Private Equity Performance In Times Of Crisis
As COVID-19 grips the world and with so much in flux, investors are trying to predict the impact this crisis will have on their portfolios.
PitchBook looked at historical data to examine how buyout funds specifically reacted during previous crises, including the Tech Bubble, 9/11, and the Global Financial Crisis .
Private Equity Tends to Be More Resilient than Public Equities, Especially More Mature Vintages
PitchBooks research found that the magnitude of pricing swings was less severe with buyout funds than in public markets.
During each of the past two recessions, TVPI fell to a lesser extent than public equity indices did. In the GFC, pooled TVPI dipped by 10% or less for vintages that were four years old or greater. Younger funds were more affected, with pooled TVPI declining nearly 20%. Funds eight to nine years old when the crisis struck were nearly flat. During the GFC, the S& P 500 fell by more than 50%.
Pooled TVPI by vintage cohort over time
Rolling pooled IRR by vintage cohort over time
Crisis-Era Vintages Typically Offer the Best Time to Invest in Private Equity Buyout Funds
As PitchBook’s previous data illustrates, crisis-era vintages typically offer the best time to invest in buyout funds. Rather than holding steady or cutting exposure to equitiespublic or privateLPs should be allocating to the space.
2001 Vintage Funds Demonstrated the Best Private Equity Performance in the Past 20+ Years
Pooled TVPI seven years since inception by vintage year
Deep Investment Cycle Experience From Start To Finish
RPCK has extensive experience representing venture capital funds, venture capital investors and the VC-backed companies in which they invest.
Our investment fund, family office and high net worth clients regularly invest in early and later-stage companies as well as lead or participate in convertible instruments, series preferred, debt and hybrid financing rounds of these companies.
We are involved in all aspects of these transactions, reviewing and negotiating financing documents from the term sheet stage through to the closing with a focus on key due diligence issues, control rights, liquidity events and other investment terms of key importance to investors.
After closing, we continue to work closely with and advise our investor clients on follow-on investments, restructurings, bridge loans, fiduciary duties relating to board representation, structuring and negotiating liquidity events and exits as well as any other issues that commonly arise with respect to the companies in which they invest.
We help our emerging and growth-stage company clients structure and conduct capital raising transactions involving a diverse assortment of securities and financing structures, including S.A.F.E.s, convertible notes, convertible preferred stock, secured and unsecured loans and royalty investments.
Our experience includes the following:
The Timeline Of A Private Equity Fund
As explained above, we have four key parties involved in the life of a fund:
The technical life of a fund is called the Fund Term. Unlike public equity funds – which usually operate on a rolling basis – the Fund Term is finite. The most common term is ten years, with optional extensions .
Note: This timeline is just for illustration.Each fund has a different schedule , the details of which are laid out in the Offering Materials . Also, the investment and harvesting periods are not clearly defined: they overlap heavily. For example, an investment made early on may begin providing cash flows to the fund before later deals have even closed. Finally, the fund term can be extended beyond the term laid out in the formation materials.
Now, we will cover the three parts of the fundâs life: Formation, Investment and Harvesting.
Please note: For Moonfare investors, the process of becoming a Limited Partner is simplified and automated through the Moonfare platform. to learn more about how private equity investing works with Moonfare.
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Real Estate Private Equity
Real estate private equity funds require higher minimum capital for investment as compared to other funding categories in private equity. Investor funds are also secured for several years in this type of funding. According to research firm Preqin, real estate funds in private equity are expected to grow by 50% by 2023 to reach a market size of $1.2 trillion.
Steady Deal Volume After Big Year For Private Equity
The onset of new risks inflation, rising interest rates, geopolitical turmoil, increased government scrutiny has contributed to the surge in volatility and slowdown in private equity deals in 2022. During the first half of the year, volume declined by 26% to 1,626 deals from 2,184 deals during the same period last year. While deal volume was still strong during the first quarter, most of the decline in the first half of the year was due to the second quarter, when volume fell precipitously.
The near-term investing climate is likely to be a test for this generation of private equity firms, most of which saw their fortunes increase in the last decade. Performance could start to diverge as the cost of debt rises and exits are more difficult. However, we expect activity to recover given record-high levels of dry powder . Due diligence will be a key safeguard against volatility and possible regulatory action.
What I would argue as a much more ambitious value creation agenda at many private equity funds leveraging cloud technology and data and analytics to drive insights quicker, as well as a tremendous amount of focus on talent, both the development and retention of talent, both at portfolio companies and the fund itself.
Manoj Mahenthiran, Private Equity Leader
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Understanding The Strategy And Operations Of A Private Equity Fund
Beyond making successful investments, one of the greatest challenges for a first-time fund manager is understanding the mechanics of a funds operations and profit model. Creating a complete and thoughtful set of pro-forma financials early on is the best way to ensure that you will be successful, not just at raising and operating your fund but also at making a profit.
