Private Equity & Venture Capital 1H16 Fundraising & Capital Overhang by PitchBook
LPs continue to seek exposure
As we progress through our coverage of the private markets, the extensive datasets on both private equity and venture capital fundraising in this report help further flesh out a holistic overview of investor sentiment and forecasts. Both private equity and venture capital investors embarked on a remarkably active first half of 2016, with both fundraising value and volume at elevated levels. Although strategies differ widely for both asset classes, they are encountering related difficulties in sculpting investment mandates given current conditions.
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For PE firms nowadays, sourcing worthwhile deals in a stubbornly high-priced environment remains challenging, particularly when attempting to account for a potential economic downturn or, at best, continued anemic growth. Venture fundraisers face the same challenge of dispensing capital shrewdly in the midst of slowly depressing valuations and round sizes in pockets of the market. Accordingly, when it comes to fundraising, larger, more experienced fund managers are still able to collect plenty of commitments, sufficient to record significant step-ups from prior vehicles. Limited partners are entrusting their capital to those with successful track records and the resources to scour comprehensively for investment opportunities even in the event of a market downturn. That isn’t precluding smaller, less experienced managers or even first-timers from fundraising, as LPs also are cognizant of the advantages in backing emerging managers, and given the relative attraction of exposure to private asset classes are at the very least looking to maintain such allocations. But larger fund managers currently enjoy sizable advantages, particularly in terms of either customizing fundraises such as extending the lifecycle of certain vehicles for PE or targeting bridging opportunities between initial financing rounds and significant capital injections for VC.
In short, fundraising processes are simply more complex in the current environment. To fully inform your own views, we’ve expanded the datasets within this report to cover PE and VC funds located in both North America and Europe. We hope the datasets and analysis in this report help inform your decisionmaking in the coming months—feel free to reach out with any questions.
Garrett James Black
Remaining Popular – Private Equity fundraising overview
Emerging out of the asset class’s peak fundraising years, which spanned 2006 to 2008, PE dealmakers faced daunting tasks: managing struggling portfolio companies while finding opportunities to deploy capital. Strategies had to shift, so in the coming years, co-investment vehicles became more prevalent in order to add valuable equity to deals while sidestepping fees for LPs, restructuring and distressed debt fund counts rose, and mezzanine funds also bumped higher as a percentage of total closed funds. GPs were attacking the market from a different angle. Debt availability shrunk, so PE firms stepped in on that front to bail themselves out via increases in direct lending and mezzanine vehicles. Global growth declined, so companies hampered by unserviceable debt piles were in need of restructuring specialists; again, PE stepped in to bail itself out. Since 2010, as deal flow hit record numbers, trillions of dollars in capital flowed from LPs to GPs and into portfolio companies before eventually flowing right back to LPs in the form of distributions. Opportunities aren’t endless, however, and despite PE transactions noticeably declining on a consistent basis and valuations skyrocketing for the fewer, quality businesses coming to market as of late, fundraising campaigns have continued to enjoy success and dry powder remains at a record level.
Midway through 2016, over $154 billion has been raised across 195 North American and European PE vehicles, on pace to make 2016 the second best fundraising year since 2008. On a quarterly basis, 2Q 2016 saw $87 billion close across 90 funds, a 31% QoQ jump in terms of total capital raised and the highest figure since 2Q 2014.
Buyout funds made up 77% of total PE contributions during the first half of the year, higher than any other year on record. Energy funds made up just 3.5% of the value of commitments in 1H 2016, down from 14.4% last year. This sharp drop can be attributed to the vast amount of dry powder that energy funds already hold. The sector has been on a fundraising spree for the past two years, but has yet to deploy much of that capital via traditional PE asset build-ups and instead has seen distressed managers step in to pick apart capital structures. Mezzanine fundraising also dried up considerably in the first two quarters, on pace to raise less than $6 billion in commitments for the year, compared to almost $18 billion last year. The gradual shift on a relative basis back towards traditional buyout funds and away from more niche mezzanine and restructuring strategies reflects the health of available portfolio companies when compared to the years just after the financial crisis.
Many puzzle over the asset class’s ability to continue attracting hefty LP commitments, yet in our opinion the current uncertain dynamic across the global investment landscape positively impacts PE fundraising. On the public side, low-cost alternatives such as ETFs have helped investors sidestep costly hedge funds and other public equity managers in a period where considerable volatility has hurt the performance of active management strategies. Such products allow LPs to locate other avenues to garner public market exposure at low fees, yet there aren’t many other options when it comes to finding lower-cost private market alternatives. Thus, as LPs have looked to work with fewer managers, committing outsized proportions to certain funds has offered them increased negotiating leverage around both fees and the co-investment opportunities they might seek. These items have noticeably underpinned the successful fundraising performance of 2016, despite a future return profile that appears set to come in lower than we’ve recently experienced.
