CALLAN INSTITUTE Private Markets Trends

IN THIS ISSUE Winter 2017 pg. 1 Private Markets in 2016 pg. 2 Fundraising pg. 3 Buyouts pg. 4 Venture Capital pg. 5 Returns

Year in Review: Private Equity Activity Trends Downward in 2016

Gary Robertson

In 2016, U.S. equity assets appreciated for the eighth con­ In the private equity market, company investments and exits secutive year. A Fed rate hike preceded a steep drop in trended downward during the year for both buyouts and ven­ January, but the rally that resumed after continued through the ture capital; however, the absolute level of activity continued to Brexit vote and accelerated after November’s U.S. presiden­ be high (except for IPOs). The one upward anomaly was the tial election. Most other countries experienced improved equity announced dollar volume for buyouts: It reached an eight-year market results during the year as well. high in 2016, although the number of transactions fell.

U.S. economic growth continued and the unemployment rate As measured by the Thomson Reuters/Cambridge Private improved to a nine-year low of 4.7%. Among the other high­ Equity Database, private equity returns strengthened over the lights for 2016: year (+0.81%, +2.12%, and +3.80% for the first three quar­ • The S&P 500 Index posted a strong 11.96% gain (following ters). The fourth-quarter return is expected to be in the +2% 2015’s 1.38% and 2014’s 13.69%); – 3% range, given the S&P 500’s 3.82% fourth quarter rise. • Annualized U.S. GDP figures fluctuated within a range of 0.8% in the first quarter to 3.5% in the third quarter. For the Looking Ahead year, GDP growth was 1.6%, compared to 2.4% in 2015; With continued strong fundraising, a high-price environment for • Non-U.S. and emerging market equities improved companies, and fundraising outpacing investment rates, 2017 from 2015 (MSCI ACWI ex USA Index: +4.50%; MSCI faces the same challenges as the prior three years. Since the Emerging Markets Index: +11.19%); presidential election, markets have anticipated business- and • U.S. fixed income, as measured by the Bloomberg Bar­ investment-friendly legislative and tax changes as well as fis­ clays U.S. Aggregate Index, posted a positive return of cal stimulus. We expect the rally and hopeful outlook will foster 2.65% for the year. continued liquidity in the private equity market, and that distri­ butions will benefit investors as company pricing remains in

Knowledge. Experience. Integrity. Exhibit 1: Funds Closed January 1 through December 31, 2016

50.4% 14.1% Amount Strategy No. Funds ($mm)* 59.1% Venture Capital 439 44,030 Buyouts 298 184,538 Subordinated Debt 25 22,481 34.2% Distressed Debt 36 29,093

7.2% Secondary and Other 24 19,786 2.9% 9.3% Fund-of-funds 50 12,229 4.1% 2.8% 6.3% 5.7% 3.9% Totals 872 312,156 Funds* Amount*

* Numbers may not sum to total due to rounding. Source: Private Equity Analyst

sellers’ market territory. Debt remains inexpensive and avail­ Analyst. The year broke the watershed $300 billion mark able, so on the investment front, larger deals are being made for the first time since 2008, which saw $350 billion raised even though the number of transactions has moderated. We (Exhibit 2). expect that strong liquidity will also continue to drive a frothy fundraising environment. Plan sponsor support of the private In the fourth quarter, commitments totaled $118.1 billion, and equity strategy—notwithstanding high-price-related general 256 funds were created. The amount raised more than doubled market concerns—continues to be strong. the third quarter’s $38.6 billion, and the number of new funds jumped by 79% from the prior quarter’s 143. Private Equity Fundraising U.S. private equity funds raised $312 bil­lion in the U.S. in 2016 By strategy, the largest change in 2016 was an 8 percentage (Exhibit 1), a moderate 6% increase over 2015’s $296 billion. point drop in Buyouts’ share of capital allocations compared During 2016, 872 partnerships were formed, up by 77 (10%) to 2015; Distressed Debt fell by 1 percentage point. The de­ over the previous year’s 795, according to Private Equity creases were offset by increases of 4 percentage points in

Exhibit 2: U.S. Fundraising Back to a Peak ($ billions)

$373.4 $350.0 Venture Capital $314.6 $312.1 $295.7 $283.4 Buyouts/Distressed Debt $246.1 Subordinated Debt $200.3 Secondary and Other $147.9 $124.0 $114.6 Fund-of-Funds

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Source: Private Equity Analyst

