EVCA delegates: Private equity model isn’t broken

Research released at EVCA’s Investors’ Forum in Geneva today reveals that despite negative returns in 2008, long-term IRRs remain robust. Comments from delegates, including Providence’s John Hahn and the Wellcome Trust’s Danny Truell, reflect an industry engaged in self-critical dialogue as it returns to its roots.

The performance of more than 1,300 private equity funds over the past 29 years has remained “strongly in positive territory”, according to preliminary data released today [see chart below] at the European Private Equity & Venture Capital Association’s Investors’ Forum in Geneva.

However, macroeconomic volatility over the past year has reduced asset valuations, the number of new investments and exits, as well as the availability of financing, causing a slump in short-term horizons. Javier Ecchari, EVCA secretary general, stressed in a statement that while IRRs are likely to fall in the short-term amid such volatility, the industry remains well placed to capitalise on countercyclical opportunities. “Vintages invested in a downturn have historically been those that perform best,” Echarri said.

The industry is definitely nursing a hangover.

Roberto Quarta

The EVCA data shows that private equity returns averaged negative 25 percent last year, with mega-buyout funds faring worst; the large funds saw returns of negative 27 percent, a drastic change from the 20 percent returns booked in 2007.

“The buyout model – even if applied to large businesses with large enterprise values – was not necessarily flawed, but the industry did get caught up in dealing with ever higher asset values and debt multiples,” John Hahn, managing director of mega-buyout firm Providence Equity Partners, told the 450 investors gathered in Geneva.

“All of private equity has been damaged by the crisis,” noted Jeremy Coller. The founder and chief executive of secondaries firm Coller Capital was among many conference attendees forecasting future fund manager consolidation.

“The boom had attracted a lot of tourists into the industry, both GPs and LPs, with limited understanding of what they were doing,” said Danny Truell, chief investment officer of the Wellcome Trust, a UK charity and influential limited partner. “These tourists will leave, leaving the rest of the industry to go back to what historically it has been good at, which is: One, be disruptive in industries that need disruption – now is a good time to be disruptive in many industries; and two, empower people.”

Danny Truell

Truell stressed the industry’s need to focus on value creation through operational expertise, as did Roberto Quarta, partner with Clayton Dubilier and Rice and chairman of its European activities. “The industry is definitely nursing a hangover,” said Quarta. “Now, its priority must be to return to its roots as a provider of patient, long-term capital.”

The amount invested by private equity firms fell by 27 percent in 2008 to €52.4 billion, compared to €72.2 billion in 2007, with deal numbers dropping accordingly from more than 5,000 to about 4,600 year-on-year.

Private equity funds also raised 20 percent less in 2008 than in 2007, having signed up LPs to €65.3 billion in commitments, compared to the €81.4 billion raised in 2007. This is due to a combination of factors which include LPs battling over-weight private equity portfolios and over-commitment strategies in the face of slowed distributions and shrinking assets.

Market participants say that many LPs, as a result, have gained greater power in LP-GP negotiations, as GPs struggle to secure re-ups and new commitments.

Urs Wietlisbach, founding partner of Swiss alternative asset manger and advisor Partners Group, noted: “There will be an up cycle again, even though some people might not believe that right now, and when it comes, LPs will once again struggle to influence the terms of the most popular funds.”

Philip Borel and Amanda Janis contributed to this report.

Investment Horizon Internal Rate of Returns to 31 December 08

 Fund Type  1yr 3yr   5yr  10yr  20yr
 Early Stage VC  -12.30 -1.70   -0.20  -2.40  -1.10
 Balanced VC  -19.30  1.70   2.70   0.60  3.30
 Development Stage VC  -17.90  0.30  4.20  3.70  7.40
 All Venture  -17.90  0.00  2.10  0.40  3.10
 Small Buyouts  -23.80  5.30   8.30   9.50   12.30
 Medium Buyouts  -17.90  9.30  14.90  18.50  16.70
 Large Buyouts  -23.90  11.40   11.40   19.30  19.60
 Mega Buyouts   -27.10  8.40   16.00  12.00  11.90
 All Buyouts   -26.40  8.50   14.10  13.30  14.10
 Generalist   -8.20  5.50  7.90  8.00  9.20
 All Private Equity  -24.90  6.30  10.50  9.30  10.40

Source: Thomson Reuters 2009