Pricing & Availability of Quality Targets Weighs on Private Equity Funds in 2015, BDO's Sixth Annual PErspective Study Finds

February 2015

Alexis Ganz
Bliss Integrated Communication
(212) 840-1661
Alexis@blissintegrated.com

Chicago – February 12, 2015 – Pricing tops the list of challenges facing private equity firms in 2015, according to the sixth annual PErspective Private Equity Study by BDO USA, LLP, one of the nation's leading accounting and consulting organizations. Forty-two percent 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 percent 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, fueled by growth in the U.S. 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.”
 
Fundraising Outlook Remains Strong, As LPs Look for Solid Track Records
 
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 percent of private equity fund managers say they are receiving new commitments from Limited Partners (LPs) in 2015. That's up from 61 percent 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 percent), followed by pension funds (22 percent) and institutional investors (10 percent). Funds with $500 million to $1 billion in assets under management (AUM) are the most likely to report receiving the majority of first-time commitments from pension funds (63 percent).
 
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 capitalize on the consistent growth in the U.S. economy and the frothy market for deals," says Scott Hendon, partner in the Private Equity practice at BDO. "At the same time, LPs recognize 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."
 
Fund Managers Report Gains in Portfolio Company Performance
 
Fortunately for GPs, a majority of private equity fund managers (75 percent) 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 percent report a decline. Among funds that reported an increase, 34 percent reported an increase of 6-15 percent and another 34 percent reported an increase of 16-25 percent.
 
Portfolio performance was not entirely rosy in 2014, however, with 30 percent of fund managers reporting that more than 20 percent of their portfolio companies are performing below forecast or expectations, compared to 20 percent 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 3 percent reporting that they will declare bankruptcy for one or more of their portfolio companies in 2015, compared to 12 percent 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 capitalize on improvements in the U.S. economy to complete add-on acquisitions and make operational improvements to fuel growth and generate increasing returns for their Limited Partners."
 
These findings are from the sixth annual BDO PErspective Private Equity Study, which was conducted from November through December 2014 and examined the opinions of more than 125 senior executives at private equity firms throughout the U.S.
 
Other major findings from the BDO PErspective Private Equity Study include:
 
  • Hiring on the Rise: Private equity professionals expect to add to job growth in 2015.  A majority (78 percent) plan to increase professional staff headcount at the operating company level and another 54 percent say they will increase administrative staff. At the fund level, 48 percent of fund managers say they will increase employee count during the next 12 months.
 
  • Heightened Transparency: As the SEC steps up oversight of private equity expenses and fees, firms are taking proactive measures to respond. A majority of firms (57 percent) are enhancing internal controls, including corporate governance and compliance actions. More than one in three (39 percent) are increasing communications and disclosures to their LPs about fees, and an equal number are monitoring agreements. One quarter are updating their Limited Partnership Agreements with more clarity around fees, and 19 percent are appointing a chief compliance officer.
 
  • Managing Regulatory and Compliance Complexities: Forty percent of respondents cite Dodd- Frank as having the most significant impact on their fund at the sponsor level, followed by 24 percent pointing to the Patient Protection & Affordable Care Act. Despite these regulatory challenges, fund managers generally feel confident that their staff is equipped to navigate them: Nearly half (46 percent) report having a dedicated chief compliance officer at their firm, with another 7 percent planning to hire one in the next 12 months. Most firms (74 percent) intend to keep compliance staffing levels even with last year.
 
The BDO PErspective Private Equity Study is a national survey conducted by PitchBook, an independent and impartial research firm dedicated to providing premium data, news and analysis to the private equity industry.
 
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