Private Equity Fundraising In Q2 2016 by Preqin

The Secret to Consistent Top Quartile Performance

by Dr. Finian Tan, Chairman, Vickers Venture Partners

Do you continue to see opportunities for venture capital firms (VCs) to deliver good performance given the risks associated with venture capital today?

There are three main things all VCs need to do to achieve good results. Firstly, they need good deal fl ow, secondly they need a good “filter” and thirdly, they need to be able to add value to facilitate and nurture their companies to grow.

To ascertain if there are still opportunities for VCs, I guess we need to ask and answer two questions:

1) Are there macro reasons why innovations will no longer deliver outsized returns?

2) Are too many VCs chasing after too few deals?

I think the answer is no to both, since innovators like Uber, Palantir, Xiaomi and our own portfolio company, Samumed, can still disrupt and become world-beaters with outsized returns for their investors. They are all decacorns (valued at more than $10bn) and are still growing at an extremely fast rate. This means that gems can still be found in many different industries all over the world. They are by no means easy finds, but this is where the deal fl ow, “filters”, contacts and prior knowledge come into play.

China is no longer as nascent in its growth phase as when I first invested in Baidu in 2000 and neither is mobile internet. Many of the low-hanging fruits are gone. But there are still many to be found in the more obscure places and perceived riskier sectors, and in very creative people in the less obscure places. For example, one of our companies called Bolome invented the video e-comerce market in China and grew seven times in value in seven months. Another one of our companies, Kuyun, dominates the interactive TV market in China and is now valued at 10 times our entry price. This is the beauty and attraction of venture capital. The home runs give such high returns that, even after compensating for the write-offs, the overall returns can still outperform all other asset classes.

What are the key drivers of consistently strong performance in VC?

We aim to achieve top-quartile performance for all our funds. Despite achieving the fifth best VC in the world, with three topquartile funds and one second-quartile fund, we are still as motivated as we were on day one, 11 years ago, to perform at these levels. Our formula is working, which reinforces our conviction with our current strategy. We, of course, will continue to tweak and improve on our methodology as we strive to remain ahead of the curve.

As mentioned above, a good VC must do all three things well: good deal fl ow, a good filter and the ability to add value.

If a firm is not good enough to sit back and receive great deals, they need to have a way to trawl for great deals. The filter comes from ability, experience and working together as a team. Having the ability and networks to help the companies grow will result in quicker exits, which will enhance their reputation and begin the virtuous cycle of good firms attracting the best deals.

At Vickers, we are not yet so well known that we can just sit back and get the first shot at all the good deals. We work hard to trawl for global deals in the perceived riskier regions such as China, Southeast Asia and India and perceived riskier sectors such as global life sciences with a focus on regenerative medicine. I say perceived because, although the risks may be higher as they are at the frontiers of their respective areas, the potential for outsized returns far outweighs the risks, resulting in greater risk-reward ratios. The filter must then be fine enough to ensure we catch the small fishes that will grow to monsters and yet not so fine that it catches all the junk as well. Our failure versus success rates are around 28% and 72% respectively, with a home run rate of 36%. This, together with an outsized return from Samumed, has mainly powered the performance of our Fund 4 (2012 vintage) to a net return of over 5x, and is the best performing fund of all vintages since 2008.

The IPO market has been tepid for the last year – as your primary exit strategy, does this make you look at other exit routes more?

VCs generally invest early, so the IPO market is actually not the primary exit route. Trade sales form the bulk of the exits to larger companies and to later stage investors. For example, Baidu bought one of our companies and invested in two others at higher valuations, and many other strategics and later stage investors have done the same. So when there is more money chasing returns, it is generally good for us because the first place that money goes to is the growth stage and not to the earlier stages. This provides us with avenues to exit investments at better valuations.

The majority of capital raised by Asia-focused VCs has been for country specific-funds. Do you think you have gained a diversity advantage by investing across different countries?

No strategy can last the test of time – it must evolve. Lowhanging fruits get plucked as more competitors come to the playpen. Anybody who focuses on a particular window of opportunity will struggle when that window closes. Our strategy is not to be bound by any specific ideology, but to be pragmatic and opportunistic across geographies and verticals, investing in companies with the biggest risk-adjusted returns. This approach allows us to take the risks associated with specific verticals and geographies into consideration when making investment decisions.

So even if China goes through a rough patch, we are well diversified to be able to ride the troughs that will set us up to take advantage of the peaks. We also try not to be too exposed to prices that swing wildly based on fundamentals, or market moods. For example, our cleantech investment was on vehicle electrification in China, which is getting so polluted that the government has no choice, regardless of oil prices. This company is called JJE (Jin Jin Electric) and is now worth 100 times what we paid at entry. We like platform plays. Betting on a geography or sector rather than trying to guess which company will succeed, is a safer bet. So in India, we invested in a platform e-payment company called MatchMove Pay, which is now worth 10 times our entry price and is just beginning its exponential growth trajectory. The key to investing in frontiers is to ensure you risk manage well.