2 Secondary and Other, 3 percentage points in Subordi­nated Buyouts Debt, and 2 percentage points in Venture Capital. Fund-of- Buyout fundraising (including distressed) totaled $214 billion Funds remained unchanged (Exhibit 3). for the year, with 334 funds formed, according to Private Equity Analyst. This represents a 6% decrease in commitment volume The largest private equity funds that closed during the year and 3% decline in funds formed from the $227 billion raised were Advent Global Private Equity VIII with $13 billion, TPG and 345 funds formed in 2015. In 2016, 15 partnerships raised Partners VII with $10.5 billion, and Green Equity Investors VII more than $2 billion during the year, down from 17 partnerships with $9.6 billion, according to Private Equity Analyst. in 2015. The 15 funds accounted for 35% of the total buyout commitments made during the year, although they only repre­ European fundraising jumped to $131 billion in 2016 after two sent 4.2% of new partnerships formed. years of declines. The increase was a meaningful $34 billion (35%) increase over 2015’s $97 billion. During 2016, 283 part­ Buyout firms purchased 1,728 companies in 2016, down 14% nerships were formed, up by 37 (15%) over the previous year, from 2,006 in 2015, according to Buyouts newsletter. The year’s according to Private Equity Analyst. announced dollar volume was $163.2 billion (a nine-year high), and was up 39% from $117.5 billion in 2015. The fourth quar­ The largest European fund that closed in 2016 was Apax ter saw 322 transactions, down from 385 in the third quarter, Europe VII with $9 billion. Cinven Fund VII was second with and disclosed­ dollar volume totaled $28.3 billion, down from $7.5 billion. $39.0 billion. According to S&P Capital IQ, in the second half of the year average pur­chase price multiples remained in the Fundraising is approaching the records seen during the lever­ neighborhood of 10x earnings before interest, taxes, deprecia­ age bubble. Large funds are being raised in very compressed tion, and amortization (EBITDA) for a second year. Aver­age time periods, making due diligence challenging for limited part­ leverage multiples of about 5.5x EBITDA are adhering to the ners. Terms for very popular general partners are (in some in­ 6x EBITDA cap imposed on banks by regulators. Of course, stances) eroding at the margin for investors. Distributions con­ averages can mask wide variability in specifics. tinue at high levels. With the resumed stock market rally and banished volatility lifting plan sponsor total fund values, we ex­ The largest transaction closed by a buy­out fund during 2016 pect fundraising to continue near peak levels. was the first quarter’s $14.2 billion take-private of beverage

Exhibit 3: The shifts from 2015 to 2016

50.3% 41.5% 14.1% 12.2% Venture Capital

59.1% 66.7% Buyouts

Subordinated Debt

37.9% Distressed Debt 34.2% Secondary and Other

7.2% Fund-of-Funds 4.0% 4.6% 2.9% 9.3% 4.1% 5.5% 10.1% 2.8% 2.8% 6.3% 2.6% 5.7% 8.3% 3.9% 3.9% 2016 2015 2016 2015 Total Count: Total Count: Total Value: Total Value: 872 795 $312.2bn $295.7bn

