over the same period. The structural headwinds that once propelled the industry forward—cheap debt, expanding multiples, and a seemingly endless parade of eager LPs—are disappearing faster than WeWork's office space.
The Numbers Don't Lie (Though PE Firms Certainly Try)
Let's start with what's staring us in the face: the latest vintage returns for most mega funds are, to use sophisticated financial terminology, pretty terrible. I've been reviewing the performance data for funds from Silver Lake, Blackstone, KKR, Apollo, and Clayton Dubilier & Rice, and the pattern is hard to miss.
Look at the recent KKR funds. KKR European Fund VI (2022 vintage) showing a net IRR of -44.2%. KKR Global Impact Fund II (2022) at -16.7%. These aren't just bad numbers; they're "maybe we should have just bought T-bills" numbers.
Blackstone isn't faring much better with its recent vintages. Its Real Estate Partners Asia III (2021) is sporting a lovely -7.0% net IRR. Although to be fair, Blackstone Capital Partners Asia II (2021) is showing a 38.0% IRR—possibly the only bright spot among newer funds across all these firms, suggesting we should all be moving to Singapore.
Meanwhile, the oldest Clayton Dubilier & Rice funds (those from the 1980s) show IRRs above 65%, with CD&R I (1984) boasting a mind-melting 96.2%.
This isn't cherry-picking bad funds. It's a pattern visible across the entire industry: older vintages crushing it, recent vintages struggling to deliver. What happened?
According to Bain's analysis, global buyout distributions as a proportion of net asset value have fallen to a dismal 11% in 2024, the lowest rate in over a decade. At the same time, the median holding period for a PE-backed company reached a record high of seven years in 2023 before slightly declining to 5.9 years in 2024—still well above historical averages. This means funds are sitting on investments longer while returning less capital to their investors.
Of course, the returns we're discussing are the ones PE firms are willing to report. Behind the curtain lies an entire magic show of IRR manipulation. Oxford professor Ludovic Phalippou has documented extensively how PE firms can juice their returns through practices like subscription credit lines (borrowing short-term to delay capital calls while the IRR clock is ticking) and "duration arbitrage" (selling winners quickly, holding losers forever). In his eye-opening paper "An Inconvenient Fact: Private Equity Returns & The Billionaire Factory," Phalippou argues that PE firms have actually delivered returns similar to public market equivalents over the long term, despite claiming significant outperformance.
Speaking of creative accounting, have you seen Apollo's latest investor day presentation? It shows the industry generating only a tiny sliver of value (less than 1%) from operational improvements, while Apollo proudly claims they create massive "alpha" through operational enhancements. It's like watching a mediocre amateur magician insist he's David Copperfield while his rabbit is visibly struggling in his hat.
When Everyone's a Buyout Shop, No One Is
Remember when private equity was just Henry Kravis and his cousins flying around in private jets buying companies with too much debt while everyone else watched in fascination? Yeah, that's not how it works anymore.
Today, there are over 9,000 private equity firms globally. When I started covering finance, "private equity" meant something special. Now it means "a bunch of MBAs with PowerPoint and Excel who pay too much for companies."
The industry has become so commoditized that it might as well sell itself in bulk at Costco. "Pick up a 24-pack of management fee streams on your way out, only $19.99 plus 2% of committed capital annually." Buy the premium version and they'll throw in some carry for free!
This commoditization has several impacts:
Too much capital chasing too few deals. With PE firms sitting on a record $2.5 trillion in dry powder (as of early 2024), they're all hunting the same limited prey. When seventeen buyout shops are bidding on the same regional warehouse distributor, guess what happens to the price? It's like watching a room full of Stanford MBAs fight over the last artisanal avocado toast at a Silicon Valley coffee shop.
The end of multiple arbitrage. For decades, PE firms could buy private companies at lower multiples than public companies traded at. Now those private company multiples are often higher, eliminating one of the industry's key return drivers. The PE playbook has gone from "buy low, sell high" to "buy high, pray higher."
Value creation theater. When you can't rely on financial engineering and multiple expansion, you need actual operational improvements. But not every PE firm is good at that. Some are, in fact, terrible at it, which is why we have case studies like Toys "R" Us and Bed Bath & Beyond.
The Toys "R" Us saga has become the poster child for PE destruction. Burdened with nearly $5bn in debt after a 2005 leveraged buyout by Bain Capital, KKR, and Vornado Realty Trust, the once-mighty toy retailer couldn't generate enough cash to both service its debt and invest in necessary operational improvements. When it filed for bankruptcy in 2017, approximately 30,000 employees lost their jobs. The financial engineering that should have "optimized" the capital structure instead bled the company dry.