Mega-funds push total raised – PE fundraising by size
Midway through the year, the $250 million-$500 million bucket made up 20.8% of closed funds, up from 17.3% last year and 15.2% in 2014. There have been 31 funds that have closed between $500 million and $1 billion in 1H 2016, nearly the same number that we saw in that bracket during the entirety of 2015. Interestingly, the $1 billion to $5 billion fund bucket raised just $50 billion in total commitments across seven vehicles, representing 32.4% of the value raised so far in 2016, a sharp decrease from the 45.4% of the value it made up in 2015. This bucket could be the new “barbell” that some have been expecting, with LPs committing to nimbler operating specialists on one side and megafunds with significant economies of scale on the other.
Coming in at $280.5 million, the median PE fund size in the first half of 2016 increased 36.5% year over year. Funds with under $100 million in commitments made up just one quarter of the total that closed in 1H, the lowest of any half since before the financial crisis. On the other end of the size spectrum, mega-funds have had considerable success thus far in 2016. Led by the $13.0 billion closure of Advent International’s Global Private Equity VIII vehicle and the $9.6 billion Green Equity Investors VII raised by Leonard Green & Partners, a total of seven funds closed in the first half of the year with over $5 billion in commitments.
Slackening pace – PE fund closing times
Over the past half-decade, both the median and average time for PE funds to close has legged consistently lower. With deal flow continuing to jump higher and the asset class outperforming on a relative basis, managers had no issues putting ample stores of capital to work. On the other end, LPs had no issue funneling that capital right back to the asset class that had taken great care of them. Even as deal flow began to decline in 2015, closing times moved lower, yet thus far into 2016, these figures have reversed. The median close time for funds holding final closes this year jumped to 14.5 months, up considerably from the 12.2 months clocked last year.
In 2015, we highlighted the increased prevalence of niche vehicles coming to market to combat a slowing and more difficult deal cycle. We posited that the ability to offer such diverse strategies to investors was fairly attractive and as those funds were raising smaller pools, LPs were able to close commitments in a shorter amount of time. 1H 2016, however, saw a significant increase in the percentage of total capital raised by mega-funds closing on more than $5 billion. While managers looking to attract that amount of capital typically have a sound track record, raising larger pools of money can simply take a bit longer. Further, LPs have grown increasingly more sophisticated, so manager diligence processes could potentially be adding to the fund close times of such large vehicles, especially with LPs looking to shrink the amount of GPs they work with— a trend that has been manifesting for multiple quarters.
Overhang issues overrated – PE capital overhang
As of the end of 2015, aggregate PE dry powder across North America and Europe remained elevated at $749 billion, just a slight 3% decline from the $773 billion that was sitting in PE funds at the end of 2014. Interestingly, we’ve continued to see headlines over recent quarters around the dire straits of the industry in terms of how managers may face significant difficulty burning off that dry powder. While that in theory holds true and is certainly a pain point for many funds, dry powder historically has been inflated. We had a series of mega-funds come to market in 2007, which brought capital overhang during that period to approximately $765 billion. Although the recession impacted the ability of managers to invest capital in the years immediately following, as soon as PE began targeting companies at a faster clip in 2010, dry powder ballooned from a near-decade low of $680 billion in 2010 to a record $773 billion in just four years.
PE is a cyclical industry with many vintages winding down just as others are starting. What that entails is a continuous cycle of distributions that LPs have to redeploy in some way, shape or form. While deal volume has declined, it makes intuitive sense that LPs continue to back the investors that had outperformed for them on a historical basis so that those managers are equipped to put money to work at a fast pace as the cycle turns and presents opportunities. Further, 3,880 PE deals were completed last year in a period where dry powder aggregated to $749 billion. Comparing that to a 2013 that saw just 3,216 deals close as dry powder came in around $10 billion higher than what 2015 saw, one could make the argument that PE has indeed found relative success putting money to work. Thus, the onus shouldn’t necessarily be put on managers taking in capital recklessly without a sound plan to deploy it, but rather on the optimism and trust LPs have given to PE. Last, the narrative of LPs working with fewer managers cannot be ignored here either as they have chosen to deploy massive amounts of capital to larger vehicles to better manage their fee structures, a trend that undoubtedly props up overhang.