Source: Private Equity Analyst

Knowledge. Experience. Integrity. 3 company Keurig Green Mountain by BDT Capital Partners, quarter, there were 105 M&A exits, and announced values to­ JAB Forest, and Acorn Holdings, according to Buyouts. The taled $18.1 bil­lion, down from 142 exits totaling $27.5 billion in Keurig buyout was significantly larger than 2015’s largest, the the third quarter. The largest fourth quarter exit was the $2.6 $9.2 billion take-private of grocery store chain Safeway by billion sale of insurance broker Acrisure to a management-led Cerberus and two real estate funds. The second largest buy­ investor group. out in 2016 was the $10.3 billion­ take-private of antivirus soft­ ware company Qihoo 360 Technology in the third quarter, with The full year produced eight IPOs raising a total of $4 billion— Sequoia Capital leading a consortium of Chinese sovereign a huge drop compared to the 31 IPOs that raised $9 billion wealth and investment firms. The largest fourth quarter buy­ in 2015, and significantly less than the ebullient 50 IPOs and out was Riverstone’s $4.3 billion take-private of independent $42 billion in 2014. Due to significant volatility around year-end power producer Talen Energy. 2015 there were no buyout-backed IPOs in the first quarter of 2016, but the market has rebounded since then. The largest Similar to the previous year, general partners appeared to be IPO in 2016 was the $1.2 billion offering in the fourth quarter trying to exercise price discipline in 2016 compared to the pre- by insurance annuity contract provider Athene Holding backed financial crisis period, where aggressive buying resulted in by Apollo Global Management. The second largest occurred in announced values of $316 billion in 2006 and $597 billion in the second quarter and was the $1.1 billion Nasdaq listing of 2007. Although the investment pace into companies has not distributor U.S. Foods Holding by CDR and KKR. There were kept up with new limited partner commitments to funds, and three buyout-backed IPOs in the fourth quarter, with a total much is being written about a growing commitment over-hang value of $2 billion—up significantly from the third quarter’s in the market, Callan is still seeing client portfolios deployed $550 million. within their investment periods. Venture Capital By transaction type, “add-on” investments crept up to almost Venture capital fund commitments in 2016 were up $8 billion 60% of transactions completed. In today’s high-price environ­ (2%) from 2015’s total, with 109 (33%) more venture funds ment, general partners appear to be seeking smaller deals formed. According to Private Equity Analyst, the $2.5 billion TCV with lower prices to average down the total cost of investments IX late-stage fund was the largest venture fund that closed dur­ and achieve savings through consolidation. By industry sector, ing the year. Accel Growth Fund IV and Andreessen Horowitz High Technology led the deal count in the fourth quarter with 49 Fund V were in second place, with both totaling $1.5 billion. invest­ments, followed by Industrials (46) and Health Care (44). Those three sectors combined account for 43% of total buyout Smaller early-stage funds represented the greatest number of transactions closed during the quarter. new funds formed (317), securing $17 billion in commitments. Ninety multi-stage funds raised the most capital by strategy, Buyouts reports that 2016’s 505 private M&A exits of buyout- totaling $18 billion. backed companies was down 11% from the 567 in 2015. The year’s aggregate disclosed M&A exit value of $85.7 billion was The year produced 8,136 rounds of new investment in venture down 35% from 2015’s $131.4 billion. The largest M&A exit of capital companies, down 22% from 2015’s 10,468, according the year occurred in the third quarter with the $4.7 billion sale of to the National Venture Capital Association (NVCA). The an­ security software company Blue Coat Systems by Bain Capital nounced volume of $69.1 billion for the year was down 13% to Symantec. The second largest was the $3.7 billion sale of from $79.3 billion in 2015. Fourth quarter VC investments totaled laundry detergent and household products manufacturer Sun 1,744 rounds and $12.7 billion of announced financing, down Products by Vestar to Henkel Consumer Goods. In the fourth from 1,979 rounds and $15.7 billion in the previous quarter.

4 According to the NVCA, the largest funding in the fourth quarter The largest fourth quarter M&A exit with a disclosed value was of 2016 was a $210 million round in online home sales market­ the $1 billion sale of Alzheimer’s treatment bio-sciences com­ place Opendoor. The consortium included Khosla Ventures, pany Chase Pharmaceuticals to Allergan. Chase was found­ Felicis Ventures, SVB Capital, and others. The second largest ed by Cipla Ventures and backed by Edmond de Rothschild round in the fourth quarter was a $180 million late-stage round Investment Partners and others. The second largest exit was in online cross-border payments company Payoneer. The con­ the $800 million sale of Krux Digital, a data collection and sortium included TCV and Susquehanna Ventures. analysis platform for targeted online advertising, to Salesforce. Krux was funded by Accel and IDG Ventures. Exhibit 4 shows the financing totals for the year by indus­ try. Overall, Information Technology-related sectors re­ceived The year produced 39 venture-backed IPOs raising $2.9 bil­ 51% of the year’s new capital, Health Care 22%, Busi­ness/ lion, down from the 77 IPOs in 2015 that raised $8.1 billion. The Industrial 9%, and Consumer/Retail 3%. The software sub- fourth quarter produced seven venture-backed IPO exits rais­ sector re­ceived the largest dollar funding during the year with ing a total of $684 million. The largest fourth quarter IPO was $33 billion invested in 3,100 rounds of financing. $133 million raised by cloud-based corporate expense man­ agement company Coupa Software, backed by a large syndi­ cate including Battery, Crosslink, Eldorado, Mohr Davidow, and Exhibit 4: Tech Dominates VC Financing T. Rowe Price. The second largest was the $117 million float by

51% Technology AquaVenture Holdings, a water desalination and commercial 40% 3,284 rounds $35.5bn filtration company, backed by DFJ Element, Advent-Morrow, Health Care 1,504 rounds $15.0bn TPG Growth, and others. Business/Industrial 18% 1,024 rounds $6.2bn 22% Consumer/Retail Private Equity Returns 13% 306 rounds $2.1bn The Thomson Reuters/Cambridge Private Equity Performance 4% Other 9% 25% 2,018 rounds $10.3bn 3% Data­base has released returns through the third quarter of 2016 15% (Exhibit 5). The All Private Equity database rose 3.8%, tracking

# of Rounds $ Invested but not besting public equity markets; the Russell 3000 Index Total: 8,136 Total: $69.1bn rose 4.4% and the S&P 500 Index gained 3.85%. Private equity

Source: National Venture Capital Association gained 2.1% in the second quarter and 0.8% in the first quarter.

