Evergreen and drawdown funds: Structural considerations for private equity

Evergreen funds and drawdown funds offer different ways to access private markets. For eligible investors, the differences can shape capital deployment, liquidity, compounding, portfolio flexibility, and diversification. In our view, understanding those structural trade-offs (Figure 1) is essential as evergreen vehicles continue to develop as an important part of the private equity toolkit.

At a high level, an evergreen fund is an open-ended vehicle that is continuously offered and seeks to stay invested over time. A drawdown fund is a closed-end vehicle that calls committed capital over a set investment period and returns capital as investments are realized.

The relative advantages of evergreen and drawdown structures depend on investor objectives, liquidity needs, risk tolerance, and market conditions. Each involves distinct risks and considerations.

Though evergreen funds aren’t brand new, they represent this shift now because they can potentially address some challenges facing eligible investors today:

• Access: Evergreen funds may expand access for certain eligible investors to private markets for a wider audience beyond institutions. ²
• Innovation: Many innovative companies across key sectors like AI, cybersecurity, and automation, for example, are private. Because evergreens expand access to private markets, they have the potential to expand access to innovation.
• Value creation: In recent years, companies have tended to stay private for longer, so they’ve experienced a greater proportion of their value-creation cycle outside public markets. If/when these companies go public, they could command higher valuations, and investors may have missed the chance to invest earlier in the value-creation cycle. However, outcomes can be volatile, with uncertain outcomes as well.

Evergreen funds may help eligible investors with an appropriate tolerance for illiquidity to address these challenges. It’s important to remember that evergreens’ periodic liquidity isn’t synonymous with daily liquidity; it can be subject to limits, including gating, suspension, or other restrictions. Additionally, these products are still invested in privately held, illiquid assets that cannot be easily sold.

Capital efficiency in evergreen performance

One of the most significant differences between evergreen and drawdown funds is how capital is deployed and returns are generated. Drawdown funds typically operate with uncalled or uninvested balances, meaning a portion of the capital investors commit to the fund may sit in cash or public markets (not private equity) for part of the fund’s life, which can span many years.

Evergreen funds, on the other hand, are designed to maintain high invested exposure over the duration of an investor’s commitment. Evergreen fund investors can have exposure to private equity investments for as long as they’re invested ― a time period with no fixed end date. This can support continuous compounding of returns (Figure 2).

A common metric for private equity performance is internal rate of return, or IRR. This is the discount rate that makes the net present value of all cash flows equal to zero. Though this is a typical performance metric, comparing IRR between drawdown and evergreen structures isn’t always apples to apples. IRR is calculated on deployed capital, so it may not fully capture the differences between invested and uninvested capital we outlined above. This distinction can end up materially affecting comparisons of the two vehicles on a holistic basis, as illustrated by (Figure 2).

Over time, the continuous compounding effect of an evergreen fund may result in different return patterns and potentially higher returns based on total value to paid-in (TVPI). The illustrative outcomes in Figure 2 are simplified and intended to demonstrate differences in capital deployment and compounding mechanics. In the closed-end example, a hypothetical $100 commitment is called at a 37% annual rate and earns a 20% IRR over 10 years, resulting in a 2.35x TVPI; uncalled capital and distributions are not assumed to be invested in assets that earn a return. In the evergreen example, a hypothetical $100 investment is funded at inception and compounds at a 10% net annualized return over the same period, resulting in a 2.6x TVPI.

The modeled outcomes show the potential benefits of compounding returns through earlier exposure, continuous reinvestment, and the absence of a fixed fund term. In this simplified example, those structural differences help explain why the evergreen outcome results in a higher ending TVPI. Despite the evergreen example having a substantially lower assumed annual return than the hypothetical closed-end fund’s IRR, the benefits of compounding can be very powerful over time.

Private equity market: Fertile ground for evergreens?

With this context, we’d like to zoom in on three potential differences of evergreen vehicles within the private equity market:

1. Open-end structure allows for greater flexibility

Because evergreens are open ended, with no fixed investment term or fund life, they may align better with the long-term interests of portfolio companies throughout their life cycles.

Evergreen funds may be attractive to founders for this reason. They can help support future rounds of fundraising and maintain involvement through multiple phases of growth. Evergreen investors can be long-term partners; closed-end funds are ultimately constrained by a finite fund life.

Another important benefit of the open-end nature of evergreens is reduced pressure to sell compared with closed-end vehicles. Venture-backed companies often take longer than expected to mature. Evergreen structures can hold promising companies without the pressure of a closed-end PE or VC fund’s expiration date. This can be especially valuable for growth-stage companies, particularly when they face delayed IPOs, staying private longer and compounding value over time. However, the increased hold periods could also lead to increased exposure to valuation and liquidity risks, given that these are still privately-held, illiquid assets that cannot be easily traded.

