VC Raised In 2015 Nears Decade Record; PE Fundraising Slips by PitchBook
How is fundraising evolving?
Investors’ perception of risk matters as much as the degree to which risk has materialized. Over the past month, we’ve detailed how the private equity and venture capital investment landscapes have been evolving in response to macro concerns, volatility and corrections in public markets and more. Yet, when we come to fundraising for PE and VC, we must consider the perspectives of both fund investors and managers and how they are adapting to the current environment.
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In some ways, PE fund managers have become victims of their own success. They must contend with an immense overhang of dry powder in a competitive dealmaking environment, generated by the vast number of commitments collected over the past few years from limited partners drawn by the asset class’s strong historical performance. To assess how PE fundraisers have responded to not only that overhang’s impetus to invest, but also investment trends, we examine multiple datasets ranging from fundraising across different fund types to fund size metrics.
When it comes to VC, currently, there is a general consensus that the venture industry is experiencing the onset of cooling after overheating to the point of overexuberance, with investors scrutinizing the fundamentals of startups more closely than in years prior, primarily in response to concerns about liquidity and growth. Venture fundraisers have had a stellar run as of late, judging by the number of vehicles and sums of capital raised, yet how will they respond to the cooling of the investment climate? In the following pages, we explore trends across the venture fundraising market, particularly the micro fundraising segment, given its especially rapid development in the past few years, to analyze the nature of their potential responses.
One last thing to note: We have included brand-new datasets in this report, including breakdowns of capital called compared to capital raised across both PE and VC, among others. We hope this helps inform your decision-making in the coming months, and feel free to reach out with any questions.
Garrett James Black
A shifting environment – PE fundraising overview
In an environment where cheap debt contributed to a significant rise in activity and LPs flocked to GPs to reap outsized returns, PE managers have amassed an enormous war chest of capital over recent years. With too much capital chasing a limited amount of transactions, competition has become fierce, with strategics often able to win out in auction processes. As dry powder levels have continued to grow, 2015 finally saw the fundraising trail begin to slow. The massive vehicles raised just prior to the financial crisis weren’t able to deploy their forecasted amount of capital during their respective investment periods, leading to lagging returns, an outcome that GPs and LPs alike are working fervently to avoid in present day.
2015 saw GPs close on just over $185 billion in committed capital across 281 vehicles, a year-over-year decline of near 7% and 14%, respectively. On a historical basis, these figures are certainly still strong, yet they fall short of what we’ve seen in in the past couple of years.
Given the shifting deal environment, GP fundraising efforts were also driven by evolving strategies last year as more niche vehicles were raised to focus on emerging opportunities including distress, direct lending and energy. The broader syndicated loan market has seen a bit of a crunch, and with that direct lenders and mezzanine players have seen opportunity to step in to fill funding gaps, albeit continued competition in that realm. We saw a 22% jump in mezzanine vehicles that came to market in 2015, yet total capital raised for such funds was actually down more than 25% at $4.7 billion. We think this reinforces some of what we’ve noticed of new managers spinning out and coming to market with smaller targets around very concentrated strategies. Moving contrarily to this was the energy space, where we saw total fund counts down some 24% during that same period, yet total capital raised for that avenue came in at $35 billion, a 55% YoY increase. Clearly this space is much more capital intensive, so bigger checks will be written to fund deals in the distressed sector, however, operational experience will be vital in a persistent low-price oil environment, contributing to the decline in aggregate fund counts there.