Like everyone's favorite industry conference speaker always says, "We don't buy companies, we partner with management teams to unlock value." Translation: "We're paying 14x EBITDA for a business that historically traded at 8x because we need to deploy capital before our investment period expires, and we're hoping our operating partners can perform actual alchemy to justify the price."
The Era of Free Money Is Over (And PE Never Got the Memo)
Remember 2021? Private equity funds were raising record amounts ($952bn globally), exit valuations were astronomical, and GPs were buying yachts to go with their other yachts.
Then the Federal Reserve decided that inflation was not, in fact, transitory. Interest rates shot up faster than a Silicon Valley bank run, and suddenly the financial math got a lot harder.
Many recent-vintage funds were built on assumptions that no longer hold:
That debt would remain cheap
That exit multiples would remain high or expand
That LPs would patiently wait for returns
None of these assumptions survived contact with reality.
According to Bain & Company's research, in 2024 alone, global buyout deal value increased 37% year-over-year to $602bn, but this recovery is tepid compared to the heights reached in 2021. Meanwhile, median EV/EBITDA multiples in North America rebounded to 11.9x in 2024, while European multiples hit a new record of 12.1x. The problem? Firms are paying historically high prices while being unable to use the same amount of leverage to juice returns.
And speaking of failures, Neiman Marcus presents another cautionary tale. The iconic luxury retailer underwent not one but two leveraged buyouts. The second one in 2013, led by Ares Management and the Canada Pension Plan Investment Board for $6bn, saddled the company with a crushing $4.8bn debt burden. Despite having a strong online business accounting for about one-third of total sales, Neiman Marcus couldn't generate enough cash to service its debt while also investing in necessary operational improvements. The company finally collapsed under this weight, filing for bankruptcy in May 2020.
The PE industry is facing a reckoning as multiple expansion dies and operational improvement becomes the only viable path to superior returns. Bain's data shows that today's firms can no longer afford to "ignore margin growth as a driver of value" as many have done over the past decade. The traditional PE playbook is becoming obsolete, and many firms are struggling to adapt.
Remember that hilarious slide from Apollo's investor presentation that's been making the rounds? The one showing Apollo generating massive "alpha" from operational improvements while the rest of the industry supposedly creates almost none? It's like watching someone claim they've invented a perpetual motion machine while their competitors are stuck with the laws of physics. If only their portfolio companies' performance matched their Illustrator skills!
The Great LP Liquidity Crunch
Limited partners have another problem: their PE investments have become the Hotel California. You can check in, but you can never leave—or at least not at a decent valuation.
Distributions to limited partners have slowed to a trickle. Buyout distributions as a proportion of NAV have hit record lows. In five of the last six years, LPs have been cash flow negative in their PE portfolios, meaning they're putting in more money than they're getting back.
When your LP base doesn't receive distributions, they can't recycle that capital into your next fund. It's PE fundraising's version of constipation.
And yet fund managers keep raising new funds as if nothing has changed. "Sure, we haven't returned your capital from Fund VII yet, but have you considered investing in Fund VIII? It's going to be even bigger!" It's like a restaurant asking you to pay for your next meal while you're still waiting for the appetizer from your last visit.
The data from Bain's 2025 Global Private Equity Report shows just how dire the situation has become. According to their analysis, COVID-era vintage funds from 2020-2022 experienced unusually rapid initial drawdowns but faced an abrupt skid in exits, creating a J-curve that looks disturbingly similar to the 2005-2006 fund vintages launched right before the global financial crisis. Those vintages took over nine years, on average, to return capital to investors. Today's funds may take even longer.
And while firms are increasingly turning to liquidity mechanisms like continuation vehicles, NAV loans, and dividend recaps, these financial tools can't fully compensate for the industry's two-and-a-half-year exit slowdown. About 30% of companies currently in buyout portfolios have undergone some sort of liquidity event, with the industry raising a total of $410bn via minority interests, dividend recapitalizations, secondaries, and NAV loans—but it's still not enough.
If you've attended any of the major LP conferences lately, you've noticed the awkward dance between GPs and LPs. The GPs all come with the same pitch: "We're different! We create alpha through operational improvements!" Meanwhile, the LPs are nodding politely while thinking, "Your last three funds are underwater and you still haven't returned a dime from Fund IV, which you raised in 2015." It's like speed dating where everyone already knows each other's terrible relationship history but pretends they don't.
The Death of Financial Engineering
PE has historically relied on three mechanisms to generate returns:
Multiple expansion (sell for a higher EBITDA multiple than you paid)
Leverage (amplify returns with debt)
Operational improvements (actually make the business better)
The first two have largely evaporated. Multiple expansion isn't guaranteed in a high-rate environment, and leverage is now both more expensive and harder to obtain.
