The 2016 Global Outlook & Review

The 2016

Global Outlook & Review

Dow Jones Private Equity Analyst ? Dow Jones Private Equity News

The 2016 3

Global Outlook & Review

To the Reader

From the Desk of LAURA KREUTZER

In late 2006, when we published the first edition of what has become our annual outlook supplement, the private equity industry was deep in the biggest buyout boom in its history. With the publication of the 10th edition of this supplement, some aspects of the market bear an eerie resemblance to those days. Debt is cheap. Deals are not. Firms that can point to a solid track record have been able to raise funds with relative ease. Those in the midmarket, in particular, can often raise amounts that are considerably larger than their prior offerings. But many limited partners remember all too well the carnage that followed the excesses of the 2006 and 2007 boom years. No doubt, memories of the difficult period that followed the boom contributed to the faint current of caution that appears to have crept back into limited partner mindsets as 2015 drew to a close. Whether LP concern will translate into a slower fundraising year in 2016 remains to be seen. Over the years, this supplement often has tried to tap into our inner psychics to pinpoint future trends. We weren't always right in our predictions for the year to come. Back in 2006, for example, several members of our editorial team predicted private equity fundraising would level off or even slow down in subsequent years so general partners could digest all of the money they raised in 2006. Boy, did we get that one wrong! However, more recently, we have gotten a few things right. Last year, we foresaw the increased appetite among LPs for firsttime funds and spinouts and also pointed to a movement toward larger funds and faster fundraising periods in the middle market as well as the growing influence of co-investment capital on market dynamics. All of these trends intensified in 2015. As we look ahead to 2016, we foresee a continued appetite for new funds but also a growing number of LPs adopting more defensive strategies with their commitments. Although small and midmarket funds remain the darlings of the LP community, 2016 may be the year things finally begin to look up for distressed debt and special situation funds as more LPs seek to hedge their bets against a frothy deal environment. As we head into a new year, we believe the air will eventually start to come out of the high pricing that has developed in the past 18 to 24 months. Whether or not we are right in the timing of our predictions will have to wait until next year's supplement.

contents

Fundraising

u Investors Prep for Active 2016, but Many Plan to Proceed Cautiously....................................... 4

Secondary

u Uncertainty Could Complicate Secondary Deals in 2016.................................................................12

Venture Capital u Herd of Venture-Backed Startups With Billion-Dollar Valuations Could Thin in 2016........14

Rising Stars

u Select 2015 profiles excerpted from Private Equity Analyst............................................................18

Timeline

u 2015: The Year in Private Equity.......................................................................................................................... 20

Copyright ? 2015 Dow Jones & Company,Inc.All rights reserved. u The 2016 Global Outlook & Review was published in January 2016. u Dow Jones & Company is a News Corporation Company.Copying and redistributing prohibited without permission of the publisher. This publication is designed to provide factual information with respect to the subject matter covered but its accuracy cannot be guaranteed. Dow Jones is not a registered investment adviser, and under no circumstances shall any of the information provided herein be construed as a buy or sell recommendation or investment advice of any kind.

Photo Credits u cover: Pavelk/; p3, 8: MyImages - Micha/ (pig); p3, 12: alphaspirit/ (roads); p3, 14: Eric Isselee/ (herd); p3, 18: Krabikus/ (red carpet); p3, 20: eskay/ (trophy); p4: ?OJO_Images; p20: ?RoosterHD (SEC), Nils Versemann/ (GE), Justin Sullivan/Getty Images (Ellen Pao), Africa Studio/ (money pots), Manfred Steinbach/ (autobahn); p22: ?ssiltane (Tokyo), file404/ (money transfer), MR. INTERIOR/ (Dell), ArtisticPhoto/ (Chinese flag), Feoktistoff/ (capitol building), littleny/ (Bumble Bee Seafoods)

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4 The 2016

Global Outlook & Review

Investors Prep for Active 2016, but Many Plan to Proceed Cautiously

By LAURA KREUTZER and JENNIFER BOLLEN

Private equity's fundraising engine chugged at full throttle in 2014 and remained steady in 2015, fueled largely by a healthy supply of cash flowing back into investor portfolios. As 2016 unfolds, investors expect that engine will continue to run for both small and large funds, thanks partly to the volume of capital seeking higher returns. However, underneath the fundraising furor, more investors have begun to question how much longer the good times can last.

last year if not their hard caps, often with more investor demand than they could accommodate. At the same time, firms are returning to market with new funds sooner than expected, often seeking larger amounts of capital, a trend that is particularly pronounced among small and midmarket firms. All of this activity has stoked fears recent vintage year vehicles will produce disappointing returns. A slowdown in the volume of initial public offerings in recent months, along with signs of a more challenging leveraged loan market and an economic slowdown in many emerging market economies has injected a degree of uncertainty into investor mindsets that was not as prevalent at the end of 2014.

