Stable year for private equity industry

If this year is shaping up as a period of bumper fundraising, 2004 was a far more modest affair. The gap between fundraising and investment increased by almost €10bn in favour of fundraising, according to final data from the EVCA’s annual private equity survey.

Private equity fundraising tipped the scales at €27.5bn, compared with investment of €36.9bn and divestment of €19.6bn. Fundraising was only marginally ahead of 2003, although investments rose by nearly €8bn and divestment picked up by €6bn.

“The record for investments and exits are a reflection of an active market in 2004, which looks set to continue in 2005 and 2006,” said Herman Daems, outgoing EVCA chairman and chairman of GIMV NV. “The increase in private equity and venture capital as a percentage of European GDP is encouraging. However, we have still got a long way to go to achieve the challenge I set in February to increase the contribution for buyouts to 0.4% in the next three years.”

Buyouts accounted for 0.26% of European GDP in 2004, up from 0.21% the previous year, while venture capital grew to account for 0.10% from 0.8%. The European private equity portfolio as a whole is estimated at €156.1bn at cost, net of divestment, up from €139bn in 2003.

Looking towards the longer term, fundraising has found a stable range between €25bn and €28bn, the EVCA said. The 2004 figure of €27.5bn has remained virtually unchanged from 2003 and 2002 levels, although delegates acknowledged that the scenario could have changed significantly by the time they came to debate trends for 2005.

Some €10.1bn or 37% of funds were raised in the UK, because most large pan-European players are based in that country. Surprisingly, the €17.8bn in funds raised for buyouts fell from €21bn, a decrease to 65% from 78%. For venture capital, the proportion increased to 32%, or €8.8bn, from 21%, or €5.7bn.

Banks were a significant contributor group, raising €5.1bn collectively, or 22% of fundraising proceeds. This commitment was down from €5.4bn in 2003. Pension funds were also prevalent, comprising 19% of fundraising. Some €7bn was raised by captives, up from their €5bn level in 2003.

Investments increased by 27% and reached a record level, surpassing the historical peak of €35bn attained in 2000. Some 70% of investments were in the buyouts space, a percentage that was worth €25.7bn, up from €18.4bn the previous year.

While buyouts represented the largest proportion of the amount invested, they only accounted for 18% of the total number of investments. Additionally, of all buyouts by number, 97% were made up of small and mid-market deals. Looking at the investment size by stage of financing, the average size for buyout investments rose to €14m from €11.7m in 2003.

Exits were at their highest level ever at €19.6bn. Some 5,917 exits were made, compared with 5,605 exits in 2003, which were worth €13.6bn.

Trade sales remained the main exit route overall, representing almost one-quarter of all divestments by amount at €4.6bn. Divestments by public offerings (IPOs and sales of quoted equity) increased by 44% to €2.3bn. Despite an 81% increase in exits through IPOs only, this exit route remained extremely modest, with only a 7% share of 2004 total divestments. Write-offs’ share of the total amount divested shrunk to 10% from 12%.

Private equity performance

The European private equity and venture capital industry’s final performance figures for 2004 saw long-term performance virtually unchanged from 2003. The annualised net pooled internal rate of return (IRR) since inception to the end of 2004 is 9.5% for all private equity, compared with 9.9% the previous year.

“Last year was a solid year and these figures show that the industry has clearly moved beyond the inflection point of a few years ago. The upward trend in short-term returns is a positive indication of a better performing industry. We hope that this will continue in 2005,” Daems said.

While long-term returns for all private equity remain relatively constant, the five-year medium-term horizon IRR has decreased. This is an expected development, given that that horizon still includes the high and over optimistic company valuations of 2000. Therefore, five-year horizon figures across all stages of development decrease to 2.8% compared with 7.3% in 2003.

The short-term returns tell a better story. The upward trend has moved beyond a clearly defined inflection point, as registered in 2002 and 2003, indicating that industry performance continues to make positive progress.

The one-year horizon returns for all private equity stood at 17.7% compared with minus 0.8% in 2003. There was a major reversal for buyouts, where returns jumped to 22.8% from 2% the previous year. Venture turned positive at 2% from minus 8.1%.

“The solid short-term returns are explained by private equity firms having already written down most of their valuations and now being able to reap the benefits of the improving exit markets. Those returns also reflect the solid performance of European private equity as an asset class, which has consistently outperformed both public equities and fixed income,” said Glenn Bedwin, European head of research at Thomson Financial.

Looking at the returns by stage since inception, buyouts and venture capital returned 12.3% and 6%, respectively. While buyouts are almost at the same level as in 2003, when they reached 12.2%, the venture return registered a slight decrease compared with 2003 at 7%. The performance of the top quarter funds – the IRR of the funds performing above the upper quartile – continues to be strong as well. The pooled IRR for buyouts in this segment since inception is 28.7%. Compared with the long-term pooled IRR for the stage, this means that the top quarter buyout funds’ return is twice as high as the return of all buyout funds.

While the absolute IRR measured in some of the tables presented indicates the overall return, it is important to separate the realised portion – distribution to paid-in or DPI – from the unrealised return – residual value to paid-in or RVPI. As of the end of 2004, for every euro invested in private equity since inception, investors could expect a total return of 1.32 times their money. From this expected amount, 0.72 times has been distributed back to investors, while 0.60 times is still tied in unrealised gains/losses.