This leaves operational improvements as the primary driver of returns. But here's the inconvenient truth: not all PE firms are good at operations. Some are, to be technical about it, absolutely terrible.
As Bain's 2024 Global Private Equity Report bluntly put it: "Buyout funds on average have essentially ignored margin growth as a driver of value over the last decade and have been carried along by multiple expansion." That's now coming back to haunt them.
Bain's 2025 report adds another frightening data point: Close to $300bn in leveraged loans is coming due by the end of 2025, dialing up the pressure on portfolio companies to generate EBITDA. But improving operational performance takes real expertise, not just financial wizardry.
Let's take Bed Bath & Beyond as a cautionary tale. While not a pure PE-owned company, it exemplifies the dangers of financial engineering over operational improvement. Since 2004, it spent an astonishing $11.8bn on share buybacks, eventually eclipsing the $5.2bn in debt reported in its SEC filings before bankruptcy. As Sarah Wyeth, a lead credit analyst at S&P, noted about the company's collapse: "We would prefer to use their cash flow to invest back in business." But instead, management focused on financial metrics rather than operational improvements, online experience, or modernizing stores.
I recently attended a panel discussion where a managing partner from a major PE firm was bragging about their value creation framework. "We have a proprietary approach to driving operational alpha," he said with complete confidence. When someone asked for a specific example from their portfolio, he spent five minutes describing how they'd helped a company implement Salesforce. Groundbreaking stuff! It's like claiming you're a master chef because you can successfully reheat leftovers in the microwave.
Zombie Portfolios Walking
The lack of exits has created a growing crisis of "zombie portfolios"—investments that can't be sold at desired valuations but must be held indefinitely. According to PitchBook data, private equity firms hold more than 28,000 assets, 40% of which have been held for longer than four years.
The median holding period for a PE-backed company reached an all-time high of seven years in 2023, before declining to 5.9 years in 2024. That's still well above historical averages, and it means that funds which typically have 10-year lifespans are running out of runway.
This explains the rise of continuation funds, NAV loans, and minority stake sales—all financial engineering designed to create liquidity without actually selling the underlying company.
Bain's 2025 Global Private Equity Report reveals that about 30% of companies currently held in buyout portfolios have undergone some sort of liquidity event. Not surprisingly, the likelihood of these partial realizations rises with the age of the asset. For assets held more than six years, a staggering 58% have undergone partial realizations, compared to just 17% for those held less than two years.
Think about that for a moment: more than half of PE's most aged investments are being "partially realized" instead of fully exited. It's like a homeowner selling off a bathroom here, a bedroom there, because they can't sell the whole house.
The industry has created an entire linguistic framework to mask this problem. We don't talk about "failed exits" or "underwater assets" anymore. Instead, we have "alternative liquidity solutions" and "value maximization strategies." It's like how no one gets fired anymore—they "pursue other opportunities" or "spend more time with family." Next time your GP sends you a letter about a "strategic partial realization," just know they're really saying, "We've tried to sell this dog for three years and no one will pay what we need to hit our carried interest hurdle, so we're getting creative."
Winners and Losers in a Post-Easy Money World
So who survives in this brave new world? A few observations:
Mid-market is eating mega-funds' lunch. Smaller funds have outperformed large/mega-cap funds by over 500 basis points during the elevated rate environment since Q2 2022, according to FS Investments data. They're simply less dependent on leverage to drive returns.
Specialized beats generalist. Funds with deep industry expertise can find value where others can't, and they're better positioned to actually improve operations.
The LP base is changing. Sovereign wealth funds and individual investors (hello, democratization of private markets!) will contribute to 60% of future AUM growth by 2033, according to Bain estimates. This changes the game.
Fund-raising is becoming a sharp-elbowed game of haves and have-nots. According to Bain's 2025 report, in 2024, top-quartile fund managers increased the size of a subsequent fund by 53% while fourth-quartile managers struggled to increase fund size at all. This 53-percentage-point delta was significantly higher than the historical 10-point gap.
It's becoming a bifurcated market faster than you can say "carried interest loophole." The top-tier firms are getting bigger, charging the same fees, and telling their LPs that size is no impediment to returns. Meanwhile, the smaller specialists are making the opposite case: "We're too small to be commoditized, and our focus on [insert niche sector] gives us an edge."
Both camps might be right. The mega-funds can succeed through scale, diversification, and overwhelming resources. The specialists can win through focus and expertise. It's the undifferentiated middle market that's getting squeezed like a tourist buying a knockoff Rolex in Times Square.
