Private equity: is the edge still there? If you’re a private equity professional, this question is probably instills one of two feelings inside you.

First, it could strike fear into your heart as you attempt to raise funds for new investments.  Why would people invest in an illiquid asset class if the promised return is not measurably higher than competing, liquid asset classes? 

Second, and counter to the first, this question could install in you a feeling of drive.  If you know that the answer to the question is almost assuredly no, then there’s nothing to fear.  You could confidently go out and sell investments into private equity as a way for investors to realistically expect higher returns over time.

Well, what is the answer to the question – Private equity: is the edge still there?

Here’s a look, based upon information put together by AQR Capital Management and discussed on Private Equity International.

What did AQR Capital Management do to evaluate the question?

AQR Capital Management took returns of the private equity industry from 1986 to 2017 and compared them to the returns of competing asset classes, such as the S&P 500 and small cap value stocks. 

What did they find?  AQR Capital Management found that, on an arithmetic basis, private equities generally offered a small amount of potentially higher return compared to some asset classes, while underperforming other, more comparable asset classes.

Their study’s results follow.

Overall, the Cambridge Private Equity buyout class and the Cambridge Private Equity de-smoothed buyout class provided investors 9.9 percent and 9.9 percent returns, respectively.  By way of comparison, the S&P 500 returned 7.5 percent over this period.  

The Russell 2000 returned 7.6 percent, the 1.2x Russell 2000 returned 9.1 percent, and the Russell 2000 Value returned 8.5 percent.  These three were bested by the private equity industry’s returns.

Interestingly, a more reasonable comparison would be small cap stocks, such as the Fama French small cap value stocks.  These small cap value stocks bested the private equity industry’s return at 11.4 percent.  Tough to sell investment in an illiquid asset class when there’s a publicly traded alternative that bested private equity’s return.  Hmm.

Source: AQR Capital Management; Private Equity International

The Geometric View

What about a geometric view of the data?  Any difference there?

The following figure contains the results.

In the geometric case, private equity performed on top.  The Cambridge Private Equity (US buyout) non-de-smoothed provided investors a 9.8 percent return.  This beat the Fama French small value stocks by 0.4 percentage points.

Source: AQR Capital Management; Private Equity International

What are the reasons for the decline in the private equity risk premium?

Overall, the net-of-fee expected returns of the private equity industry has declined over the years.  What might be causing this?

The authors speculate that a few issues are at play.  First, increasing investor demand has driven up PE valuations.  Second, PE returns tend to be lower following hot vintage years.  Third, competition for deals has made it difficult for PE to deliver market-beating returns.

Source: AQR Capital Management; Private Equity International

Conclusion

Overall, as one might have expected, it depends upon how return is measured in order to answer the question of whether private equity has lost its return edge. 

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If you were asked how the venture capital (VC) industry performed in 2018, what would you say? Red hot? Slowing? Just starting to boom? Sick of San Francisco?

Private equity and venture capital data provider Pitchbook recently released their accounting of the state of the VC industry at the end of 2018. Here’s a look.

Deal Activity

First up, deal activity. VC activity performed incredibly well in 2018. Overall, according to the Pitchbook-NVCA Venture Monitor, deal value surged to $130.9 billion in 2018, far surpassing the $83.0 billion in 2017.

Interestingly, although deal value ballooned to over $130 billion, deal count dropped a little bit, going from 9,489 in 2017 to 8,948 in 2018. Hmm. Fewer deals but the deals that were made much at a much higher valuation than the prior year.

VC Deal Activity with PE Moves Up

Although typically viewed a frienemies, in 2018 VC deal activity with PE expanded. In 2016, a total of 727 deals worth a total of $25.6 billion involved both VC and PE investment.

In 2018, that amount expanded to 792 deals and $38.5 billion in deal value. Unsurprisingly, it wasn’t just a good year for VC.

The Doubling of the Mega-Deals

One of the findings from the Pitchbook report that comes at very stark is the massive increase in deal value in 2018.

In 2014, deal value totaled only $17.8 billion, with the total number of deals at 82. The 2015, 2016, and 2017 figures were $25.0 billion, $24.2 billion, and $24.6 billion, respectively (109/79/104 deals from 2015 through 2017).

What happened in 2018? Things exploded. The total deal value grew to $61.1 billion, more than double the 2017 value. The number of mega-deal activity also increased, from 104 to 198.

There’s certainly a lot of cash looking for high returns.

Angel and Seed Deal Sizes Jump Again

Two other figures from the Pitchbook report appear telling of where we are with VC in the U.S.

The first is the median angel and seed deal sizes from 2008 to 2018. The median deal size for seed funding increased substantially in 2018, from $1.5 million in 2017 to $2.0 million in 2018, representing a 25% ballooning in value.

On the angel front , deal size increased from $500k to $700k, an increase of 40%.

As with the previous measures, these figures on angel and seed deal size suggest an American economy that is on the lookup for healthy investment deals.

Another Year of Decline for First-time and Follow-on VC Rounds

Although the previous figures were immensely positive on the state of the VC industry, one interesting finding is that both the first-time VC funding round and the follow-on VC funding rounds declined in 2018 after fairly decent figures in 2017.