Stages Of Venture Capital Financing
Among the different investment types, venture capital is usually not an âintroduction to private equityâ because of its high risk and high reward nature.
The likelihood of failure among private companies backed by venture capitalists can be startling.
Most of the VC funds tend to make a sizeable number of deals with hopes that one or two become actually successful.
This helps the fund compensate for several failed investments while still attaining a profit.
As all in nearly all aspects of business, venture capital financing doesnât happen in a vacuum nor overnight. Venture capital financing warrants distinct private equity stages:
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Choosing And Executing A Portfolio Strategy
As we have seen, competing with private equity offers public companies a substantial opportunity, but it isnt easy to capitalize on. Managers need skills in investing and in improving operating management. The challenge is similar to that of a corporate restructuringexcept that it must be repeated again and again. There is no return to business as usual after the draining work of a transformation is completed.
Competing with private equity as a way to create shareholder value will make sense primarily for companies that own a portfolio of businesses that arent closely linked. In determining whether its a good move for your company, you need to ask yourself some tough questions:
Do you have the skills and the experience to turn a poorly performing business into a star? Private equity firms typically excel at putting strong, highly motivated executive teams together. Sometimes that simply involves giving current managers better performance incentives and more autonomy than they have known under previous ownership. It may also entail hiring management talent from the competition. Or it may mean working with a stable of serial entrepreneurs, who, although not on the firms staff, have successfully worked more than once with the firm on buyout assignments.
Mapping Potential Portfolio Strategies
If you can comfortably answer yes to those three questions, you next need to consider what kind of portfolio strategy to pursue.
Definition What Is Follow
1. It is an additional investment sourced by a Venture Capital firm from its incumbent investors to finance a private equity company.2. It can be defined as subsequent funding by investors who made previous investments in a startup. It arises at a later stage investment and not an initial investment.
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Venture Capital Is A Game Of Home Runs Not Averages
The first, and arguably most important, concept that we have to comprehend is that venture capital is a game of home runs, not averages. By this, we mean that when thinking about assembling a venture capital portfolio, it is absolutely critical to understand that the vast majority of a funds return will be generated by a very few number of companies in the portfolio. This has two very important implications for day-to-day activities as a venture investor:
To many, particularly those from traditional finance backgrounds, this way of thinking is puzzling and counterintuitive. Conventional financial portfolio management strategy assumes that asset returns are normally distributed following the Efficient-market Hypothesis, and that because of this, the bulk of the portfolio generates its returns evenly across the board. A 66-year sample analysis of 1-day returns from the S& P 500 in fact conforms to this bell curve effect, where the mode of the portfolio was more or less its mean.
Turning away from the more liquid public markets, investment strategies in private markets also strongly emphasize the need to balance a portfolio carefully and manage the downside risks. In an interview with Bloomberg, legendary private equity investor Henry Kravis said this:
We Capitalize On Ardians Global Networks
Our unique positioning combines the strengths of Ardians Fund of Funds and Direct Funds platforms. Through the Fund of Funds team we gain privileged access to several hundred leading private equity firms. We also draw on the expertise of Ardians direct investment teams and many industrial contacts, which supports our due diligence and delivers value to our portfolio companies post-acquisition.
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The Private Equity Sweet Spot
Clearly, buying to sell cant be an all-purpose strategy for public companies to adopt. It doesnt make sense when an acquired business will benefit from important synergies with the buyers existing portfolio of businesses. It certainly isnt the way for a company to profit from an acquisition whose main appeal is its prospects for long-term organic growth.
However, as private equity firms have shown, the strategy is ideally suited when, in order to realize a onetime, short- to medium-term value-creation opportunity, buyers must take outright ownership and control. Such an opportunity most often arises when a business hasnt been aggressively managed and so is underperforming. It can also be found with businesses that are undervalued because their potential isnt readily apparent. In those cases, once the changes necessary to achieve the uplift in value have been madeusually over a period of two to six yearsit makes sense for the owner to sell the business and move on to new opportunities.
How Private Equity Works: A Primer
To clarify how fundamental the buy-to-sell approach is to private equitys success, its worth reviewing the basics of private equity ownership.
With large buyouts, private equity funds typically charge investors a fee of about 1.5% to 2% of assets under management, plus, subject to achieving a minimum rate of return for investors, 20% of all fund profits. Fund profits are mostly realized via capital gains on the sale of portfolio businesses.
Disadvantages Of A Follow
Follow-on investors are usually unable to get major shareholder rights, like board seats or observer rights, because their holdings generally do not meet the threshold determined in the initial agreements dictated by the lead investor.
They are also generally not able to change the terms first set out in the lead investor agreement. This means they likely wont get inspection or information rights and will have no pro-rata participation rights.
