Private Equity Growth Funds: A Shrinking Market?
Ahead of SuperInvestor, Mark O'Hare, Founder of Preqin and a key speaker at the event, shares his thoughts on the private equity market with a focus on the changing trends on growth funds.
The private equity market is hitting historic highs in 2017. As of the end of October, 738 funds have closed in the year, raising a total of $367bn. This is close to the $396bn that was raised by 1,133 funds in all of 2016, and is on course to potentially surpass 2007’s all-time fundraising record of $415bn, secured by 1,041 funds.
The majority of this boom has been seen by buyout and venture capital funds, with both fund types seeing high annual fundraising and record average fund sizes. Growth funds, by contrast, have not seen the same success, and are increasingly being overshadowed by other private equity fund types. In particular, as late-stage venture capital funds have become larger, and sought consummately larger deals, growth funds have struggled to differentiate themselves from these vehicles, while simultaneously competing with small-cap buyout funds targeting similar deal opportunities.
The number of private equity funds of all types closed rose year-on-year to 2008, before falling sharply in 2009 in the wake of the Global Financial Crisis (GFC). Buyout and venture capital funds showed a similar trend in the number of fund closures in subsequent years: the total number of closures rebounded gradually in the years 2010-2012, before entering a period of very robust activity in 2014-2016, approaching or surpassing pre-Crisis levels. Growth funds have seen a markedly different pattern in fundraising activity, though. The number of growth funds closed annually rebounded much faster than for other fund types, reaching a new all-time record in 2011 and equalling that total in 2013. Since then, though, growth fund closures have become fewer, even as the industry as a whole has entered a period of extremely high activity.
This divergent pattern extends to the capital raised by private equity growth funds in the past decade as well. Although the capital raised annually by buyout funds is largely uncorrelated, up until around 2013 venture capital and growth funds saw very similar trends in annual capital totals. Both fund types saw record highs in 2008 before the GFC, and both fund types rebounded to meet or surpass those records in 2011. However, since 2014, the venture capital industry has seen three successive record fundraising years, with 2017 potentially setting a fourth. The capital raised by growth funds, however, has declined year-on-year, with the first 10 months of 2017 recording just $25bn of investor capital secured.
Growth fund sizes have remained larger and more consistent than venture capital funds, despite a recent proliferation of extremely large vehicles of the latter type.
The reduced fundraising totals reflect that the growth sector has not kept pace with the overall expansion of the private equity industry. However, the size of growth funds that have closed has remained robust, suggesting that those fund managers which secure capital from investors do so successfully. In fact, the average size of growth funds closed remained relatively constant from 2007 through the GFC and until 2011. After declining slightly in 2012-13, the average growth fund size reached successive records in 2014 and 2015, and has stayed high since then. Notably, growth fund sizes have remained larger and more consistent than venture capital funds, despite a recent proliferation of extremely large vehicles of the latter type.
Most encouragingly for growth fund managers, there has been a significant upswing in investor sentiment regarding the fund type. In midyear surveys conducted by Preqin in 2013-15, fewer than one in 10 investors said that they felt growth funds offered the best opportunities at present, trailing venture capital, small/mid-market buyouts and large/mega buyouts by significant margins. However, in June 2016, 21% of investors said they thought growth funds offered the best opportunities, and this grew further to 30% in 2017. This puts growth funds on par with venture capital and ahead of large buyout funds, suggesting that investors are cognizant of the opportunities growth funds can provide.
The private equity growth sector, then, can perhaps best be described as an industry in transition. Facing mounting competition from both late-stage venture capital and small buyout funds, the sector has had to clearly distinguish itself to investors in order to attract capital. However, institutions seem to have taken note, and sentiment for growth funds is stronger than ever. If they can capitalise on investor enthusiasm, we may well see the growth sector flourish in the next few years.