A lull after heavy fundraising – Secondaries
Concurrent with the global deal landscape, secondary market transactions suffered from growing macro volatility through the first half of 2016. According to Greenhill Cogent, approximately $12 billion worth of such transactions closed in 1H, the lowest figure since 1H 2013 and on pace to come in much lower than the $40 billion+ the firm witnessed in each of the past two years. While fundraising has remained fairly robust for general PE despite many market headwinds, secondary market fundraising has slid midway through the year with just $2.2 billion raised across six closings. We believe this decline can be attributed to a rather impressive 2013-2015, during which a collective $51.3 billion was raised across 42 vehicles, rather than a strategy shift from either GPs or LPs.
We aren’t quite out of the woods from the impact 2008 had on the record PE funds (in terms of size) that were raised just a year prior, so as fund lives have dragged on, opportunities are available for skilled distressed specialists to demand significant discounts either via direct secondary deals or by traditional liquidity offerings to LPs stuck in such vehicles. In cases where the vehicles are focused on struggling or hurting asset classes, GP-led fund restructurings are also being utilized to help cater to LPs and thus, we think the massive amounts of capital already raised for secondary strategies will have plenty of opportunities to be put to work over the next few quarters. Further, we think it has become fairly evident that both the market and economic cycle is nearing, if not already, at a top. Thus, just as distressed debt and restructuring vehicles have recently raised plentiful amounts of capital to help ailing and/or overleveraged companies, liquidity providers in the form of secondaries managers will become extremely valuable to the LPs exposed to the aforementioned distressed assets.
Can the pace be sustained? – VC fundraising overview
At the current pace, venture fundraising across North America and Europe could well set a record by the end of 2016. With $30.6 billion already raised across 177 pools of capital, the first half of the year has already seen more amassed than the entirety of 2010 or 2013. On a quarterly basis, 2Q saw no less than $17 billion garnered by 91 vehicles, the highest quarterly sum since 2011 began–although admittedly that total was skewed by outliers such as the $1.5 billion Andreessen Horowitz Fund V and KPCB Digital Growth Fund III, which accumulated $1 billion.
The timing of this torrid pace, amid a general cooling on the dealmaking side of venture, suggests that GPs not only anticipate a resumption of activity within the timeframe of a normal venture fund lifecycle but also some may well be looking to take advantage of a period of what could be depressed valuations. As the repricing of growth expectations around more sustainable burn rates continues, midstage valuations are set to decline, which could present an opportunity for VC firms to move up or down the capital stack and raise larger vehicles than before in order to snag bargains even at Series B.
LPs are willing to oblige, given the relative appeal of VC as an asset class within their broader portfolios, particularly as the top decile of managers continue to see sky-high IRRs. Anecdotally and as suggested by fundraising figures broken down by size on the next page, LPs are still favoring experienced investors, in response to general perceptions of highly volatile political and economic climes. However, first-time fundraisers are still experiencing significant success, with $5.2 billion collected by 54 pools in 1H. As seen by the surge in both average and median times to close, GPs have been out fundraising for quite some time, which helps explain the astonishingly high success rate, so timing definitely has played a role in the outsized numbers posted in the first half of the year. VCs have assessed the temperature of the overall venture climate and determined that it is a good time to keep raising while they can, doubtless expecting further liquidity to be achievable over the next few years even by their expensively priced holdings to a degree sufficient to satisfy their LPs. In short, it’s taken longer to close because every fundraiser was looking to time the concurrent if staggered cycles of investment and fundraising. Accordingly, the pace of closings is more likely than not to slow in the back half of the year, if only minutely: PitchBook data shows 143 venture funds in North America and Europe with a first close as of the middle of August.
Tilting heavier – VC fundraising by fund size
Through the end of June, funds sized between $100 million and $250 million accounted for 26.5% of all vehicles closed, the highest such proportion of the past decade. In fact, the two largest fund size categories also account for decadehigh proportions, with $500 million-$1 billion pools at 7.6% of total funds closed.
