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Focus on private equity fundraising: past, present and future

Depending on where you look, 2004 marked a big improvement in fundraising or yet another disappointment. Chris Davison, Associate Director at Almeida Capital, on how Almeida saw the events in the private equity market in 2004 and why 2005 will be a year of further improvement.

When dealing with figures, certainty is usually related to the visible and historical rather than the murky business of making forecasts. You can generally find more agreement, for example, about levels of activity last year than what the next 12 months are going to produce. Curiously, however, the opposite appears to be the case when discussing private equity fundraising.

There is a firm consensus across the industry that fundraising in 2005 will mark a massive improvement on the last few years but there appear to be big differences of opinion about what those last few years actually looked like. Some information sources have suggested that 2004 marked the low point of the present cycle, falling steeply from 2003 levels. Others, such as Almeida Capital research, show a clear improvement last year on the one before.

The answer to this apparent contradiction lies partly in the inherent problems of generating reliable statistics about private equity. (In that sense, fundraising is no different from investment activity, returns data, or any other of the statistical furniture.) A lot of what happens is not accurately recorded. But there is also some explanation in the contrasting methodologies being used by the different information sources. There are no real rights or wrongs here. Most of the data is competently put together. But it is important to be aware of those differences. Once digested, it's up to you to decide which story you think fits most neatly with your experience.

There are essentially two different ways of measuring annual private equity fundraising. The first is to record the amount of capital committed to funds across the region during the course of the year, independent of any formal closing event that may have been held by funds. In other words, it attempts to add up all the cheques written by investors with the right date stamp. The ambition is laudable; the theory would produce the most accurate measure of capital raised in a given year.

The difficulty, however, lies in getting the information because it relies on surveying the funds themselves or hoping for voluntary submissions. And surveys in this asset class are becoming suffocating and ever less productive. Everyone is at it; data providers, industry associations, service providers, and wannabe thought leaders of every hue. Try all the compulsion you like, arm-twisting or carrot-dangling, but completeness is fantasy. And without completeness, there is significant risk of double-counting over successive years, underestimating signs of an upturn, or allowing historical assumptions to distort activity as patterns of behaviour change.

The second way of measuring fundraising - to count the value of final closes during the calendar year in question - is simpler in execution but not without its own anomalies. The main problem is the extent to which extended fundraisings, those that last for more than 12 months, are treated as purely a phenomenon of a given year. So if someone spends three years on the road, that activity is measured purely as something that happened in the year in which the final close was held. This issue is then compounded by the fact that circumstantial timing issues can impact the total for a given year in a way that might potentially be misleading.

If, for example, a big fund holds a final closing in January then its statistical contribution is to the most recent year instead of the year that accounted for most of the fundraising sweat and tears. The benefits of this method, however, reside in its simplicity - normally the case in matters of statistical methodology. All the constituents are transparent - the closings themselves can be disaggregated so there is no confusion among consumers of the data about assumptions that have been made in putting together the numbers. There are no assumptions. This is the method that Almeida Capital research employs to track fundraising.

So what has happened over the last few years? Well, the Almeida version of events has 2004 fundraising in Europe recovering to €25.4bn from a low for the cycle of €17.6bn in 2003. And this is the version of events that seems best to chime with the mood of the market and, indeed, the external variables that inform fundraising. It was, after all, 2003 that suffered the early-year financial paralysis of the second Gulf War and the brooding concerns about the residual imbalances of the global macroeconomy.

By contrast, 2004 felt the warmth of an enduring recovery in public markets and, perhaps more importantly, a jump in distributions from fund managers to their limited partners. A recovery in confidence and liquidity can only be expected to translate into an improvement in fundraising. The experience of Almeida's placement activity simply reinforced these broader currents. In other words, this doesn't feel like the cardinal historiographical sin of making the facts fit the story. It feels like what happened.

And there are other indicators that appear to corroborate the story. For example, more than 50 per cent of the year's final closes were reached in less than 12 months, compared with just a third in 2003. Equally, the mean length of time taken to reach a final close in 2004 was 15 months, compared with 16 months in 2003. This might suggest a relatively modest change in market conditions over the course of the year but the distribution of fundraising performance within 2004 was much broader. There was a more dichotomised overall experience with a significant proportion of funds doing a lot better but a number still finding life very difficult. So it goes at the turning point in the fundraising cycle.

So what of the future? Forecasts are in some respects much easier methodologically because there is less data to work with, just a set of assumptions. Almeida Capital research expects 2005 fundraising to be around €42bn, based on a model that incorporates both LP demand and the supply of product in the market. That would mark an increase of 67 per cent on 2004 and be the second highest figure ever after the €48bn raised in 2000.

To shed a little more light on the workings behind this forecast, around €30bn will be accounted for by funds that are already in the market and at an advanced state of fundraising - the longwindedness of private equity fundraising provides helpful visibility for forecasters. The remaining €12bn will be accounted for by funds that are expected to begin marketing in sufficient time to be able to hold a final close before the end of this year.

Obviously, it helps that large funds, which make the biggest impact on the total, are easy to spot in the market and can be expected to benefit most from the strength of global institutional demand for European buy-out funds. So have other forecasters employed the same methodology in producing their prognostications? You'll have to ask them. But the result, regardless of their answer, is an unlikely consensus of collective confidence about the short-term outlook for 2005. (There is a loss of nerve when it comes to 2006.) And that, in turn, must say something about the stage in the cycle. The upturn may have started in 2004 or it might only just be underway, but no one doubts it is happening.

The Almeida Capital research report this article is based on is currently available to private equity professionals to download free. Click here to get the research.