Private equity joins venture capital in the doldrums

Recently the creditors of Nine Entertainment approved a $3.4 billion recapitalisation that resulted in a $1.9 billion loss by private equity fund CVC Asia Pacific. This is probably the largest private equity loss in Asia and among the biggest ever. This financial year has already seen the collapse of other private equity deals such as Gourmet Food Holdings, Australian Music Group, and Australian Convenience Foods. The likely capital loss of the Australian private equity industry this year will exceed $2 billion. 

It has been long been argued by private equity fund managers that because it is less risky than venture capital that it offers a better risk-adjusted rate of return. Returns on both types of funds are notoriously difficult to obtain but there is no doubt the private equity fund managers have had much more success in raising funds.

Over the past 10 years Australian private equity funds have raised $25.9 billion while venture capital funds have only managed to raise $2 billion. This has resulted in only $1.5 billion being invested in venture capital in Australia over the past 10 years compared to $28.5 billion for private equity. It is a chilling thought that the losses in the private equity industry this year exceed by a considerable margin the amount invested by Australian venture capitalists in the past 10 years!

The classic claim by Australian venture capital and private equity investors is that over the long  term, the returns exceed that of listed equities by 3%. For venture capitalists this is now beginning to lack credibility. A damning report from prolific US group Kauffman Foundation, which has about $249 million of its $1.83 billion of assets in venture capital, found that of the 100 funds it invested in over its 20-year history, only 20 generated returns that beat a public market equivalent by more than 3% annually.

Similarly, it has been argued that if you geared your investment in listed equities to the same degree that private equity managers do (say $3 debt to $1 equity) your returns would be greater than 3% more than listed equities and you would not have to suffer liquidity risk.

I retired as a venture capital fund manager in June 2007. Timing beats analysis any day of the week.  However, I am an adjunct lecturer at University of Technology Sydney where I run the venture capital elective for the MBA program. Preparing for the lectures means I have to review the statistics. The latest data by the Australian Bureau of Statistics is current to June 30, 2011.  According to the ABS for FY2011 there was a 2.5% decline in dollars invested, a 11% decline in the number of deals, and an 8% decline in the $15.9 billion of funds committed. Unfortunately with the write-offs so far in 2012 it does not look as if the situation is going to improve.