Particularly when looking at how much capital has been concentrated at the upper end of the size spectrum, what this suggests more than anything else is caution on the part of LPs. As the old truism goes, you don’t get fired for buying IBM, after all. So as public pensions in particular face the difficult task of finding public markets-beating investment opportunities, they are prioritizing potential returns over risk and illiquidity but still seeking to hedge somewhat by recommitting to trusted fund managers or backing more proven firms. Accordingly, although the political, economic and financial turbulence of the past year hasn’t been any near as world-shaking as that of 2008, just as in that year, we have seen 27% of all VC raised in 1H by funds between $500 million and $1 billion in size. Many of these funds have been in the works for some time, as befits their sheer size, but it is possible that their managers sought to close sooner at their target rather than take extra time to soar above, after seeing the venture landscape shift in response to a few sharp external shocks. That happened up and down the funding size stack, as the $100 million to $250 million range—comparable to last year with 23.3% of all 1H VC raised—actually saw a considerable 45 vehicles close by the end of June. Such activity in that particular range suggests VC investors are also looking to hit the emerging sweet spot of immediately post-seed startups that have finally achieved the type of metrics institutional investors are looking for at Series A or even modestly sized Series B. In addition, VC GPs are also still grappling with the new reality of prolonged private tenures and slowly resetting valuations. After all, valuations have not suddenly dropped across the board, but rather, they are diminishing slightly at particularly difficult transition stages, whether between angel & seed and the first significant injection of institutional financing or the leap from high midstage growth to stratospheric, unicorn-like expansion.
Consequently, venture investors have been raising larger and larger funds, evidenced by the significant jumps in both mean and median fund sizes. Even more striking is the surge in median fund step-ups, with 1H 2016 sustaining a remarkable figure first observed in 2015: the median fund closed in Europe and North America was more than 40% larger than its predecessor. Those fundraising are seeking to adapt to a new reality of potentially drawn-out pay-toplay series of financings, along with the sheer expenditures required to scale to a level demonstrated by companies such as Uber. For many, such strategies are merely the next step beyond what has worked before, the logical evolution to either a seed or pre-seed stage of intensifying complexity or the inflection point of takeoff. With the venture landscape resetting slowly into 2017—as many expect—these strategies are what seem best for deploying capital as fledgling startups jockey desperately for traction and winners gradually emerge from consolidating niches.
Micro VC funds
Fundraising at the sub-$50 million level is somewhat off the pace of the past several years in terms of volume if not value just yet. On the broadest of levels, such a decline makes sense if only due to market saturation and consequent consolidation at what was the traditional seed funding playground. Even the emergent diversified seed landscape, with multiple, potentially bespoke tranches becoming more frequent, cannot host an unlimited number of seed funds, particularly first-timers. Plus, the sheer level of competition is sufficient to dissuade LPs from backing untested managers, the most experienced and proven of which are moving upwards in the capital stack to play later in the seed process, hoping to capitalize on the gulf between the heftiest, final seed round and significant institutional financing. Hence the uptick in the median micro VC fundraise–those that can are closing on more to stay relevant across multiple installments or targeting later in the lifecycle. It should also be noted that currently, the window for investing in such nascent startups remains nearly shut in Europe, with state-sponsored programs typically filling that role and, in general, economic and political prospects rendering the risk level untenable.
In fact, going forward, such caution is likely to be played out in the micro VC market by slowing fundraising as relatively new managers look to demonstrate sufficient success, with consolidation and washing out occurring consequently. Capital raised numbers may be bolstered by those who prove merit, but as their subsequent raises could move beyond the $50 million mark given general market conditions, that is unlikelier than not.
Recent vintages predominate – Venture capital overhang
With updated dry powder figures through the end of 2015, it’s clear that the VC overhang has decisively tilted to favor the most youthful of vintages. 2015 vintages contain $36.8 billion; add that to the $24.4 billion of 2014 and we arrive at funds of those vintages alone accounting for 64% of all venture capital dry powder across Europe and North America, as of the end of last year. Most of the overhang total—$46.2 billion, to be exact—is locked up in funds in the $250 million to $1 billion range. Hardly less considerable are the sums still committed to even larger funds, with $1 billion-$5 billion pools containing $17 billion and the largest $19.5 billion.
In terms of supply, then, VCs have probably even more capital than they know what to do with, given the external macroeconomic and political landscape. In Europe, VCs must assess just how Brexit will play out when it comes to the primary concerns of startups, ranging from talent to intellectual property. As for North America, the fact no material evidence of a recession has emerged but growth remains weak at best isn’t likely to assuage the fears of VCs who saw how swiftly tech stocks tumbled earlier this year. The ongoing shakeout in venture valuations and round sizes as entrepreneurs and investors re-center on what they hope are more sustainable terms is encouraging discipline in the dispensing of capital, but as the supply remains considerable, whatever opportunities are deemed best will command significant sums. Hence the stubbornly high levels of VC invested in late-stage financings, with investors simply looking to fulfill their mandates.
Accordingly, this state of affairs may persist for some time, as the reset continues in the absence of any further significant shocks.