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PRIVATE EQUITY OUTLOOK

June 2014

T A B L E O F C O N T E N T S

1

Executive Summary Page 2

Buyout Page 7

Venture Capital & Growth Page 11

Secondary Market Page 13

Private Credit Page 15

Recommendations Page 18

Market Environment Page 20

E X E C U T I V E S U M M A R Y : S T R A T E G Y R E C O M M E N D A T I O N S

2

Outlook:  Neutral Market dynamics improving, but the majority of capital is allocated to larger funds

Venture/Growth

Outlook:  Neutral Rising asset values, growing dry powder and rising transaction prices limit expected returns

Secondary Markets

Outlook:  Negative (US Large/Emerging markets)/ Neutral (U.S. Middle Market, Europe) New commitments face higher than average purchase prices which reduces expected returns U.S. middle market, European buyout more attractive than U.S. large and mega deals or Emerging

Markets

Buyout

For those with a strategic allocation requirement, select opportunities include Opportunities to participate in the apparent dislocation in European markets, including direct lending Smaller, niche sectors or companies that are overlooked by mega‐funds Special vehicles, timely opportunities and other unique offerings

Skilled GPs have delivered attractive returns in most market environments through superior companyselection and ability to lead portfolio companies to greater than market driven growth

Manager Selection

Private Credit Outlook:  Neutral (U.S.)/ Positive (Europe) Premiums for direct lending appear more attractive in Europe than in the U.S

E X E C U T I V E S U M M A R Y : M A R K E T E N V I R O N M E N T

3

Neutral In a period of slow expected economic growth it will be more difficult for companies to grow EBITDA. 

Five years into the US economic recovery, it is likely that growth will slow sometime in the next five years,hurting EBITDA growth, while growth in Europe and the emerging markets should improve over that period.

Facing sIow growth, General Partners must find other ways to grow portfolio company revenues andearnings to support exit values. “ Buy and Build” strategies reflect an attempt by General Partners to createvalue by “bolting” portfolio companies onto one another.

EBITDAGrowth

Neutral/Unattractive While it is impossible to know what the exit environment will be in 7 to 10 years,  the possibility of longer 

holding periods for portfolio companies, and the expected large number of portfolio companies needing exists (based on record levels of  buyouts taking place today) are headwinds to attractive exit prices.

Exit Environment

Unattractive Purchase price multiples are near historical highs, driven in part by easy access to inexpensive credit.

Rising distributions have been a tailwind to increased fund raising, leading to record amounts of drypowder that has negative implications for future purchase price multiples, expected IRRs and thecomposition of future private investments.

Valuation

Today’s environment for new commitments to private equity is not broadly favorable for generatingattractive long‐term expected returns, and is characterized by headwinds to new investments that havenegative implications for future performance.

O V E R V I E W : M A R K E T E N V I R O N M E N T

4

2013 was a good year for distributions, but 2005 to 2008 vintage funds have yet to return all of theirinvestors’ capital.

Evaluated as a whole, private equity returns have been average for some time, but skilled managershave delivered attractive risk‐adjusted returns over time.

1.79x 1.47x 1.32x 1.24x 0.78x 0.52x 0.48x 0.46x 0.25x 0.16x 0.09x

0.20x0.36x

0.39x 0.49x

0.64x0.75x 0.81x 0.88x

0.97x 0.98x 0.98x

2.00x1.85x

1.72x 1.71x

1.43x1.28x 1.29x 1.35x

1.22x 1.15x 1.07x

0.00x

0.50x

1.00x

1.50x

2.00x

2.50x

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Global Average PE Fund Return Multiples By Vintage Year

DPI RVPI TVPI

While investors in early vintage funds (pre-2004) have been made whole (theirDPI: Distributions to-Paid-in-Capital are greater than one) they still havesignificant amounts of unrealized value (RVPI: Remaining Value to Paid-in).

0%5%10%15%20%25%30%35%40%45%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

PE vs. VC Top Decile & Quartile IRRs by Vintage

VC Top Quartile VC Top Decile PE Top Quartile PE Top Decile

During most vintage years since 2001, top quartile buyout managers haveoutperformed top quartile venture capital funds.

Source: Pitchbook Source: Pitchbook

O V E R V I E W : M A R K E T E N V I R O N M E N T

5

 ‐

 20

 40

 60

 80

 100

 120

 140

 160

2006 2007 2008 2009 2010 2011 2012 2013

Billion

s $

US PE Dry Powder By Fund Type and Vintage

Buyout PE Growth Co‐Investment Restructuring Mezzanine Energy Other

The majority of dry powder in US focused funds is held by buyout funds ($400b),and the majority of that in recent vintage funds with several years left in theirinvestment periods.

 ‐

 50

 100

 150

 200

 250

 300

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Billion

s $

PE Fund Raising by Fund Size 

Under $100M $100M‐$250M $250M‐$500M $500M‐$1B $1B‐$5B $5B+

Source: Pitchbook Source: Pitchbook

2013 fund raising not only saw its best year since 2008, but the return of “mega”funds. Nearly half of committed capital went to funds that raised more than $5billion.

Positive net‐cash flows to limited partners helped fund raising, but 2013 also saw the return of“mega” funds‐those that closed with more than $5 billion of committed capital.

Dry powder continues to grow and has negative implications for purchase price multiples, expectedIRRs and the composition of future private investments.

