My company, Portico Advisers, has completed several studies on the state of play within the emerging markets private equity industry. We also put out a terrific newsletter (sign up here).
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Does EM Private Equity Scale?
I recently re-read Fred Wilson’s 2009 blog post on “The Venture Capital Math Problem,”
and it got me wondering whether emerging markets private equity and venture capital (“EM PE / VC”) might face similar capacity constraints to U.S. venture.
If you haven’t read Fred’s post, you should. But in essence, Fred looks at the fundraising figures for U.S. venture and, after making some assumptions about required returns, determines that the volume of exits caps the industry between $15B to $17B in annual fundraising. In his words, “the venture capital asset class does not scale.”
What I thought I’d do is take a page from Fred’s playbook and see whether we can back into a reasonable estimate of the absorptive capacity of EM PE / VC.
Our conclusion: annual flows to EM PE / VC may need to decline by 60%.
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The Mid-Market Squeeze
Portico surveyed 76 emerging market private equity professionals with two objectives in mind: (i) to test our hypotheses for the supply-demand imbalance; and (ii), to illuminate potential paths toward solutions.
Most of our hypotheses were affirmed, in whole or in part, but the report’s overarching finding is that the declining number of EM mid-market funds is more than just a funding gap, it is a symptom of industry-wide problems. Our survey reveals four drivers for the mid-market squeeze:
- Macroeconomic developments in EMs are not the reason why LPs aren’t committing to mid-market PE funds; it’s the failure of EM PE funds to deliver returns.
- There is an acute funding gap for EM PE funds smaller than $100 million in size.
- Development finance institutions are walking away from smaller EM PE funds, and investing with larger, more established firms. Moreover, their preferred ticket sizes are in the sweet spot of where commercial LPs prefer to play.
- Institutional investors lament the lack of transparency in the EM PE industry.
To learn more, please download a copy of the report, or peruse it below.
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Is Emerging Markets Private Equity Dying?
Portico’s first research piece explores several existential challenges besetting the emerging markets private equity industry.
Key findings include:
- Stage of the industry life-cycle: The volume of capital raised annually has been stagnant since 2011, while the number of growth equity funds achieving a close declined by 30% between 2010-15.
- Are new firms entering? Fewer first-time funds are achieving a final close, and they’re not getting help from development finance institutions (DFIs)—DFIs are committing to more funds IV+ than to Funds I, II, or III.
- Are stragglers leaving? There are more “zombie” funds than viable GPs—56% of the firms that raised a fund between 2005-09 have failed to raise a follow-on fund; a significant volume of GP restructurings and secondaries may be required to clear the market.
- Are there substitutes? Venture and credit funds are gaining traction, as are “impact investing” funds; and, in their quest to reduce fee drag, large LPs are bypassing funds for platforms.
- Legal and regulatory hurdles: Regulatory complexity is making it more difficult for fund managers to raise capital from developed market LPs.
- Where are we going? Read the study to learn more.
Mike Casey 