By maturity, combined expansion and late-stage investments Exhibit 5: Private Equity Performance Database garnered 56% of capital investment but only 19% of the rounds (Pooled Horizon IRRs through September 30, 2016) of financ­ing in 2016. Combined early-stage and start-up Strategy 3-Mo 1-Yr 3-Yr 5-Yr 10-Yr 15-Yr 20-Yr companies re­ceived 44% of capital invested through 81% of All Venture 3.3 3.4 17.8 14.8 10.5 6.7 20.9 the rounds. Growth Equity 3.8 8.8 12.0 12.3 11.2 10.9 13.6 All Buyouts 3.9 11.45 12.0 13.7 10.4 13.0 12.6 Mezzanine 2.9 9.12 8.8 10.3 9.4 9.0 9.2 Venture-backed M&A exits for the year totaled 687, down 22% Distressed 4.2 7.7 7.3 11.9 9.4 10.7 10.7 from 884 in 2015, with announced values of $43.9 billion, up All Private Equity 3.8 9.1 12.2 13.4 10.4 11.1 13.2 3.8% from $42.3 billion in 2015. The quarter had 184 exits with S&P 500 3.9 15.4 11.2 16.4 7.2 7.2 7.9 announced values totaling $7.5 billion, compared to 192 and Russell 3000 4.4 15.0 10.4 16.4 7.4 7.6 8.0

$13.4 billion in the third quarter. Sources: Thomson Reuters/Cambridge, Standard & Poor’s, Russell Investments

Knowledge. Experience. Integrity. 5 Since public eq­uity was up about 4% in the fourth quarter, the Private equity returns now outpace public equity across the three- private equity re­turn is expected to be in the range of 3% – 4%, year horizon and all periods longer than five years. A year ago, due to the effect of appraisal-valuation smoothing. private equity had superior performance across all horizons, but the gradually strengthening public equity rally in 2016 has turned For the third quarter, Distressed produced the highest return the tables in some of the more recent horizon periods. (+4.2%), followed by All Buyouts (+3.9%), Growth Equity (+3.8%), All Venture (+3.3%), and Mezzanine (+2.9%). Note: Transaction count and dollar volume figures across all pri- vate equity measures are preliminary figures and are subject to update in subsequent versions of Private Markets Trends and other Callan publications.

Did You Know...

Callan conducts Pacing Studies for clients seeking guidance on achieving and maintaining private equity funding targets. Our projection process considers the current total fund value, the anticipated total fund growth rate, existing private equity net asset value and uncalled capital, and each client’s unique manager structure. The study determines the current year’s commitment target and forecasts future requirements over a 10-year horizon. A disciplined annual pacing projection process is a central part of strategic planning. Pacing studies can also be integrated with an annual portfolio review, and manager evaluations for upcoming reinvestments being considered.

For private markets inquiries, contact your Callan consultant or Gary Robertson at 800-227-3288.

6 Private Markets Trends is published quarterly for professionals of the institutional investment com­ munity. It discusses the market environment, recent events, performance, and other issues involving private equity.

Author – Gary Robertson is the manager of Callan’s Private Equity Research group. Gary is responsible for the firm’s Alternative Investments consulting services.

Editor – Stephen R. Trousdale Designer – Jacki Hoagland

About Callan Callan was founded as an employee-owned investment consulting firm in 1973. Ever since, we have empowered institutional clients with creative, customized investment solutions that are backed by propri­ etary research, exclusive data, and ongoing education. Today, Callan advises on more than $2 trillion in total fund sponsor assets, which makes it among the largest independently owned investment consulting firms in the U.S. Callan uses a client-focused consulting model to serve pension and defined contribution plan sponsors, endowments, foundations, independent investment advisors, investment managers, and other asset owners. Callan has five offices throughout the U.S. For more information, please visit www.callan.com.

About the Callan Institute The Callan Institute, established in 1980, is a source of continuing education for those in the insti­ tutional investment community. The Institute conducts conferences and workshops and provides published research, surveys, and newsletters. The Institute strives to present the most timely and relevant research and education available so our clients and our associates stay abreast of impor­ tant trends in the investments industry.

© 2017 Callan Associates Inc.

Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to be reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational purposes only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of this report is your sole responsibility. You should consult with legal and tax advisers before applying any of this information to your particular situation. Reference in this report to any product, service or entity should not be construed as a recommendation, approval, affiliation or endorsement of such product, service or entity by Callan. Past performance is no guarantee of future results. This report may consist of statements of opinion, which are made as of the date they are expressed and are not statements of fact. The Callan Institute (the “Institute”) is, and will be, the sole owner and copyright holder of all material prepared or developed by the Institute. No party has the right to reproduce, revise, resell, disseminate externally, disseminate to subsidiaries or parents, or post on internal web sites any part of any material prepared or developed by the Institute, without the Institute’s permission. Institute clients only have the right to utilize such material internally in their business.

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