After several years of record distributions and positive net cash flows back to LPs, both private equity and venture capital saw enormous amounts of fundraising last year. VC set a decade high by raising more than $51 billion across North America and Europe, while PE funds raised the highest total since 2013.
Our 2016 Annual PE & VC Fundraising Report delves into the factors that have led to staggering amounts of dry powder, which could fuel dealmaking for years. Highlights include:
- Median fund sizes for both PE and VC grew substantially in 2016, each setting decade highs
- More than 86% of PE and VC funds closed last year hit their targets
- More VC funds closed on at least $500 million in commitments last year than in any other year during the past decade
LPs looking for greater exposure
Introduction
Limited partners have continued to allocate substantial capital to the private markets in recent years as they look to generate outsized returns, especially as other global markets have moved in volatile and at times lackluster fashion. While the risk profile of both private equity and venture capital is certainly a concern for many market participants, the niche and specialty services they provide, along with the illiquidity premium that can be generated from backing such investors, remain top-of-mind for many LPs.
Dry powder figures today across PE and VC have reached record levels. Concurrently, valuations across both asset classes have trended higher leading to larger, albeit fewer, deals. Though the prospect of a declining supply of investable companies, along with higher multiples can equate to a lower return profile, many LPs find themselves underfunded and in need of hefty returns, forcing them to rigorously evaluate the private markets, as these asset classes have outperformed on a historical basis.
Throughout this report we examine private market fundraising trends and showcase datasets that encompass PE and VC fund sizes, types, time between raises and dry powder, among others. We hope you find this report useful in your practice and feel free to reach out with any comments or questions at [email protected].
NIZAR TARHUNI
Analysis Manager
PE fundraising holds strong
PE fundraising overview
Total capital raised strong for fourth year in a row
As public markets have been volatile and other alternatives have struggled to produce in the last few years, many limited partners have increasingly leaned on their private equity allocations in hopes of maintaining the returns needed to meet obligations.Capital committed to PE funds located in North America and Europe totaled $268.5 billion in 2016, which represents a 2.6% increase from the previous year. The number of funds that closed, meanwhile, decreased by 5.8% to 356 new vehicles. To say that PE fundraising has departed from its financial crisis struggles would be an understatement. On average, $269.7 billion has been committed to PE funds in each of the last four years, compared to just $145.7 billion in the years from 2009 to 2012. The PE fundraising market experienced its usual fourth-quarter rush last year. 86 funds closed in 4Q 2016, garnering $80.3 billion in commitments, the most of any quarter in the last two and a half years.
Historical outperformance aids current efforts
We’re all well aware that past performance does not necessarily predict future returns, but sometimes looking at past performance is a necessary tool LPs must use when allocating capital. Using our most recent data showing returns through the first quarter of 2016, PE outperformed the Russell 3000 index on one, five, 10 and 15-year horizon. What’s more, net cash flow to LPs has been positive every year since 2011. With pension funds in the US facing growing obligation deficits, sovereign wealth funds of petro-states looking to diversify into PE for the first time, and PE having shown past outperformance over other asset classes, it’s no wonder that LPs are plowing capital back into these funds at such a fast pace.
In another sign of confidence for the PE industry, 87.6% of funds hit their stated target last year—up from 81.3% in 2015 and the highest figure we’ve ever recorded. This number speaks volumes to the health of PE fundraising this year. That nearly nine out of every 10 managers hit their stated goals shows that most managers are receiving outsized demand from LPs compared to expectations.
US takes a breather, Europe and Canada surge
PE commitments fell by 8.9% in the US last year—to $182.65 billion—across 33 fewer funds. Capital commitments in Canada and Europe, however, leaped by 40.7% and 34%, respectively. As cross-border activity continues to play a large role in the PE space and firms become increasingly international in nature, it is becoming harder to attribute fundraising to particular geographies. For example, the largest European fund to close last year, a $9 billion vehicle by UK-based Apax Partners, took commitments in both US dollars and euros, and has already made acquisitions in both Europe and the US.
Fund sizes are growing
PE fundraising by size
Mega-funds return to prominence 13 funds held final closes last year with commitments in excess of $5 billion. That’s the most since 2013 and the third most of any year in the last decade. Those 13 funds alone raised $103.1 billion, or 38.4% of all dollar commitments to PE last year, compared to just 30.7% in 2015. This jump can be attributed in part to simple chance or the cyclicality of the largest funds. A fund of that size which delays a planned December close until the first quarter of the next year can skew fundraising figures considerably. It should also be noted, however, that some LPs are choosing to cut the number of PE firms that they work with, sticking with larger and more established investors in times of uncertainty and hoping to cut administrative fees in the process.
