Determining the Effect of Fewer Private Equity Funds
Last week, I attended a presentation by Philip Canfield of GTCR, a Chicago-based private equity firm that has invested more than $8.5 billion in 200 companies since its founding in 1980. Canfield covered several themes about which I’ve written in the past. These included the staggering amount of cash being held by private equity funds and publicly traded non-bank companies. These groups currently hold $400 billion and $1 trillion, respectively. All of this cash seeking investments has brought business valuations higher.
Another trend discussed has important implications for any door or window company that might raise equity capital from or sell their company to a private equity fund. Data compiled by Steven Kaplan of the University of Chicago shows that, in 1990, there were less than 200 U.S. private equity funds that raised a few billion dollars that year in total. By 2000, the number of funds had only increased to 250 funds that raised a total of $50 billion. By 2006, however, the number of funds had more than doubled to roughly 550 funds. Total funds raised quadrupled to more than $200 billion. Thus, the period from 2000 to 2006 represented well above average levels of fund raising by an above average number of funds. Whenever a variable behaves in a way that is radically unlike the long-term average, the odds are that future measurements of that variable will be closer to the average. In statistics, this is known as reversion to the mean.
In the case of private equity fund-raising, reversion to the mean would indicate that there would be fewer funds in existence raising less money. In fact, if the amount of funds raised returns to the long-term average, that could force the number of funds to drop. If a private equity fund doesn’t succeed in raising the money for its next fund, it sells off its existing investments and quietly ceases to exist. Thus, the invisible hand of the market will ensure that the funds that add the most value to their investments and that earn the highest returns will be able to raise their next round of capital. For any door or window manufacturer considering accessing capital, this means that the funds in existence two to five years from now will be a strong group of financial partners that have survived the winnowing out process, are capable of adding value and earn strong returns on their investments. Thus, seemingly bad news is really good news for industry participants.