Capital Markets

Rebirth of the Private Equity Market

The last few years have seen a sharp decline in both the number of partnerships raising capital and the amount of capital raised.
Stephen TaubJuly 6, 2004

In 2003, the private equity market posted its first gains after three straight years of negative returns, according to a report by Mercer Investment Consulting.

“Confidence returned as investors witnessed stronger deal pipelines, rising valuations, and an increase in IPO activity stemming from the strengthening economy and rising stock market,” Mercer pointed out. The consultancy also stressed, however, that current investors appear to be cautiously optimistic and are returning to more realistic valuation and performance expectations.

Mercer noted that the last few years have seen a sharp decline in both the number of partnerships raising capital and the amount of capital raised.

Fundraising peaked in 2000, when 629 venture funds raised more than $105 billion, a total that shriveled to just $9.1 billion two years later. Also in 2000, 158 corporate finance funds raised more than $76 billion, a figure that dropped by two-thirds by 2002.

In 2003, less than 25 percent of the partners that had been active during the 2000 peak were still involved. “Fewer funds and smaller fund sizes have become the norm,” Mercer pointed out. It added, however, that fundraising has begun to recover due to growing investor optimism and more exit opportunities in light of the improving stock market.

In terms of performance, later-stage venture capital and private equity fared the best in 2003 among seven categories tracked by Mercer, rising by 25.4 percent and 24.1 percent respectively. Early-seed venture capital was the only category to fall, dropping 7 percent.

Over the most recent three-year period, the only type of financing to post a gain was mezzanine capital — short-term, high-risk, and high-yield capital, usually taking the form of subordinated debt, convertible debt, or debt with warrants. Mezzanine capital is appealing, observed Mercer, because of its unique risk/return characteristics: it carries slightly higher risk than high-yield fixed income but has the potential for equity-like returns.

Meanwhile, according to The Scotsman, a Scotland-based newspaper, worldwide investment in private equity increased 16 percent in 2003.

Indeed, last week, private equity giant Bain Capital closed its eighth buyout fund at $3.5 billion, more than the $3 billion it was looking to raise, according to published reports crediting Bain also raised $750 million for a co-investment fund, according to the report.

Also last week, private equity firm Kohlberg Kravis Roberts bought German car-part retailer Auto-Teile-Unger for $1.75 billion.

KKR bought the stake from British private equity firm Doughty Hanson, which owned 72 percent of the company. The British firm had hoped to sell the stake in an initial public offering on June 16 but scrapped those plans due to lack of investor interest. Doughty reported a return of 3.5 times its cash investment.