After 2009, Private Equity Fund-Raising Has Low Expectations for 2010

The private equity sector suffered severely in 2009. The late 2008 financial crisis shaped the year that followed it, constraining institutional investor capital and limiting strategic alternatives. Even with the recovery in public capital markets that occurred in 2009, investors in private equity funds remained cautious with their cash, a trend that appears likely to continue into 2010. New capital raised by private equity funds fell 61% from 2008 to 2009, with the deferred effects of the 2008 financial crisis finally coming to bear.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%%Only $246 billion in new capital found its way into private equity funds last year, the lowest tally for a full year since 2004, according to data provided to DailyFinance by alternative investment research firm Preqin. The fourth quarter was dismal. Only $35 billion was raised, making it the worst single-quarter performance since the third quarter of 2003.

Last year, private equity fund-raising fell 61% from 2008's $636 billion total and 62% from the $646 billion raised the year before. Though the financial crisis struck in 2008, nearly three quarters had passed before a financial event generally limited to credit markets became a worldwide economic affair. As a result, the decline from 2007 to 2008 was modest.

"Fundamentally Altered Their Attitudes"

The uptick this year in public markets did provide some relief, boosting asset valuations and increasing investor confidence in private equity and other asset classes, but the impact of the financial crisis has nonetheless had a profound impact on the investor community.

According to Tim Friedman, head of communications for Preqin, "Although the recovery in the public markets and adjustment in private equity fund valuations has alleviated the denominator effect that many investors were suffering from at the start of 2009, we are finding that many backers of private equity funds have fundamentally altered their attitudes toward the asset class."

The pressure on the private equity sector as a whole hasn't fundamentally changed its composition. Buyout funds continued to lead the sector in 2009, with 84 of them raising $102 billion. Meanwhile, 170 venture funds picked up $27 billion, and 96 real estate funds were able to raise $41 billion. In the fourth quarter of last year, 13 buyout funds close with an aggregate $14 billion, while 24 venture funds closed with $24 billion in capital. Seventeen real estate funds closed with $7 billion.

Likewise, regional breakdowns remained consistent with previous years, in that funds focused on North America raised the most capital, followed by Europe, then Asia, and then the rest of the world. The 228 funds targeting investments in North America attracted $145 billion last year. The 136 funds focusing on Europe raised $74 billion. While the 118 targeting investments in Asia and the rest of the world raised $27 billion. For the fourth quarter, funds focused on North America raised $19 billion, with $11 billion for Europe and $5 billion for Asia and the rest of the world.

Examining Portfolios More Closely

The pressure on both fund-raising and returns last year made it more difficult for private equity funds achieve final closes. On average, it took more than 18 months for a fund to close in 2009, up 50% from the 12 months it took in 2007. Investors are examining their portfolios more closely before making investments and taking much more time to consider new opportunities before deploying their capital.

Says Friedman: "Negotiating terms and conditions has become more of a key concern, and we are seeing a trend away from the bigger mega-buyout funds toward more of a focus on smaller midmarket and regionally focused vehicles."

Though 2009 was quiet for the private equity fund business, there is some hope for this year. Preqin puts the number of investors making new private equity commitments this year at 60%, with the rest not making any new moves. But expectations are changing based on last year's experience.

Better Exit Strategies Needed

Friedman observes: "Although investors are in a much clearer position now than at the start of 2009, the chances of a return to the fund-raising levels seen in 2007 and 2008 are very slim." The fact that fund distributions were leaner in 2009 means investors won't have as much capital as usual to put to work in the private equity market. So, Friedman notes, "Although the majority of investors will be active in 2010, it will be at a lesser rate than in recent years."

For the private equity market to recovery fully, the market for exits will need to bounce back. After all, this is what's needed to free capital already invested, and the availability of a way out will make it easier for investors to put money in. Not until private equity investors can have confidence in their exit strategies, Friedman says, "will we see annual private equity fund raising attaining $500 billion-plus levels once again."
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