Over the past few years, co-investment vehicles have risen in popularity as they serve both LPs and GPs in different ways. LPs benefit from lower fee structures, while GPs gain a couple of things—the ability to access larger pools of capital for larger transactions and the ability to split deals between a flagship fund and a co-invest fund when the LPAs of select vehicles may not allow for certain deals. From 2010 to 2014, the amount of yearly coinvestment funds coming to market more than tripled and the aggregate amount of capital being raised for such funds each year has grown by nearly 10x. 2015 saw a reversal, with the number of these vehicles dropping by half. With quality deal flow remaining an issue for investors across the board, co-investors are strapped as well for deployment opportunities, which is why we’ve seen that decline. What does become a bit more interesting, however, is that the amount of capital raised in 2015 across half as many co-investment funds was only down around 6% to $5.2 billion. With the drop-off in high-yield and debt accessibility for larger transactions, mangers looking at deals in the megasize range may be forced to deploy more equity. In order to do this they may not be able to finance those hefty equity portions alone and thus, larger co-invest funds are also being raised in mitigation.
General opportunities are scarce, yet pockets of prospective quality have emerged and moving forward we think we’ll see the same. Capital will be deployed across select opportunities including direct lending opportunities, distress, energy and non-core carveouts. Strategies will also continue to evolve. We saw an Apollo Global Management-led consortium agree to a $1.1 billion deal without the proper debt financing in hopes of accessing that debt at a later time while Carlyle just raised a vehicle with a lifecycle of twice the traditional length. PE investment is evolving to the environment and fundraising efforts will do the same.
Small funds remain popular – PE fundraising by fund size
As fundraising by both count and capital invested subsided a bit lower last year, the space experienced similar trends. Sub-$100 million vehicles continued to represent the highest percentage of total vehicles raised, with 104 vehicles coming to market last year. Those funds accounted for 38% of all PE vehicles raised during the period, which still was a decline from the 126 sub-$100 million funds raised in 2014. In an environment of lofty multiples, many GPs were forced to move lower down the chain into the lower middle market in order to find attractive quality. At this stage, various companies are simply smaller or are still at relatively early stages in their lifecycles to attract auctiontype competition. As strategies have begun to incorporate more operational components, companies in the LMM can significantly benefit from experienced GPs to sustain growth; fund managers recognize that many of these companies may need a qualified partner to help underpin growth if we face continued economic uncertainties. Further, as owners in that realm might begin looking for liquidity in the face of a down cycle, PE players can be valuable partners in that scenario.
At the high end of the spectrum, funds raising between $1 billion and $5 billion in capital remained relatively flat by count, while total capital raised dropped a bit. We did see, however, funds at the largest fund bucket—$5 billion+— experience a surge in capital raised, attributable to a record amount of capital being raised for energy.
Niche strategies succeeding – PE fund closing times
In what may seem counterintuitive given an increasingly sluggish deal environment, GPs coming to market with new vehicles in 2015 found success in terms of the time it took to hold final closes on those funds. Median and average fund sizes were up relative to what we saw in 2014, yet at $187.4 million, the median U.S. PE fund size came in fairly low on a historical basis. Further, only growth and energy vehicles posted increases in YoY median fund sizes, highlighting a dataset that was skewed by the 14% decline in the population of vehicles coming to market.
The median close time for vehicles completing raises in 2015 came in at 12.8 months, the lowest figure we’ve seen since 2008, which saw GPs able to close in just 12 months. With a record amount of capital being raised that year, those fund IRRs are under significant pressure stemming from the recession and, subsequently, GPs coming to market in the few years following had faced some difficulties in persuading various LPs. In light of scarce deal flow, we think that GPs were able to find success in rounding up capital quickly last year due to niche and targeted strategies, as well as a greater focus on the process they employed to chase LP dollars. As LPs have become more sophisticated, the opportunities that have presented themselves in light of a global slowdown across equities and fixed income have made certain PE strategies fairly attractive. LPs are certainly aware of the profits that can be realized when deploying capital in a downturn, and the long-term horizon these investors employ match well with the investment strategy of new, niche managers. Further, GPs have been able to increase the amount of targeted investor relations campaigns they utilize to court LPs, which becomes a vital component of the fundraising trail during a period where LPs have also begun shrinking the number of managers they work with and instead writing bigger checks to fewer managers.
