Rothstein Kass Survey: Increased Liquidity, Deal Flow Drive Private Equity Optimism

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PE Firms predict strong returns, more investment opportunities despite heightened competition and ongoing regulatory pressure.

Rothstein Kass (http://www.rkco.com), a leading national professional services firm, today released its sixth annual Private Equity Outlook report, titled “On the Ascent.” Produced by the Rothstein Kass Institute, the firm’s thought leadership arm, the survey of 215 private equity firms reveals that private equity firms are generally optimistic about the industry’s outlook for 2013, despite increased competition for deals from institutional investors and ongoing regulatory and fee pressures. For the majority of firms, the optimism is driven by the recovering economy, a much-needed liquidity boost from increased exit opportunities, and a strong belief that there will be more attractive investment opportunities in 2013 than there were in 2012.

“With increases in liquidity and deal flow, both private equity firms and investors are optimistic about the outlook for 2013, but that’s not to say there aren’t still challenges to overcome,” said Tom Angell, principal-in-charge of Rothstein Kass’ Private Equity Practice. “Competition for deal flow is stiff as institutional and strategic investors increasingly participate directly in private equity transactions. In addition, the tax and regulatory environment is widely expected to remain challenging. Regardless, the private equity funds in our survey predict strong returns this year and many investors view private equity as the most attractive of the alternative investment asset classes. Certainly, for the first time in a number of years, conditions are ripe for private equity to return to peak form.”

The survey reveals that the overwhelming majority of firms polled (80 percent) are targeting double digit returns for 2013. Only eight percent of firms are targeting returns between five and ten percent, while none of the respondents expect returns of less than five percent. When it comes to investment opportunities, the sentiment is equally strong as more than three quarters of respondents (78 percent) believe there will be more investment opportunities in 2013 than there were in 2012. The recovering economy and pent-up demand were the most frequent reasons cited for the increased opportunities (29 and 28 percent respectively) followed by more entrepreneurs seeking investment (14 percent). Few respondents (4 percent) believe the Jumpstart Our Business Startups (JOBS) Act will be a catalyst for increased deals.

While there is expected to be an increase in the number of deals, the competition for those deals is likely to intensify according to the survey results. In fact, more than three quarters of firms polled (77 percent) agree that institutional investors will increasingly invest directly in private equity transactions. The survey also revealed that more than three quarters of firms polled (80 percent) agree that private equity firms will face increased competition from strategic buyers in 2013 than in 2012.

“Co-investment will no doubt increase in the months and years to come, creating both upside and downside for general partners and investors,” predicted Angell. “Many funds see co-investment opportunities as an inducement to encourage future investment, which may or may not materialize. Alternatively many investors look at co-investment as a way to escape fees and gain control over investments, but may have unrealistic expectations about the level of time and effort involved. Certainly, these factors must be balanced within the industry.”

While overall sentiment is positive, there are a number of forces working against private equity funds at present. Roughly five percent of those polled currently face an “invest it or lose it” situation with undeployed cash as they near the end of their five-to-ten year investment horizon with uninvested cash on the balance sheet. These funds will have to make a decision between what may be viewed as less-than-optimal investments and returning capital to their investors. While dry powder has decreased somewhat since its peak in 2007, there is still a glut of money on the sidelines, and deal flow would have to increase dramatically and rapidly to absorb these assets. In fact, another 10 percent of the funds polled expect to face this situation later in 2013.

In addition, ongoing regulatory pressures, tax uncertainty and fee pressures weigh on the minds of most firms according to the survey. In fact, 79 percent of respondents believe that private equity funds will more frequently turn to outside consultants to understand evolving regulatory demands. Beyond that, more than two-thirds of firms polled (68 percent) believe there will be increased federal taxes on carried interests.The overwhelming majority of those polled (80 percent) believe there will be continued downward pressure on fees in 2013.

Other key findings from the survey include:

  •     More than 60 percent of the private equity respondents believe there will be more exit opportunities for portfolio holdings in 2013 compared with 2012. Nearly 58 percent agree that there will be increased initial public offering (IPO) activity this year. However, those polled were almost unanimous in their belief that mergers and acquisitions (M&A) activity will provide the lion’s share of liquidity in 2013.
  •     Fewer funds plan to raise capital in 2013 compared with 2012. Roughly 33 percent of those polled will not be on the fundraising trail in 2013, compared with 27 percent in 2012.
  •     The amount of women and minority ownership in the private equity industry remains low, with 56 percent of those polled reporting their firm has no women or minority general partner (GP) stakeholders.
  •     While 70 percent of the private equity funds polled believe that ongoing political turmoil will continue to hamper the markets, only 22 percent think the U.S. will enter a recession in 2013.
  •     Nearly half of those polled will offer deal-by-deal fund structures to attract new capital. This will provide investors with increased control over their investments while protecting the fee structure of a private equity fund.

If you would like a copy of the full Private Equity Report, please contact: Meredith Jones at mjones(at)rkco(dot)com.

About Rothstein Kass:

Founded in 1959, Rothstein Kass is a premier professional services firm serving privately-held and publicly-traded companies, as well as high-net-worth individuals and families. With more than 1,000 professionals, the firm provides accounting, advisory, auditing and tax services, as well as a full array of integrated services such as litigation and forensic consulting and concierge and tax accounting to clients across industry spectrums and in all stages of development. Rothstein Kass is widely recognized as a leader in the financial services space, consistently ranking among the top CPA firms serving the Hedge Fund, Private Equity, Venture Capital, Broker Dealer and Family Office segments.

At the core of Rothstein Kass’ remarkable success is a commitment to hiring, developing and retaining employees with the same entrepreneurial spirit that permeates the sophisticated business and financial services communities the firm serves.

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Kathleen O'Toole
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