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What Sets Today’s Buyout Market Apart From the Pre-Crisis Boom Era

The private equity industry's measured pace of deal making may help protect the internal rates of return for funds raised after the 2008 financial crisis.

  • By Alicia McElhaney

The private equity market looks increasingly similar to the later stages of the buyout boom that ended in 2007, but there are a couple differences that may help the industry survive a downturn.

While the large amount of dry powder, high asset valuations and the use of leverage in buyout deals look a lot like 2006-2007, private equity firms have been doing smaller deals at a slower pace, according to Scott Reed, co-head of U.S. private equity at Aberdeen Asset Management.

A bust the magnitude of the one that occurred after the boom era may be avoided as firms aren't rushing to deploy the massive un-invested capital that's been building in the private equity industry, according to McKinsey & Co. partner Bryce Klempner. A record year of fundraising in 2017 pushed dry powder, or committed capital that has yet to be invested, to more than $1 trillion for the first time ever, but deal making has slowed, according to data firm Preqin.

“Back in 2006 and 2007, managers were coming back to market very quickly and deploying as much capital as they could,” Reed said in a phone interview. “While the pace of deal activity isn’t quite as frothy as it was today as it was back then, the pace of capital raising is as frothy.”

The buyout boom ended badly for many private equity firms because they had paid high multiples of earnings for their deals and "deployed large percentages of the funds at the top of the market,” Klempner said by phone.

Maximum net internal rates of return dropped to 53.7 percent for funds raised in 2007, from 105.5 percent for vintage 2005 pools,  Preqin data show. During that same period, minimum net internal rates of returns fell into negative territory, with losses of 66.7 percent for funds raised in 2007 and 38.2 percent losses for the vintage 2005 crop.

Private equity firms were investing capital at a much faster clip in 2005-2007 than they had been previously, leading to "vintage concentration,” Klempner said. “Instead of funds being deployed by historical standards, in equal tranches between four and five years, the industry had a bunch of capital deployed in a short amount of time.”

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Total deal buyout deal value dropped in 2016 after generally rising in the economic recovery from the 2008 financial crisis, according to Preqin. Last year, $347 billion of deals were completed, down 19 percent from $427 billion in 2015, and only half the $696 billion peak in 2007. Meanwhile, the number of buyout deals has risen slowly over the past five years, to 4,191 last year from 3,848 in 2012, Preqin data show.

Private equity firms are now focused on smaller deals, rather than the large, leveraged buyouts of major public companies in 2006-2007, Reed said. 

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