The median time between funds rose significantly in 2015 to 5.4 years from just 4.3 years in 2014, a further testament to the difficulty managers have faced in deploying ample amounts of legacy dry powder.
Second-highest sum raised – VC fundraising overview
VC fundraisers have been on a tear recently. From 2014 through the end of last year, 500 venture vehicles were closed on a gargantuan $69.4 billion in commitments. 2015 alone saw a staggering $35.5 billion in total capital committed to VC funds, the second-highest total of the decade. On a quarterly basis, fund counts slid in the back half of 2015, with the 53 pools closed in 4Q the lowest tally since 3Q 2013, even though capital raised remained hefty. In short, investor uncertainty that has been evidenced by the decline in activity on the dealmaking side has yet to substantively lead to a slowdown in VC fundraising as firms take longer to cut deals. Such elevated fundraising as of late had to keep pace with the increasingly massive sums dealt out by VCs.
The disparity between the two is also explained by the entrance of nontraditional VCs into the investment and fundraising scene, as well as the resurgence of mega funds. The venture boom of the past few years also spawned a surge in first-time fundraising, primarily centered in the smaller reaches of the market. LPs have been markedly willing to back even such emerging fund managers, judging by the slide in both the average and median times to close, despite the sheer number of vehicles on the fundraising road. Further underscoring LP enthusiasm are the percentages of successful fundraises in the past two years; 84.8% of all 2014 vehicles hit their target, while last year saw no less than 85.9% do likewise. Such success is partially attributable to more targeted investment strategies as well as an abundance of capital seeking returns—pensions have increasing payouts to meet given demographic shifts, for one—but by and large, LPs have been piling into VC in particular, entranced by the promise of outsized returns generated by high-profile VC firms. After all, VCs did return $21 billion in the first half of 2015.
But the dealmaking climate has cooled. Liquidity has become a chancier prospect, particularly for many latestage, heavily financed startups. Fundraisers are forward-looking, but LPs are cautious, still open to commit but wishing to see what happens in 1Q. As public market valuations soften, private comparables will correct in turn, potentially paving the way for a resurgence in activity far down the road. But as investment declines gently for now, fundraising will likely follow suit or plateau, as investors seek to put dry powder to work at a slower pace, and consequently take longer to fundraise as well.
Return to the middle – VC fundraising by fund size
21% of all venture funds that closed last year ranged between $100 million and $250 million in size. Not only was that the largest proportion of overall VC fundraising for the size bucket since 2009, but the total number of funds closed—51— was the highest of the decade. We’ve discussed the apparent bifurcation in venture fundraising before, wherein both ends of the fund size spectrum have seen increased activity over the past few years; 34 funds of $500 million or more in size closed in 2014 and 2015, while the same timeframe saw no fewer than 269 sub-$50 million vehicles. But as previously stated, those twin surges at different ends of the market did not preclude steady fundraising in the middle, and, in fact, given the proportion of midsized funds raised last year, a return to the middle appears to be already underway.
The most significant drivers of that return have been the increasingly broad definition of what constitutes early-stage financings and the entrance of emerging fund managers on the scene. Not only has competition as well as hefty financings pressured early-stage firms to raise funds of sufficient size to pull off follow-on financings when opportunity arises, but it has also encouraged VCs to narrow fund focuses to particular sectors and geographies.
Despite current uncertainty swirling around late-stage venture financings in particular, this surge in midsized fundraising implies that VC firms are anticipating the need for significant sums to invest in order to stay competitive, even at early stages, in the future. With the decline in earlystage investment, however, it’s easy to see early-stage round sizes and valuations deflating somewhat in the coming quarters, due primarily to increased investor scrutiny whittling down the pool of eligible targets. Once that deflation has occurred, investors should have more leeway to remain active, although sheer caution sparked by general macroeconomic concerns, as well as extended vetting of prospects, will remain a counterbalancing factor for the interim.
See full report below.