Portfolio Company Performance & Quality of Targets Rank Among Top Challenges Facing Private Equity, According to the Fourth Annual Private Equity Study by BDO

-- Fundraising Activity Increases as Limited Partners Look for Track Record, Operational Experience --

CHICAGO--(BUSINESS WIRE)--Identification of quality targets and maintaining portfolio company performance are the most significant challenges facing private equity firms in 2013, according to the fourth annual PErspective private equity study by BDO USA, LLP, one of the nation’s leading accounting and consulting organizations.

“Private equity fund managers are feeling pressure on all sides of the fund cycle”

When asked to rank the challenges facing private equity firms in the coming year, the largest percentage of fund managers (28 percent) – regardless of fund size - indicated that the identification of quality targets would be their most significant challenge, followed by maintaining portfolio company performance, which was ranked as the number one challenge by 26 percent of respondents. Fund managers with larger funds – those with more than $1 billion in assets under management – were particularly concerned about maintaining portfolio company performance, with the most respondents (35 percent) ranking it as the primary challenge they will face in the year ahead.

“Private equity fund managers are feeling pressure on all sides of the fund cycle,” said Lee Duran, Partner and Private Equity practice Leader at BDO. “General malaise in the global economy, combined with pricing concerns, has created a challenging environment for fund managers working to source and close deals, while at the same time, they are under increasing pressure to optimize portfolio company performance and realize returns on their aging investments.”

Portfolio Performance is on the Rise as Funds Mitigate Losses

In good news for private equity firms, however, portfolio company performance seems to be on the mend. According to BDO’s study, 64 percent of fund managers saw the overall value of their current portfolio increase during the past 12 months. That’s compared to only 15 percent who saw the value of their portfolio decline and approximately one in five (21 percent) who indicated the value of their current portfolio stayed the same during 2012.

Of fund managers who saw the value of their portfolio decline, 46 percent each indicated that their fund’s value decreased by less than 6 percent and by 6-15 percent. Another 8 percent indicated that their fund’s value declined by 16-25 percent, the largest reported decrease. That’s compared to 83 percent of respondents who reported that their fund’s value decreased by 6 percent or more in last year’s study.

Conversely, of fund managers who saw the value of their portfolio increase, the largest percentage (38 percent) reported increases of 16-25 percent during the past year, followed by increases of 6-15 percent, which were reported by 34 percent of respondents. Nine percent of respondents reported an increase of 26-35 percent and another 7 percent reported increases of more than 50 percent in 2012.

The improvements fund managers have seen in the performance of their portfolio companies during the past year correspond with steps they have taken to mitigate losses and improve the returns on their investments. During the past year, 72 percent of fund managers have reassessed market strategy at portfolio companies performing below forecasts or expectations. Another 67 percent have monitored cash flow on a weekly basis, 58 percent have reduced headcount, 58 percent have reduced costs by scaling back and 53 percent have renegotiated debt.

Track Record, Operating Experience Among Top Priorities for Limited Partners

Fund managers are not the only ones closely monitoring portfolio company performance. When it comes to the factors Limited Partners (LPs) use when evaluating General Partners (GPs) in today’s environment, 67 percent of fund managers indicated that “track record” is the most important, followed by “management team” (12 percent) and “operating experience” (12 percent).

“Track record will always be a critical differentiator for private equity firms looking to raise new funds,” said Dan Shea, Managing Director with BDO Capital Advisors, LLC and a member of the Private Equity practice at BDO. “However, with blockbuster deals – and returns – becoming more elusive, Limited Partners have increased their focus on funds’ management teams and their ability to make operational enhancements to garner a return on Limited Partners’ investments.”

Fundraising Continues, with Family Offices, Pension Funds Committing Capital

Despite a difficult fundraising environment, the majority (64 percent) of fund managers are receiving new commitments from LPs. That’s a marginal increase from last year when 63 percent of fund managers were receiving new commitments from LPs, but a significant uptick from 2010 and 2009 when 56 percent and 40 percent of fund managers were raising new funds, respectively. The largest percentage of fund managers (45 percent) indicated that they are receiving the majority of first-time financial commitments from family offices, followed by pension funds (24 percent), international investors (18 percent), endowment funds (10 percent) and universities (2 percent).

When it comes to Limited Partnership Agreements, 15 percent of fund managers indicated their management fees have changed, with 6 percent reporting an increase and 9 percent reporting a decrease. Of those who reported an increase or decrease, 75 percent and 70 percent, respectively, indicated their management fee has changed 0.50 percent above or below the standard 2 percent management fee.

These findings are from the fourth annual BDO PErspective Private Equity Study, which was conducted from November through December 2012 and examined the opinions of more than 100 senior executives at private equity firms throughout the U.S. with $15 million to $157 billion in assets under management.

Other major findings from the BDO PErspective Private Equity Study include:

• Tax Burdens, Changes to Treatment of Carried Interest Pose Significant Challenge: One in seven (14 percent) private equity fund managers – regardless of fund size – identified the impact of tax burdens on private equity, including the proposed increased tax on carried interest, as the most significant challenge facing private equity firms in 2013. Pricing also ranked among top concerns, with 15 percent of fund managers identifying it as the primary challenge in the year ahead.
• Funds Report Hiring, Increasing Headcount at Operating Company & Fund Level: For the third year in a row, the majority of private equity fund managers (71 percent in 2012, 62 percent in 2011 and 63 percent in 2010) reported that they will increase professional staff headcount at the operating company level during the next 12 months. When asked about the past 12 months, 63 percent of respondents said they have increased professional staff headcount and another 30 percent reported increasing administrative staff headcount at the operating company level. At the fund level, 51 percent of respondents reported increasing employee count during the past year and 44 percent said they plan to do so during the next 12 months.
• Bankruptcy Filings Among PE-Backed Companies Set to Decline: One in ten (10 percent) fund managers reported that they declared bankruptcy on one or more portfolio company in 2012. However, when looking into 2013, the outlook is brighter. Only 5 percent of fund managers expect to declare bankruptcy for one or more portfolio company in the coming year.

The BDO PErspective Private Equity Study is a national survey conducted by PitchBook, an independent and impartial research firm dedicated to providing premium data, news and analysis to the private equity industry. More than 100 senior executives at private equity firms throughout the U.S. with $15 million to $157 billion in assets under management responded to BDO’s latest study, which was conducted from November through December 2012.

About BDO’s Private Equity Practice

Strategically-focused and remarkably responsive, the experienced, multi-disciplinary partners and directors of BDO’s Private Equity practice provide value-added assurance, tax and consulting services for all aspects of a fund’s cycle, wherever private equity firms are investing.

About BDO USA

BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through 45 offices and more than 400 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multi-national clients through a global network of 1,204 offices in 138 countries.

BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. For more information please visit: www.bdo.com

Material discussed is meant to provide general information and should not be acted on without professional advice tailored to your firm’s individual needs.