Private Equity has turned into one of the most sought-after asset classes for long-term investors. Long-term investors, such as insurance companies, pension funds, and endowments, account for 75% of the capital sources in Private Equity. Overheated equity capital markets, overall low interest rates and their superior return profiles, approximately 15% net IRR (Internal Rate of Return) p.a. over 15 years, made PE funds so attractive for investors. Last year was record-setting in terms of fundraising. Nearly USD 1,300 billion were committed to this asset class in 2021 alone.
A total of USD 5 trillion was raised over the past 5 years. In consequence, this also led to an all-time high in terms of undeployed capital (dry powder) of USD 3.4 trillion chasing for assets.
What returns investors are looking for in Private Equity? A fund’s performance is measured with two key parameters: the absolute multiple of the investment returned to investors and the net IRR over the investment period. Hence, to achieve the expected returns of 20% p.a. over 5 years, a fund needs to return 2.5 times the invested capital to their investors, also referred to as LPs (Limited Partners).
How can these returns be achieved? Originally, PE was all about financial engineering. At times, when a fund could acquire a company for six times EBITDA and re-finance the acquisition with 50% debt capital (i.e. three times EBITDA), hold the investment for five years, repay the loan and sell the company for the same multiple, the fund generated a multiple of two or an IRR of 16% p.a. on the investment.