The Great PE Reckoning Is Coming (But Not Today)
Will the PE industry collapse? No. Will it undergo a painful adjustment period? Absolutely.
Here's my prediction: we're going to see a massive bifurcation between the haves and have-nots. Top-quartile funds—the ones that actually create operational value—will continue to raise capital. Everyone else will struggle.
Fund managers will promise to do better on operational value creation. "We've hired three former McKinsey partners and a Six Sigma black belt!" But talk is cheap, and most will fail to deliver.
We'll see consolidation—the strongest firms buying the weakest. We'll see strategy shifts—more credit strategies, more GP stakes, more private wealth channels. And we'll see a lot of GPs quietly accepting lower fees to keep the lights on.
The winners will be firms that can genuinely transform businesses, not just financial statements. The losers will be the financial engineers who never developed real operational chops.
Bed Bath & Beyond: A Case Study in PE-Adjacent Destruction
While not a pure PE failure, the Bed Bath & Beyond saga offers valuable lessons. The company spent an astonishing $11.8bn on share buybacks since 2004 before collapsing into bankruptcy. That's financial engineering gone horribly wrong—the kind of short-term financial thinking that permeates both public companies and PE-owned ones.
As Sarah Wyeth, lead credit analyst at S&P, noted: "We would prefer to use their cash flow to invest back in business." But that's not what happened. Instead, management focused on financial metrics rather than operational improvements, store experience, or e-commerce development.
Sound familiar? It's the same playbook that many PE firms run, just with public company money instead of LBO debt.
The comparison with Toys "R" Us is revealing. In that case, a leveraged buyout in 2005 by KKR, Bain Capital, and Vornado Realty Trust saddled the company with nearly $5bn in debt. This debt burden made it impossible for the iconic retailer to both service its debt and make the necessary investments to compete in an increasingly digital world. By the time it filed for bankruptcy in 2017, it had been bled dry, resulting in 30,000 job losses.
Similarly, Neiman Marcus underwent two separate leveraged buyouts. The second one in 2013, engineered by Ares Management and the Canada Pension Plan Investment Board for $6bn, left the company with a crushing $4.8bn debt load. Despite having a solid online business representing about one-third of its total sales, the luxury retailer couldn't generate enough cash to service this debt while also investing in necessary operational improvements. When it filed for bankruptcy in May 2020, it was a victim of financial engineering, not retail failure.
These cautionary tales share a common theme: financial engineering doesn't create real value. It merely redistributes it, often from employees, customers, and vendors to financial sponsors.
When Senator Elizabeth Warren introduced legislation targeting private equity practices following the Toys "R" Us collapse, industry defenders argued it was a few bad apples. But the rot seems more systemic. As Warren put it: "Private equity firms are like vampires—bleeding the company dry and walking away enriched even as the company succumbs." A bit dramatic for political theater? Sure. But she's not entirely wrong.
So What Happens Next?
Here's what to watch for:
A flight to quality. LP capital will continue to concentrate with the best performers, making it even harder for middling firms to raise funds. Bain's report shows this trend already accelerating—in 2024, top-quartile fund managers increased the size of subsequent funds by 53% while fourth-quartile managers struggled to increase fund size at all.
The rise of the operator. Firms with genuine operational expertise will outperform, while financial engineers will struggle. With nearly $300bn in leveraged loans coming due by the end of 2025, PE firms are under immense pressure to generate real EBITDA growth.
New liquidity solutions. Expect more continuation funds, NAV loans, minority sales, and other creative ways to generate liquidity without exits. Secondary funds raised $102bn in 2024 alone, pushing total secondaries AUM to $601bn.
More PE firm failures. Yes, the firms themselves, not just their portfolio companies. Many smaller shops won't survive.
Fee compression. The 2/20 model is already under pressure. For all but the elite firms, it's going to get worse.
Private equity isn't dead—it's just entering middle age, with all the aches, pains, and existential crises that entails. Like a 45-year-old who just bought a Porsche and started CrossFit, the industry is desperately trying to recapture its youth.
For limited partners, the message is clear: be selective, be patient, and perhaps reconsider those public market index funds. For general partners, it's time to deliver real operational value or face extinction.
Until next time,
Your friendly Muppet Capital correspondent
Disclaimer: This newsletter is for informational purposes only and does not constitute investment advice. The author may hold positions in companies or funds mentioned. Always do your own research, and remember that past performance does not guarantee future results, especially in private equity. And if a GP tells you their fund is "top quartile," ask them which metric they're using, which time period, and which benchmarking service—then watch them squirm like they're being audited by the IRS.