Two major (and perhaps related) trends driving private capital markets post-financial crisis have been exceptional levels of distributions and new capital entering the market.
While there are some obvious explanations – namely high valuation multiples supporting opportunistic exits, and continued outperformance of the asset class attracting new capital (see: Sweden) – we wanted to dig deeper on exit volumes to understand how asset turnover in private markets has changed, and how the US and Europe have compared through this period.
We decided to include the geographic element in our review of the data as exit opportunities implicitly incorporate many financial, political, and social considerations, namely: overall investor confidence, cost of capital, regulatory regimes, cultural comfort with corporate combinations, and other structural elements.
Given the series of sovereign crises acutely impacting Europe’s growth over the past several years we had naturally assumed that exit volumes in the Eurozone would have been materially suppressed. This presumption was wrong (see Exit Volumes chart).
2012 – 2014 did indeed feature decreased total exit value(s) during the peak of southern Europe economic and political turmoil, but overall volumes have recovered and in fact overtook the US in 2017.
On some level, this seems like a return to trend: both the number of deals and the US dollar value of Eurozone exits was higher in Europe than the US pre-crisis (partly the result of peak EUR/USD exchange rates).
One notable difference between the environment in the US & Europe is the lower percentage of corporate acquisitions of sponsor-backed exits. From 2009 – 2017, corporate acquisitions accounted for 50% of total exits in Europe, compared against ~60% in the United States (see Average Exit Volume by Type (2009-2017) chart). While sussing out explanations for this multi-deca-billion dollar difference is beyond the scope of this article, it is an interesting observation nonetheless.
Putting aside geographic splits and looking at overall buyout hold periods, another somewhat surprising trend is the rise in average holding periods post-crisis, despite total exit volumes .
A simple explanation is sellers chose to wait for decent valuation multiples and willing buyers to re-emerge following both the immediate credit crunch and subsequent volatility (including US debt rating downgrade, and the aforementioned Eurozone currency crises).
As the markets have worked through this exit overhang (which also included the closing of IPO markets during the depths of market turmoil), average holding periods have begun to tick down (meaning investors are finding opportunities to exit assets more quickly), but they are likely to remain higher than pre-crisis.
The percentage of ‘quick flips’, i.e. assets exited in less than 3 years, stood at 20% as of the beginning of 2018, compared against 40% pre-crisis (see ‘Quick Flip’ Exits chart).
Opportunities for quick flips are likely to continue to decrease with the new US tax law, which requires investors to hold assets for at least 3 years to qualify for the capital gains tax rate (previously it had been 1 year). It is highly questionable how this politically-decided and arbitrary timeframe will lead to better outcomes for investors and limited partners, or what skewed incentives this might introduce, but again such discussion is beyond the scope of our current commentary.
Two takeaways from this review of exit data are thus: investors should be prepared to hold onto assets for longer going forward, and any limited partner of scale should feel comfortable with transatlantic private exposures, as both the US and Eurozone markets feature sufficiently deep capital markets and corporate environments to support continued return of capital even through highly disruptive events.
Investors can use Chronograph to efficiently track not only distributions and hold times, but every other aspect of private capital portfolios.
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