It’s tough to decipher what this means outside of the obvious that VC may be becoming pickier in what they invest in. Overall, though, first-time and follow-on VC investments are still at very healthy levels compared to historical experience.

Conclusion

Overall, the VC industry ended 2018 are very healthy notes. The industry is on the up, with startup and entrepreneurial activity in the U.S. looking fairly good after years of weakness. Life is good right now if you’re working in the VC industry.

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2018 was lots of things to lots of people.  Some may remember the year as the year America gained back respect from China by addressing its unfair trade practices.  Others may focus on the terrible fires in California.  Others may wish to focus on the positive, such as the amazing PyeongChang Winter Olympics.  Still others may remember 2018 as the year stocks failed to deliver a Santa Claus rally. 

Lots of other things happened in 2018.  One them – a massive year for private equity buyouts – is addressed here. 

If you had to guess which year was the best year for buyouts ever, would you guess 2018 could be on top?  Perhaps 2000, just before the dot.com bust? 

Here’s a look at buyout activity since 2008.  On top is this year, 2018, with more than $700 billion in deal activity.  That places 2018 second all-time according to data from private equity data provider Pitchbook, surpassed only by the massive 2007. 

2018 was also the highest deal count ever, with an estimated 4,828 deal counts.  This expansion is certainly kicking on all cylinders (or at least most cylinders).

The Pitchbook report, available here, also has many other interesting tidbits of information.  Let’s see if you can guess how 2018 compares to the past 10 years on the following questions.

First question – How do the multiples experienced in 2018 compare to prior years?  Would you guess deal multiples are the highest they’ve been in the past decade?  Or perhaps you’d guess things have cooled somewhat compared to the recession and recovery years of 2008 to 2014? 

The look follows. 

Fascinatingly, 2018 was fairly good for Equity per EBITDA, debt per EBITDA, and EV per EBITDA, but not the highest since 2008. 

The winner for the highest debt per EBITDA is 2013 at a 7.1x multiple.  The winner for the highest equity per EBITDA is 2017 at 5.8x.  And the overall winner for the highest EV per EBITDA was 2014 with an EV per EBITDA at 12.4x.  Interesting, interesting.

Let’s take a look at one other measure and see how well you know 2018 compared to the past decade.

According to Pitchbook, what percentage of deals would you guess were done in 2018 that had multiples above 10x?  Would you guess 2018 had a higher percentage of deals above 10x than ever before?  Below is the look.

Captivatingly, more deals were priced above 10x in 2018 than ever before.  Incredibly, over 60% of deals in 2018 had valuations over 10x.  The next closest year?  2017 saw about 55% of deals with valuations at or above 10x.

 

Conclusion

In a fascinating look at private equity deal making and deal values in 2018, the year looks quite favorable to activity in the past decade.  It’s a good time to be employed or be involved in the private equity sector.

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Who are the 25 Most Valuable Startups in the U.S.?

January 7, 2019

Every now and then we enjoy looking at the most valuable startups in the U.S.  It provides perspective and sometimes inspires awe at the state of American ingenuity.  Without further adieu, the list follows. But, before looking, can you guess which companies show up in the top 5?  Where would you guess the most valuable […]

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Could Take-Privates Spike in 2019?

December 24, 2018

In an interesting speculation on the state of the private equity universe, Adam Lewis of private-equity data provider Pitchbook is out with an interesting look take on the “take-privates” activity.  In particular, he speculates that the take-private activity will spike in 2019. Some Background Before getting into the reasons why take-private activity could spike in […]

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How Did Financial Employment Do in 2018?

December 10, 2018

The year is almost over.  As such, now seem like a good time to review how financial employment did in 2018. There are two charts here.  The first compares growth in financial employment with other major sectors.  The second compares growth in financial industry employment by president for the first almost 2 years in office. […]

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Who are the Top 11 PE investors in the US Midwest?

November 27, 2018

Private equity data provider Pitchbook recently released some interesting data on the top 11 private equity (PE) investors in the U.S. Midwest.  Which entities would you guess show up on top? Would you guess the big entities – Canadian Pension Plan Investment Fund, AlpInvest Partners, Hamilton Lane, HarbourVest Partners, or Washington State Investment Board show […]

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The Top 9 Trends in US Private Equity Right Now

November 12, 2018

One of the most well-known data providers used by private equity professionals is Pitchbook.  They’re out with their take on the top 9 trends in US-based private equity activity right now. Before looking at the list, which topics would you guess show up?  Take your guess now – the top 9 list follows. #1: 2018 […]

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A Look at Pitchbook’s 2018 Startup Graveyard

October 29, 2018

In an almost interesting fashion, Pitchbook, the private equity data provider, is out with a look at the 2018 startup graveyard.  The tally reviews companies that died in the year of 2018. Before looking at the list, which companies would you guess are on the list?  Does a certain blood-testing company come to mind?  Perhaps […]

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Looking at the Most Valuable Startups in Each State

October 15, 2018

Private equity data provider Pitchbook is out with a fascinating new look at the most valuable startups by U.S. state. Before looking at the results, take a guess.  Would you guess the most valuable startup is headquartered in Massachusetts, with its biotechnology-centered cluster?  What about California?  Silicon Valley certainly has some very valuable startups.  Perhaps […]

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