Private Equity & VC Cash Flows Set To Decline From 2014 Levels by PitchBook
Introduction
As more funds data from 2015 rolls in, a more comprehensive, holistic picture of the current investment landscape for private equity and venture capital investors emerges. Let’s take the most recent installment of private equity cash flows data. Limited partners are still raking in hefty distributions from general partners, as the seller’s market that persisted throughout last year has produced rich rewards. However, heightened valuations cut both ways, leading to a competitive, expensive environment for PE dealmakers, which is a primary factor cutting into contributions currently.
Those same heightened valuations have been, if anything, even more pronounced for the venture industry. 2014 saw massive distributions back to LPs by venture fund managers, but 2015 is already setting an even more torrid pace in terms of both contributions and distributions, reflective of the hefty sums VCs were, and in some cases still are, paying out.
As we have seen for both PE and VC, the dealmaking landscape has shifted considerably in recent months. Coupling our analysis of PE and VC investment trends with this most recent set of benchmarking data, accordingly, will help inform your analysis for an even richer picture of the forces shaping the dealmaking environment. As a final note, all the funds return data within this report is as of June 30, 2015; the lag is due to reporting cycles.
KS PME Benchmarks
When using a KS PME, a value greater than 1.0 indicates outperformance of the public index (net of all fees). For example, the 1.12 value for 2005 vintage private equity funds means investors in a typical vehicle from that year are 12% better off having invested in PE than if they had invested in public equities over the same period.When using a KS PME, a value greater than 1.0 indicates outperformance of the public index (net of all fees). For example, the 1.12 value for 2005 vintage PE funds means investors in a typical vehicle from that year are 12% better off having invested in PE than if they had invested in public equities over the same period.
The KS PME charts on this page show the relative performance for a particular vintage of PE or VC funds against the specified index since the funds’ inception. Pre-2006 vintage private equity funds outperformed the public markets consistently between 2002 and 2005, while VC funds across most vintages show overall underperformance. The stock market’s surge over the last couple of years has definitely cut into PME values for more recent vintages on the private equity side in particular; though, in the event of a market downturn, it’s possible recent PE and VC fund vintages will begin to swing up if they generate returns better than stocks.
KS PME Case Study: B2C
This edition of the report series examines private equityprivate equity performance in the B2C sector. Using a KS PME benchmark formula, post-recession B2C-focused private equity vehicles have rather significantly underperformed the public markets. Most notably, 2012 vintage vehicles have recorded a KS PME of 0.77, which reflects an underperformance of roughly 23% if investors were to place their capital in a comparable public index in 2012. What should be highlighted is that the KS PME tracks funds’ cash flows, so GPs would have had to exit and distribute capital back to LPs to adequately track their performance. Since many investments made in recent years have yet to be exited, successful B2C investments have likely contributed to increasing fund values for certain vintages due to those assets being marked up based on their performance and the consistent outperformance of their public comps, yet without funds exiting such companies, their PME values would lack until those gains are realized.
We’ve experienced a noticeable decline in median fund multiples from 2009 to 2010 vintages, with the median TVPI during that time period moving from 1.36x to 1.17x. Over time, increased exits will contribute to a spike in DPI multiples, yet with the median time to exit for private equity-backed companies in 2015 declining significantly, the suppressed TVPI of 2010 vintages speaks to a few points. For instance, the drop in TVPI from 2009 to 2010 may be explained by the quality of B2C companies in private equity funds leading to difficulty in garnering heightened exit multiples today, while also being affected by recent public volatility inducing revised valuations.
Specifically for DPIs, fund managers may be forced to hold on to these companies for longer periods as they look to bolster and underpin growth before agreeing to a potential depressed exit price, thus reducing the amount of distributions currently flowing to LPs.
IRR by Fund Type
With private equity funds outperforming by a fairly wide margin in older vintages, heightened competition and increased sophistication among GPs have led to a considerable tightening in investment returns across various fund types. Older private equity vehicles have also lived through the majority of their life cycles, thus completing a higher level of profitable liquidations, seen in the asset class’s 10-year horizon IRR.
Over the last few years, however, private equity returns have experienced a bit of a plateau as we’ve yet to see a significant number of exits from these vehicles, especially given the fact that newer funds are still working through their investment periods.
In contrast, newer VC funds have fared much better. 2010 vintages are enjoying a fairly impressive 20% IRR to date and 2012 vintages also are experiencing a significant uptick over 2011 vintages, driven by a continued rise in strategic M&A allowing fund managers to cash in on younger investments at record multiples.
Quartiles & Benchmarks
The spread between the most recent venture vintages is one of the most striking features of the chart to the right. The 75th percentile of 2010 vintages and the 25th differ by around 28%, while the 2012 counterpart stands at 30%. This is indicative of nothing so much as the recent venture boom’s surfeit of exuberant valuations and round sizes, primarily at the late stage, resulting in not only higher overall IRRs but also a greater spread. Even over a short timeline, the disparity should shrink somewhat, with the loftiest IRRs coming back down to earth as public market corrections exert downward pressure on unrealized private venture valuations. Although public technology stocks could rally somewhat, providing more of a positive backdrop for private valuations in the short term, in the long term, even top-tier venture returns trend downward. As that is due to venture fund holdings, once past a certain age, being much less likely to produce substantial returns than their PE counterparts, the window of liquidity for VC investors appears to be quite short.
Competitive fundraising and deal environments over the last 15 years have contributed to a tightening of return spreads between top-quartile and bottom-quartile funds. As of late, however, they have begun to widen, notwithstanding vehicles with vintages during or near the recession. Looking at 2010 vintages and beyond, we’ve witnessed a consistent uptick in top-quartile fund benchmarks, while simultaneously seeing a consistent move lower in bottom-quartile fund returns. This increased divergence has led to a top quartile-to-bottom quartile spread of over 15% in 2012 vintages relative to a comparable spread of just 9.7% in 2010.
While top-quartile managers are displaying greater IRRs, especially with LPs continuing to funnel money back into top performers, the decline in lower-quartile benchmarks in recent vintages may also be a result of newer, niche, and distressed fund strategies coming to market, without having deployed capital yet. Thus, the pooled returns of those vintages have remained depressed, yet we should continue to see many of those benchmarks inch higher as these select strategies begin to bear fruit in coming years.
Private Equity IRRs
As we look at 10-year horizon IRRs for private equity vehicles, those returns continue to flatten, an unsurprising observation giving the continued effect of aging portfolio companies acquired during or near the latest recession, along with the increased pressure we’ve seen recent market volatility induce in the private markets. While attractive valuations have been sustained for many portfolio companies, a variety of other businesses have had difficulty exiting at levels previously achieved in the last couple of years, thus forcing GPs to either hold on to companies or, in certain situations, potentially accept lower multiples—two occurrences that can bog down IRRs.
