HarbourVest’s Zug foresees lackluster returns for vintage 2015 funds

Private equity veteran Brooks Zug said high purchase price multiples in the face of “enormous competition” for deals may limit the returns from vintage 2015 top-quartile funds to a less-than-dazzling net IRR of about 15 percent.

Zug, senior managing director and co-founder of HarbourVest Partners, compared the current period of low credit coupled with inflated purchase price valuations of well over 10x EBITDA to past peaks in the deal environment.

Buyout pricing in the United States in 2002 or 2003 typically ranged around 6.5x EBITDA, and peaked at around 9.5x EBITDA prior to the start Global Financial Crisis in 2008. Multiples stayed higher than expected in the years after the collapse of Lehman Brothers and then got even steeper, Zug said.

He made the comments on March 25 after receiving a lifetime achievement award at the Buyouts East conference produced by Buyouts publisher Buyouts Insider.

“Almost every deal we see these days is 10x EBITDA or 12x EBITDA,” he said.

Zug said one deal his firm looked at recently was valued at about 13x EBITDA based on several projections, but turned out to be 23.5x EBITDA against its most recent actual result.

The year 2015 could be a weak vintage, based on past cycles he’s seen dating back to the 1980s, Zug said.

Venture capital funds raised in the five years prior to 1983 did well, but funds raised during the more frothy days of the 1980s didn’t fare as well. Buyout funds raised around peak years in the 1990s and 2007 also lagged. Those periods also marked large fundraising totals for sponsors, not unlike now.

“It’s unlikely we should expect the kind of returns we saw a decade ago,” Zug said. “We’ll be lucky if the top-quartile funds have a 15 percent (net) IRR.”

Still, private equity will continue to outperform public equities by 300 to 500 basis points, down from 1,000 basis points in the past, he predicted.

Zug said the United States may be at the top of its economic cycle now, but “we may be here for the next five years,” which would help boost returns in private equity.

HarbourVest, which invests in private equity funds, said you have to trust GPs to be aware of the current cycle and plan for any possible downturn.

Meanwhile, institutional investors, particularly sovereign wealth funds in Asia, continue to ramp up allocations to private equity as an asset class, he said.