Where do you see the best VC investment opportunities in Asia with regard to geography and sector?

China will remain a huge opportunity due to its size and stage of growth. At the moment, there is less of a rising tide effect due to the lower growth rate. Having said that, China is still growing at over 6%, with domestic growth at 10% or so. If you select the faster growing domestic industries, you could get over 20% growth. If you select the best companies within these industries, you could get growth in the triple- or even quadruple-digit ranges. Of the 11 potential home runs in our portfolio, seven are from China, and the compound annual growth rates (CAGR) from 2014-2016 range from 41% to 914%.

India is at an interesting stage. Many investors have invested money there over a short span of time, thinking that it was the next China, but have been burnt as the market was not ready for such a large infl ow of capital. Investors are now retreating somewhat. We see this as an opportunity as the new economy market size is getting large enough to have the momentum to indeed be the start of the next China.

Indonesia is starting to exert its ability to produce unicorns and is a market that we are actively investing in. One of our companies there called Mainspring has the number one newsapp and is worth fi ve times our entry price.

The CAGRs of our potential home runs in this region range from 112% to 4,096%, albeit with a couple of them starting from a low base.

Global life sciences is at its most innovative at the moment. After the lack of commercial success from the stem cell boom and discoveries linked to the human genome, we think that prices have become more reasonable even as fundamental and technical breakthroughs of equal or even larger magnitude continue to occur in the regenerative medicine space.

Have you seen any changes in attitude/strategy from the investor community towards Asian VC?

Yes. Now that Asia-based VCs are producing real track records, investors are relying less on what they thought would make a good VC and more on the VCs that have proven themselves with their track records over several vintages. Data speaks louder than words.

What are your predictions for Asian VC markets for the rest of 2016 and beyond?

We expect to see some consolidation. The VCs that have not performed will find it harder to raise money and will have to morph themselves, while the best will go from strength to strength. But a maverick may always come through with superb performance. Incumbent performers should never rest on their laurels.

On the global life sciences scene, we expect regenerative medicine to come to the forefront and to finally offer diseasemodifying therapies for many of the incurable, debilitating and fatal diseases that we know today. This will not only save the lives of hundreds of millions of people and prevent the suffering of another billion, but make the innovators and VCs who invest in them untold wealth. What could be more satisfying than that?

Fundraising in Q2 2016

Q2 2016 was a strong quarter for private equity fundraising: 180 funds reached a final close, raising $101bn in aggregate capital, marking only the fourth quarter since Q4 2008 in which fundraising has surpassed the $100bn mark (Fig. 1).

Private Equity Fundraising

Forty buyout funds closed in Q2 2016, the lowest number of buyout funds closed in a single quarter since Q1 2013. Despite this, buyout funds closed in Q2 2016 secured $36bn more in capital commitments than in Q2 2015, when 50 funds raised $20bn (Fig. 2). More venture capital funds closed (89) than any other fund type, with these vehicles securing an aggregate $16.9bn (Fig. 3). Just two secondaries funds closed, securing $11bn, including Ardian Secondary Fund VII, which raised $10.8bn and is the largest secondaries fund to ever reach a final close.

Combined, the five largest private equity funds that closed in the second quarter of 2016 raised $46.5bn, and excluding the aforementioned Ardian vehicle, the rest of the largest funds utilize a buyout strategy (Fig. 4). Also securing more than $10bn in Q2 was TPG Partners VII, which reached a final close on $10.5bn.

Private Equity Fundraising

Private Equity Fundraising

Funds in Market

The number of private equity funds in market has continued to grow in recent quarters, reaching a high of 1,720 funds as of the beginning of Q3 2016. However, the amount of capital targeted by private equity funds has fallen from the peak of $504bn in Q4 2015 to $447bn (Fig. 1).

Private Equity Fundraising

Two-thirds of these funds have been seeking capital for over a year, while 31% of funds have been in market for over two years (Fig. 2). Sixty percent of funds that are yet to hold an interim close have been in market for over a year, compared with three-quarters of funds that have held at least one interim close.

North America-focused funds continue to represent close to half of the total number of funds in market (846) and together account for 45% of aggregate capital targeted ($203bn, Fig. 3). There are 325 Europe-focused funds, targeting $109bn in capital commitments. Although North America and Europe remain the geographic preference for a large proportion of funds in market, Asia has also attracted growing levels of interest. There are currently 327 Asia-focused funds in market, targeting $94bn, close to the $109bn targeted by Europe-focused funds.

Private Equity Fundraising

Private Equity Fundraising

Institutional Investors in Private Equity

In terms of the most prevalent strategies targeted by institutional investors planning new private equity investments over the next 12 months, investor preferences in Q2 2016 are similar to those of Q2 2015, with buyout representing 66% of fund searches and venture capital 46% (Fig. 1). However, there has been a slight shift in preference away from these areas and towards growth, fund of funds, secondaries and turnaround vehicles, which are all being targeted by greater proportions of investors than this time last year.