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Optimizing For The Power Law
At the beginning of the article, I mentioned how the venture capital industry, as an asset class, has posted generally unsatisfactory returns. A fascinating report by the Kauffman Foundation shed further light on the issue with some salient data points. In the report, called We Have Met the Enemy and He is Us, the Foundation uncovered that when looking at a collection of venture capital funds, only a few were responsible for most of the returns for the asset class as a whole.
In many ways, the performance of VC funds as an industry is analogous to the performance of venture deals: a few home runs and a lot of strikeouts. The shape of fund level returns follows a similar pattern to the distribution of single deal returns from the Correlation Ventures study from the beginning of the article, in which the 50x deals constitute a tiny portion of the sample, but with a significant magnitude of absolute returns.
The implication of the above is very significant. Readers will recall how returns of public stocks seemingly follow a normal distribution. What we hope to have conveyed in this article is that venture capital returns, both at a deal level as well as at a fund level, do not follow a normal distribution. Rather, they seem to follow a power law distribution, a long-tail curve where the vast bulk of the returns are concentrated within a small number of funds. The figure below illustrates the difference between a power law distribution and the more common normal distribution.
Rpck Private Investment Funds Practice
RPCK has evaluated and negotiated over 60% of the impact investment funds that have come to market. Our core Impact Investing competency and attunement to mission uniquely qualify us to understand and work with these funds and investors and to help align the often-conflicting dual objectives of delivering financial performance alongside measurable social and environmental impact. We use non-traditional fund structures, such as holding companies with unlimited life, to help sponsors provide the longer-term patient capital that is often best suited to solving some of the more critical and persistent issues facing the world and targeted by the impact community.
Key Contacts:
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Private Equity Explained With Examples And Ways To Invest
James Chen, CMT is an expert trader, investment adviser, and global market strategist. He has authored books on technical analysis and foreign exchange trading published by John Wiley and Sons and served as a guest expert on CNBC, BloombergTV, Forbes, and Reuters among other financial media.
Investopedia / Mira Norian
Are Private Equity Firms Regulated
In 2015, U.S. legislators proposed increased transparency in the private equity industry due largely to the amount of income, earnings, and salaries earned by employees at all private equity firms. As of 2021, legislators have pushed bills and regulations allowing for a bigger window into the inner workings of private equity firms, including the Stop Wall Street Looting Act. However, other lawmakers on Capitol Hill are pushing back, citing limitations of the Securities and Exchange Commissionâs access to company information.
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Committed Capital Drawdowns Vintages
The money committed by limited partners to a private equity fund, also known as committed capital, is usually not transferred immediately. It is provided and invested over time as investments are identified.
Drawdowns, or capital calls, are issued to limited partners when the general partner has identified a new investment and a portion of the limited partner’s committed capital is required to pay for that investment.
The year in which a private equity fund first draws down or calls committed capital is known as the fund’s vintage year. Paid-in capital is the cumulative amount of capital that has been drawn down. The amount of paid-in capital that has actually been invested in the fund’s portfolio companies is simply referred to as invested capital.
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What Is A Follow
In venture capital, a new private company might need funding to scale its growth. It can often obtain significant Series A, B, or C funding from a larger investor. However, other investors may be interested in the company as well, but not be willing to match the large investments of the primary investors.
Follow-on investors can include smaller venture capital firms, angel investors, wealthy family members or friends, or other entrepreneurs. They will typically invest a smaller amount than the lead investor, but may still receive the same class of stock.
A follow-on public offering aims to attract smaller firms in an effort to gain additional funds for growth following an initial public offering.
A follow-on public offering is based on the market value of the companys shares, while an IPO is based upon the performance and health of the company. A follow-on public offering must be registered and a prospectus should be issued to regulators. In contrast, a venture capital follow-on investment does not require this.
Vc Is The En Vogue Asset Class
From humble beginnings, the venture capital industry has evolved into one of the most significant, and certainly best-known, asset classes within the private equity space. Venture-backed startups have redefined entire concepts of industry, with some of the trailblazers usurping the traditional oil and banking giants to become the most valuable companies on earth. The venture capitalists backing them have also taken their spot in the limelight, with the likes of Marc Andreessen, Fred Wilson, and Bill Gurley gaining recognition far beyond the confines of Sand Hill Road. You could compare this cult of personality to that of corporate raider era of the 1980s, when Michael Milken et al catalyzed the start of the LBO and junk-bond boom.
Partly as a result of this, the venture capital space has seen an influx of participants and professionals. First-time fund managers continue to raise new VC funds at healthy clips, and the once clear lines separating venture capital from private equity, growth equity, and other private asset classes have begun to blur. Corporates have also shifted into the space, creating venture arms and participating in startup funding at ever increasing levels. And perhaps the greatest sign of the times, celebrities are increasingly throwing their hats into the startup-investment ring. As John McDuling puts it,
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