"It's been a really healthy and active fundraising environment for a number of years now, and the music is going to stop eventually," said Kevin Campbell, managing director and portfolio manager at DuPont Capital Management. "But the big question is how long can it keep going, and how does the industry absorb the capital?" Limited partners, placement agents and fund formation attorneys said they expect U.S. private equity fundraising to remain busy in 2016, with many of the same trends that emerged in 2015 continuing into the year ahead. Firms that generated strong returns in prior funds quickly hit their targets

"There is big divergence between private multiples and where people think the value ought to be for deals," said David Fann, president and chief executive at TorreyCove Capital Partners. "Really good companies are trading at 13-times cash flow in the buyout space, and historically, nobody made a reasonable rate of return on private equity when multiples were more than 10 times. People are pricing these deals for perfect execution." Some investors also question whether all of the money limited partners have recycled back into the asset class will put some at risk of hitting or exceeding their allocations, should the public markets experience another dramatic downturn.

The 2016 5

Global Outlook & Review

A Small and Midmarket Cornucopia

LPs have plenty of funds to choose from in the coming year, particularly in the small and midmarket segments. U.S. midmarket buyout shops that returned to the fundraising trail in late 2015 or that expect to return in 2016 include Arsenal Capital Partners, Avista Capital Partners, Berkshire Partners, Thoma Bravo, Kohlberg & Co., Leonard Green & Partners and Vista Capital Partners. A survey of 104 investors conducted by placement agent Probitas Partners found U.S. midmarket buyout funds, defined as funds ranging from $500 million to $2.5 billion in size, ranked as the most popular strategy among LPs in 2016, followed closely by U.S. small buyout funds, defined as less than $500 million. Strong investor demand has allowed certain midmarket firms to raise much larger pools than they did last time around, a trend LPs predict will continue into 2016. Audax Group, Genstar Capital and American Industrial Partners all raised funds in 2015 that were significantly larger than their prior offerings. Although investors say some firms can successfully manage a fund-size increase, particularly if it is accompanied by a matching increase in investment staff, others contend LPs need to tread carefully. Dan Cahill, a managing partner at midmarket-focused fund-of-funds manager Constitution Capital Partners, said his firm declined to re-up with at least one manager in its portfolio due to concerns over fund-size inflation. "Some groups will get out there and their overall numbers look strong, but they have a lot of volatility in the portfolio," said Mr. Cahill. "A lot of groups look good until you drill down into the portfolio." As some midmarket firms raise larger amounts for their core strategies, others are launching funds to target smaller deals, following in the footsteps of groups such as Vista Equity Partners and Riverside Co. Thoma Bravo, TSG Consumer Partners and Alvarez & Marsal have all pitched new funds in the past year that target investments that are smaller than those they back through their flagship funds. "It's an opportunity for GPs to leverage the halo that they already have in certain sectors or [strategies]," said Eric Zoller, co-founder and partner at placement agent Sixpoint Partners. Investors also say they expect more firms to return to market earlier than anticipated, even before they have reached the threshold at which they would be allowed to start raising a new fund, typically when they've invested two-thirds to threequarters of the prior fund's capital. In such cases, the firms typically don't start charging management fees on the new fund until they make the first investment. "The really good GPs have a well-refined nose for sniffing out money and raising it when they can," said Mr. Fann of TorreyCove, "It's like a sixth sense they've developed."

A Look Back

10 Years of Memorable Outlook Quotes

2007 "Nobody is making any more predictions and there is no

outlook at this point. Last year, they kept saying it would be the end of this year...but larger deals keep getting done...There is no letting up." ?Robert Polenberg, a director with S&P Capital IQ's Leveraged Commentary and Data, speaking about the potential for a credit market downturn

2007 "Management teams are refusing to take that much leverage.

They are telling us, `I don't feel like running a company if you're not going to do something to lower that leverage.'" ?Joe Nolan, a principal at what was then GTCR Golder Rauner (now GTCR), speaking about portfolio company resistance to the high debt loads buyout firms wanted to place upon them

2007 "I don't expect anything to come out of this investigation,

but I do foresee PE funds putting in place safeguards and guidelines for how they invest with other PE firms." ?Marco Masotti, a partner with Paul Weiss Rifkind Wharton & Garrison LLP, on the Department of Justice investigation into possible anticompetitive practices associated with club deals

2008 "The biggest opportunity [in 2008] is to take advantage of

the carnage: Take advantage of pendulum swings and people's emotions." ?Mark St. John, CVC Capital Partners

2008 "Every time you heard a whiff of a problem, it used to be that

you had to stay out of emerging markets. Now that things in the U.S. have gone south, people say: `At least I have emerging markets.'" ?Jennifer Choi, then research director for the Emerging Markets Private Equity Association, on the relative attractiveness of emerging markets private equity to investors

2008 "It's very hard to buy today knowing that it may be cheaper

tomorrow. As a result, everyone waits, prices drop and you create a vicious cycle." ?Steve Smith, then head of Americas financial sponsor coverage at UBS AG, on the potential exit environment in 2008

2009 "We're in the baby pool right now. For a $100 million credit

facility, you can still get a club [of banks] together. But if you get much bigger than that, it's a lot more difficult." ?John Neuner, a managing director at midmarket investment bank Harris Williams & Co., on the difficulty in securing deal financing

2009 "It will take some time for the fear and paralysis to dissipate.

Hopefully, it's a matter of months and not quarters, but it's not a matter of days." ?Daniel S. Evans, a partner with law firm Ropes & Gray LLP, on prospects for the deal environment

2010 "There is a pulse back. We do see a lot of signs of life,

though the recovery is by no means robust." ?Herald Ritch, then chief executive of advisory firm Sagent Advisors LLC, on the resumption of deal activity

see more memorable quotes on p. 11 >

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