Geographically, Europe currently has the highest level of interest from investors looking to make new commitments to private equity funds in the next 12 months, with 56% of investors targeting the region, up from 50% in Q2 2015 (Fig. 2). North America (48%) is the next most preferred region, followed by Asia-Pacifi c (23%) and emerging markets (19%). Thirty-six percent of investors are explicitly targeting funds with a global investment mandate.

Private Equity Fundraising

Close to half (47%) of institutional investors expect to commit less than $50mn to private equity funds in the next 12 months (Fig. 3). Nevertheless, there remains a significant proportion (16%) that aim to invest at least $300mn, including 8% that plan to invest at least $600mn in the asset class in the next 12 months. Furthermore, the majority of active investors will invest in multiple vehicles; only a fifth of investors planning new investments in the next 12 months intend to invest in a single fund, with the majority (57%) targeting investment in at least four vehicles (Fig. 4).

Private Equity Fundraising

Buyout Deals and Exits

In Q2 2016, there were 1,004 private equity-backed buyout deals announced or completed globally, representing a 7% increase from the previous quarter (Fig. 1). The total value of deals rose 76% from $50bn in Q1 to $89bn in Q2; however, deal value remains significantly below the post-crisis record of $138bn in Q4 2015.

Private Equity Fundraising

The growth in global aggregate deal value was primarily due to increases in deal activity in North America and Europe (Fig. 2). There were 534 buyout deals in North America in Q2, accounting for $57bn of total deal value, while 356 European deals were valued at an aggregate $25bn. However, in Asia, buyout deal value declined from $5.7bn to $4.9bn, coinciding with a 22% reduction in the number of deals in the region.

There were 434 private equity-backed exits globally in Q2 2016, valued at an aggregate $90bn; this represents an 18% increase in the number of exits and an increase of a third in aggregate exit value from the previous quarter (Fig. 3). The number and value of secondary buyouts also saw noticeable improvements from the previous quarter, increasing by 26% in number and more than trebling in aggregate exit value to $29bn.

Private Equity Fundraising

Private Equity Fundraising

Venture Capital Deals

In Q2 2016, 2,244 venture capital financings were announced globally, with an aggregate deal value of $40bn, the second highest on record. There have been a number of large deals in the quarter, notably Ant Financial’s $4.5bn Series B round and Didi Chuxing’s $4.5bn equity round, which rose to $7.3bn including debt financing.

Private Equity Fundraising

North America accounted for 40% of global financings in Q2 2016, although the 900 financings represented the lowest number of deals for the region since Q3 2009 (Fig. 2). Conversely, the aggregate value of these financings equated to $17bn, representing 43% of global deal value. Venture capital in Greater China experienced another strong quarter, with 460 deals valued at an aggregate $17bn, accounting for 20% and 41% of the market share respectively and representing the region’s highest quarterly aggregate deal value on record.

Angel/seed financings remain the most prevalent stage of venture capital deals, representing a third of the number of deals in Q2 2016 (Fig. 3), while Series B/Round 2 financings accounted for the largest proportion of aggregate deal value (28%), with 260 deals worth $10bn.

Private Equity Fundraising

Private Equity Fundraising

Fund Performance and Dry Powder

Estimated dry powder held by private equity funds reached a record $818bn in June 2016, up from $745bn in December 2015 (Fig. 1). Venture capital funds saw the greatest percentage growth over this period, with dry powder rising 15% to $163bn in June 2016; buyout funds saw the greatest absolute growth, from $460bn to $512bn.

Median net IRRs of recent vintages have tended to be higher for private equity funds; vintage 2012 funds have the highest median net IRR of any vintage year examined (15.1%, Fig. 2). However, the median is lower for 2013 vintage funds at 11.8%. The difference between top-quartile and bottom-quartile funds has also increased significantly for 2013 vintage funds, with a difference of 25.1 percentage points, compared with 19.5 for 2012 vintage funds.

Private Equity Fundraising

Venture capital funds have the highest one-year horizon IRR among private equity funds (20.3%); however, they also have the lowest horizon IRR over a 10-year period (5.1%, Fig. 3). In contrast, buyout funds have a one-year horizon IRR of 16.2% but have the highest IRR over a five- and 10-year period (16.3% and 15.4% respectively).

The amount of capital distributed by private equity funds has significantly outstripped the amount called up in recent years (Fig. 4). In the first three quarters of 2015, $359bn was distributed to investors, while only $175bn was called up. The difference is comparable with 2014 when $475bn was distributed by private equity funds compared with only $294bn called up during this period. Unrealized value held by private equity funds also reached a record $1.64tn as of the end of Q3
2015.

Private Equity Fundraising

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