In terms of last year’s deal flow, many PE investors were squeezed out of their own markets by higher multiples and a subsequent lack of feasible investment opportunities. In the same way that corporations often divest non-core business units in times of financial struggle, we saw PE firms stick to their own bread and butter when raising new funds. 64.9% of funds closed last year were buyout funds, as opposed to 10.7% PE growth, 9.3% co-investment, 5.9% mezzanine, and 8.7% energy funds. This was the highest proportion of buyout funds we’ve seen in the last decade and is a sign that PE firms are sticking with the industry’s core strategy in the face of heightened uncertainty in the market. However, some funds that may have originally targeted core-middle-market buyouts have started sourcing smaller companies in an effort to find relatively cheaper deals, and the smaller equity contributions may allow for flexibility in strategy, including growth equity rounds.
Dry powder at record high
PE capital overhang
Dry powder at record amount Global PE capital overhang reached a new all-time high of $754 billion last year, according to returns data through June 2016. Of that sum, $213.3 billion, or 28.3% of the total, comes from 2015 vintages. 81.5% of the capital raised in 2015 has yet to be deployed.
These vast reserves of capital will help to fuel PE deal flow this year and the next. Even despite the high multiples in the market, and subsequent difficulty managers are having penciling out returns, PE firms will be under pressure to deploy capital quickly. However, given the lofty prices and lower levels of leverage being used across the market, it will become harder to produce the returns to which many PE investors have become accustomed. That said, many already expect returns on capital in coming years to be lower across most asset classes, whether they be public or private. This will soften the relative potential diminishing of PE funds’ performance.
A slowdown likely ahead
VC fundraising overview
The venture capital industry experienced a decade high of capital committed in 2016, with an aggregate $51.3 billion raised across 328 vehicles. Largely driven by a record amount of distributions—VCs distributed over $120 billion back to LPs between 2014 and 2015—VCs set out to raise larger funds, seeking to tap an unprecedented supply of capital. Subsequently, a considerable amount of money was recycled back into the asset class, with many LPs increasing their exposure during the fundraising cycle. The latter could be due to a rotation of capital out of hedge fund strategies and in part into VC strategies. For instance, due to complexity, cost and scale, major pension funds such as CalPERS and PGGM have recently liquidated their hedge fund allocations. Amidst an aging population, tight state budgets and baby boomers entering into retirement, pension plan managers are likely capitalizing upon the illiquidity premium offered by the VC market as they attempt to grow their pensions out of an underfunded state. A recent study produced by the Stanford Institute for Economic Policy Research revealed that the nation’s largest public pension plan, CalPERS, is underfunded by over $1 trillion, underscoring the severity of the matter. In turn, we may continue to see pension fund managers increase their exposure to the VC asset class as they look to boost returns.
In part attributable to recycled distributions, we saw the most capital since the dot-com era enter venture funds. This increased appetite for the venture asset class enabled a decade-high 86.1% of fund managers hit their target during the year. In addition, 28 funds were able to raise upwards of $500 million in commitments, accounting for 44.4% ($22.8 billion) of all capital closed during the year. Altogether, the median fund size increased 70% year-over-year (YoY) to almost $85 million. Coupling the sheer amount of available capital with demonstrated interest in the unique verticals and geographies offered by emerging and new managers, first-time funds garnered the most commitments ($3.8 billion) since 2008. For instance, the Geodesic Capital Fund I raised $335 million to bridge the gap between Silicon Valley and Japan, while the Eight Partners VC Fund I closed $420 million to fund software companies which hold the potential to have a positive impact on the global ecosystem. The largest firsttime raise (£500 million) came from the London-based Cocoon Networks Fund, which has a mandate to increase Chinese foreign investment in the UK technology sector. What should be noted, however, is that the fund doesn’t appear to be akin to a traditional venture vehicle as it is funded by just two major LPs.
Despite the dry powder level today sitting at a record amount, investors have become more selective with the deals they pursue and thus, the pace at which capital is being deployed has slowed. The robust net cash flows LPs have seen in recent years have also started to taper off as we’ve seen VC-backed exits decline in recent quarters. Moving forward, the aforementioned factors will likely lead to a slower fundraising market, an outcome we view as healthy given the current state of VC.
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