What’s more, closed-end drawdown funds eventually need to return capital to investors, which can create pressure to sell shares, distribute stock, or push for liquidity. Under normal conditions, evergreen funds have the potential to be more patient as they aren’t obligated to exit strong companies simply because the fund clock is running out. Note that evergreen conditions may vary based on investor sentiment, redemption gates and liquidity pressures that could lead to early exits.

2. Adaptable portfolio management

As evergreen funds aren’t constrained by fixed liquidation timelines, managers can make decisions based more on company fundamentals and market conditions. For example, they can hold a late-stage private company through a weak IPO market rather than selling at a discount in a secondary transaction.

For the same reason, managers of evergreen funds could have greater control over position sizing and entry/exit timing than closed-end drawdown fund managers. This is important in venture capital and growth because tender offers and direct secondaries can be more prevalent in these markets since ownership is often distributed across a broad set of minority investors. This differs from many buyout strategies, where managers typically seek control positions, so, tender offers and secondary investments in single companies may be less central to portfolio construction.

Position size is particularly important in the single-company secondary market. If a position increases in size to the point where it presents concentration risk, it can be helpful to be able to reduce the exposure. Or, if conviction in an existing, undersized position grows, it can be helpful to be able to pursue additional secondary purchases. Ultimately, there’s a different opportunity set available within venture and private equity, one that may benefit from portfolio management with more flexibility in position size and entry/exit timing. However, while evergreen funds can provide more flexibility, strong portfolio management is critical within an evergreen fund structure.

These structures require stronger liquidity and portfolio construction oversight due to the portfolio diversification and potential for periodic redemptions. The trade-off is dependent on investor needs and how a venture and growth equity investment may fit within their overall portfolio.

3. Diversification

Many traditional, non-evergreen venture and growth funds focus primarily on certain sectors or stages of investments. Evergreens can have more flexible mandates.

First, these vehicles can provide broad exposure to a range of innovative technology and companies with a lower minimum commitment than is often required in traditional venture funds. Drawdown funds typically require investors to commit larger amounts of capital for more focused exposure to a strategy, stage, or sector.

Additionally, evergreen funds offer potential exposure to a wider range of investment vintages, or the years in which capital is put to work. They can be diversified across later-stage venture businesses, scaled pre-IPO companies, and other exposures, depending on the mandate. This gives evergreens the potential benefit of exposure to different market segments with different return drivers, which could potentially generate a different risk-adjusted return profile over time.

Finally, these vehicles could allow for greater diversification across investment types, including direct investments, secondaries and, where appropriate, credit. These broad investment mandates can provide investors with a means of sourcing attractive investments from a bottom-up perspective with fewer top-down restrictions. And evergreen funds’ structure may be more conducive to taking advantage of market dislocations that may arise throughout market cycles compared to vehicles governed by set durations given the flexible investment mandate and ability to continuously invest without the limitations of an investment period or fund term.

How and why to be discerning among evergreen funds

Importantly, evergreen funds do not represent a one-size-fits-all solution for every private equity investor. It’s prudent to consider funds’ liquidity management, diversification across vintages, exposure to quality assets, and approach to fundraising and redemption management before investing. In addition, evergreen funds may involve risks related to timing of subscriptions & redemptions and potential constraints on liquidity in stressed market conditions. Some evergreen funds may be better positioned to withstand market dislocations without forced asset sales than others, so investors should weigh the risks and potential benefits thoughtfully.

Conversely, drawdown funds could pose some potential benefits over an evergreen structure as well. Drawdown funds do not require any liquidity planning. As a result, the funds do not have to reserve any percent of capital for liquid assets and can focus more exclusively on private investments. Additionally, closed-end funds make fewer investments and therefore can often provide more specialization in a given sector or asset class, which could benefit certain investors.

But we believe the bottom line is that thoughtful, well-structured evergreen funds can expand the private equity toolkit. They can continuously recycle proceeds, pursue a more flexible mandate including secondary, shorter-duration, or crossover opportunities, and potentially remain invested in high-conviction companies beyond a traditional fund life, potentially supporting compounding and more flexible portfolio construction over time.

Footnotes

1. Typically limited, with periodic redemption windows, may be subject to gating, suspension, or other restrictions, and may not be available in all market conditions.
2. Subject to applicable regulatory requirements applicable regulatory, jurisdictional, and product eligibility requirements.

This material is provided for informational and educational purposes only and does not constitute an offer to sell or a solicitation of an offer to invest in any product, strategy, or fund. Any offering will be made only pursuant to formal offering documents and in accordance with applicable law. Availability of any strategy or investment is subject to regulatory, jurisdictional, and investor eligibility requirements.

Commentary provided is for illustrative purposes only and should not be viewed as a current or past recommendation and is not intended to constitute investment advice or an offer or solicitation to buy or sell securities.