While private equity firms are enjoying more dry powder than ever, the overall fund lifecycle is expanding. Mergermarket interviewed private equity partners, directors and principals from across the United States and their responses point to increases in time in all three lifecycle segments of a fund: raising capital, searching for suitable targets, and exit.
For the majority of US GPs, the time period spent raising money from investors for their most recent fund was longer than the preceding one, 76% of the respondents needing between 9 to 18 months total. While fund lifecycles are extending, the amount of capital being raised has largely remained stable, increasing only slightly year over year. Mergermarket believes that the reason for the increased fundraising time horizon is caused by changing investor demand and regulatory pressure. Investors are streamlining their PE assets by selling into the secondary market, which continues to grow, and concentrating their capital with fewer managers for primary commitments. By writing larger checks for fewer GPs, they are able to leverage economies of scale and negotiate more favorable fund terms. Preqin data supports the trend citing that the US$550bn raised by US PE funds in 2015 was shared between 1,061 funds, an annual drop of 24% by fund count. While the blue chip funds easily meet their fund raising targets, the remaining PE managers take substantially longer to close their funds.
Searching for suitable target
More than half (56%) of surveyed PE shops report that the length of time spent tracking and investigating potential investment targets has increased over the past five years, with more than a quarter (28%) saying it has increased significantly. The US PE industry is very competitive and the global low interest rate environment coupled with a bull market in US equities propels target expectations. Purchase price multiples have reached an all-time high, as US buyout firms paid an average of 10.3x EBITDA for their deals in 2015, according to S&P Capital IQ’s LCD. Additionally, the caps on leverage imposed through Dodd-Frank limit the funds’ ability to create value through financial engineering. As the market not only forces GPs to pay top dollar for target companies but also creates pressure to bolster yield through operational improvements, extensive due diligence is imperative. The increased time spent assessing assets to justify high prices and creating appropriate operational growth strategies drags out the target search period.
Disposition of assets
Similarly, 56% of respondents say that the timeframe from investment to disposition has increased over the past five years, with 12% saying it has increased significantly. According to the survey, 76% of the funds own portfolio companies for 6 to 9 years on average before divestment. Arguably, the reinforced emphasis on operations as opposed to financial engineering can take longer to achieve target growth. Even though the US economy has been relatively strong, business profits were down in the recent years in light of the energy slump and sluggish global growth. As profits and growth are fundamental to company valuations, it has been more difficult to sell portfolio companies at an acceptable price.
Longer lifecycle & more capital
While the PE lifecycle is prolonged, dry powder in the industry is piling up. Estimates put the global reserves of uncalled capital under GPs’ management at US$1.31tn. According to Mergermarket, over the last five years, a clear majority of firms have relaxed their buying criteria in terms of valuation in order to utilize liquidity. The next few years will show whether PE managers are up for the challenge to handle the increased pressure through record entry multiples and depressed annualized returns through prolonged holding periods.
The author would like to thank Hugo Margoc, Articling Student, for his assistance in preparing this legal update.
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