Pricing tops the list of challenges facing private equity firms in 2015, according to the sixth annual PErspective Private Equity Study by BDO USA.
Forty-two per cent of fund managers say it will be the primary challenge facing their firm during the next 12 months, marking the second year in a row that private equity professionals identified pricing as their most significant pressure point. The identification and quality of targets came in second, with 27 per cent of fund managers saying it represented their top challenge in 2015.
"We're coming off of a strong year for private equity activity across the board, fuelled by growth in the US economy and the availability of cheap credit that allowed investors to justify higher purchase price multiples," says Lee Duran, partner and Private Equity practice leader at BDO. “With significant competition from both strategic and financial buyers, as well as a lingering capital overhang in the private equity industry in 2015, we don't expect to see valuations level off anytime soon, making it increasingly challenging for funds to identify and execute on the right opportunities at a reasonable price.”
At the same time that private equity fund managers are balancing increased competition for deals with their need to deploy cash, capital continues to flow into the industry. Following historically high fundraising figures in 2014, 74 per cent of private equity fund managers say they are receiving new commitments from Limited Partners (LPs) in 2015. That's up from 61 per cent who reported that they were currently fundraising in last year's survey.
The majority of first-time financial commitments are coming from family offices (59 per cent), followed by pension funds (22 per cent) and institutional investors (10 per cent). Funds with USD500 million to USD1 billion in assets under management (AUM) are the most likely to report receiving the majority of first-time commitments from pension funds (63 per cent).
For the second year in a row, when it comes to evaluating General Partners (GPs) in today's environment, a majority of private equity fund managers (59 percent) say track record is the most important factor for LPs. Management team (16 percent) and operating experience (15 percent) were also ranked among the most important considerations for LPs when considering where to invest their capital.
"Private equity has once again become an asset class of choice for many Limited Partners looking to capitalise on the consistent growth in the US economy and the frothy market for deals," says Scott Hendon, partner in the Private Equity practice at BDO. "At the same time, LPs recognise that rising valuations and competition could make it more and more difficult for private equity firms to put their money to work. These dynamics have made funds with a strong track record and management team, as well as the operational experience to grow their investments, an increasingly hot commodity among Limited Partners."
Fortunately for GPs, a majority of private equity fund managers (75 per cent) say that they experienced an increase in the value of their entire current portfolio, including all funds, during the past 12 months. One in eight (12 percent) say the value of their portfolio stayed the same in 2014 and only 13 per cent report a decline. Among funds that reported an increase, 34 per cent reported an increase of 6-15 per cent and another 34 per cent reported an increase of 16-25 per cent.
Portfolio performance was not entirely rosy in 2014, however, with 30 per cent of fund managers reporting that more than 20 per cent of their portfolio companies are performing below forecast or expectations, compared to 20 per cent of funds who reported more than one in four portfolio companies were underperforming in last year's survey. Even so, fewer bankruptcies are expected in the year ahead with only three per cent reporting that they will declare bankruptcy for one or more of their portfolio companies in 2015, compared to 12 per cent who said they have done so during the past 12 months.
"While there were pockets of underperformance in 2014, the overall environment for portfolio companies was strong," says Kevin Kaden, Partner in the Private Equity and Transaction Advisory Services practices at BDO. "In 2015, we expect to see funds continuing to capitalise on improvements in the US economy to complete add-on acquisitions and make operational improvements to fuel growth and generate increasing returns for their Limited Partners."
