The private equity and venture capital sectors face a lot of questions in 2017 as they come off a year marked by huge fundraising even as dry powder continued to pile up.
Among them, will all that money prompt fund managers to loosen their disciplined approach to investment as they try to put their money to work?
How will investors react if unicorns do not generate significant liquidity through IPOs or big M&A deals in 2017?
How will high entry prices for assets affect future returns? This is a top concern of private equity managers and investors, according to a new report.
As 2016 drew to a close, PitchBook asked its editorial staff to review the year in private equity, venture capital and M&A, and to look ahead at the coming year.
Following are their predictions for 2017.
Adley Bowden, Vice President, Market Development & Analysis
Bowden saw two outstanding trends take shape in 2016. Both private equity and venture capital raised vast amounts of money on top of already massive stores of dry power, even as deal volume and investment amounts remained at relatively modest levels, mainly because of high valuations.
And unicorns (startups valued at $1 billion or more) for the most part were able to raise money or push their business models toward profitability and extend their runways.
These trends play into what Bowden considers the biggest questions marks for 2017:
Can investment managers maintain the discipline they have so far exhibited (assuming there is not a change in the business cycle), or will all that capital burn a hole in their pockets? Bowden anticipates a weakening of discipline as firms find new strategies and routes to put the capital to work, though not a total lack of discipline. “I do imagine some interesting structures and head-scratching deals will happen,” he says.
Bowden says unicorns represent a new asset class, so he wonders, will the late-stage, private, high-growth-company asset class prove it’s here to stay or will it blow up in the face of VCs, hedge funds and mutual funds in spectacular fashion? He predicts that the best unicorns will prove they are for real and capable of generating vast investment returns for the bold. But many will also fail, causing investors to rethink and better target in the future the right companies to take into “Unicorn Land.”
Andy White, Analysis Manager
White predicts that venture fund returns will fall. VC investment activity in the U.S. has soared in recent years, with valuations increasing dramatically and forcing VCs to pay more for each investment regardless of whether the valuations were warranted.
Although more recent fund vintages produced solid returns through the middle of 2016 — with the median IRR at 15.3% for 2009–2013 vintages, compared with a median IRR of 5.2% for pre-2009 vintages — those returns exist only on paper, White says. The very vintages with strong IRR figures still hold a massive proportion of the fund’s value in active portfolio companies. For reporting purposes, this value is factored into the fund IRR calculations, propping up returns.
White thinks it is unlikely for all the investments still held to reach an exit, and it is also unlikely that many of those still held will reach an exit at the value they received at their last funding round. “So unless the winners far outshine the losers, we will see IRRs drop.”
Nizar Tarhuni, Senior Analyst
Tarhuni says he agrees with the suggestion that 2017 fundraising figures will subside, but predicts the decline will be softer than anticipated. He points to sovereign wealth funds, which have been hit by volatile commodity prices. These will seek higher-earning assets to replenish some of the money they have spent to fund social programs — and might very well look to private equity. Moreover, bigger LPs will continue to support large vehicle as a way to secure advantageous fund terms. Both this and managers marketing more products with longer lifecycles could drive bigger commitment check to private equity, he says.