O V E R V I E W : M A R K E T E N V I R O N M E N T

6

Leveraged buyouts continue to drop as a share of total private equity deals, reflecting a change in howgeneral partners believe they can best create value. Sponsor‐to‐sponsor transactions (“DirectSecondaries”), “buy and build” strategies and taking minority positions in growth/expansion deals havegrown in importance.

The growth in sponsor‐owned portfolio companies is leading to rising holding periods for portfoliocompanies, and has negative implications for returns to future investments in private equity.

Buyouts represent a declining portion of private equity deals as GPs see greateropportunity to add value through add-ons and in the growth/expansion stage ofventure.

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Q1

US Private Equity Investments by Deal Type

Buyout/LBO Add‐on Recap

PE Growth/Expansion PIPE Platform Creation

4.23.8 3.7 3.5

3.9 3.9

4.7 4.95.3

6

0

1

2

3

4

5

6

7

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Years

Private Equity Median Hold Period

2012 and 2013 were good years for portfolio liquidations and distributions tolimited partners, but holding periods continue to rise.

Source: Pitchbook Source: Preqin, Landmark

B U Y O U T

7

G L O B A L B U Y O U T : U . S .

8

Rising stock prices, aging dry powder and inexpensive debt is a tailwind to purchaseprice multiples. Smaller LBOs face less competition and require greater equity andless leverage, helping hold down prices.

The use of debt to finance LBOs fell dramatically following the financial crisis.As credit markets have opened up, the use of debt has increased to pre-crisislevels.

.x

2.x

4.x

6.x

8.x

10.x

12.x

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

2012 2013

EV/EBITDA Purchase Price Multiples by Deal Size

$0‐$25M $25M‐$250M $250M+Source: Pitchbook Source: Pitchbook

Rising public equity markets, growing dry powder and easy access to credit drove U.S. buyout purchaseprice multiples higher, creating headwinds to future performance

Buyout deals completed at today’s purchase price multiples face a number of headwinds to expected performance:

In a period of slow expected economic growth it will be more difficult for companies to grow EBITDA, forcing general partnersto hold portfolio companies longer in order to generate enough earnings to justify the necessary sale prices. This brings IRRsdown.

Five years into the US economic recovery, it is likely that growth will slow sometime in the next five years, challenging EBITDAgrowth. The increased use of leverage to finance deals is a drag on performance in a weakening economic environment.

Growth in the number and value of portfolio companies needing liquidation will increase the supply of companies beingauctioned, a headwind to exit prices.

Outlook: Large (Negative); Small/Mid (Neutral): Fund raising and dry powder will keep purchase price multiples high for large deals.Prices and leverage are more attractive for Small/Mid size deals, but trends seem to support higher prices ahead.

61%62% 63%

60%

54%56% 55%

62%

65%

45%

50%

55%

60%

65%

70%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Median % Debt by Year

G L O B A L B U Y O U T : E U R O P E

9

6.8 6.97.7

8.87.8 7.7 7.6 7.9 7.57.6

8.3 8.89.7 9.7

8.9 9.2 8.8 9.3 8.7

4

6

8

10

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

European Private Equity EV/EBITDA Purchase Price Multiples

<250m Euros All

Source: LCD European Leveraged Buyout ReviewSource: Preqin

Investors’ growing confidence in European reforms and economic growth has led torecord levels of dry powder as fund raising appears ahead of deal-making.

Purchase price multiples for smaller deals are generally more attractive, reflectingless competition and more difficulty in obtaining financing.

Growing confidence in economic reform and recovery is leading to renewed activity and opportunityin European leveraged buyouts, but slow growth may limit returns

A review of 2013 fund raising, deal flow, exit activity and purchase price multiples reveals a return to more normalized levels ofactivity. This appears to reflect investors’ growing confidence in the effects of economic reforms and recovery on earnings andvaluations.

Purchase price multiples have nearly recovered to pre‐crisis levels, but reflect: cyclically‐low/depressed EBITDA: as EBITDA recovers with growth, price multiples will decline. a limited supply of available companies as sellers seek to avoid selling at depressed EBITDA levels and buyers seek only high

quality, low risk assets.

Outlook: Neutral Europe’s economy has turned, but investor sentiment appears ahead of fundamentals as reflected by rising dry powder. Slow

growth will limit returns. European recovery is expected to be uneven and slow, favoring northern over southern Europe. Successful General Partners

will be those that recognize these risks and identify high quality, global companies with limited exposure to on‐going risks. While economic growth is slower, European buyouts are more attractive than U.S. given their valuations are lower and based

on cyclically depressed EBITDA.

272 241 245 221264 277

0

50

100

150

200

250

300

2009 2010 2011 2012 2013 2014Q1

Billion

s $

European‐focused Dry Powder

N/A

G L O B A L B U Y O U T : E M E R G I N G M A R K E T S

10

Emerging markets remain an attractive long-term opportunity, but over the next year the dynamicsand fundamentals associated with private equity investing are poor

As a whole, emerging markets private equity investing is characterized by: A decade of successful fund‐raising that has led to significant dry powder, placing upward pressure on purchase price multiples. A weak exit environment (including the closure of the Chinese IPO market) has increased holding periods and hurting exit prices. Poor performance on the part of general partners in managing and creating value in their portfolio companies. Macroeconomic conditions (weak economic growth, market and exchange rate volatility), that negatively impacts company

competitiveness, revenue and earnings growth.

Outlook: Neutral Demographic trends favor a growing allocation to emerging markets, but in the next year private equity faces many of the same

headwinds that developed markets struggle with: an overhang of capital, slowing growth and challenging exits, and managerschallenged to create value.

For those with capital to put to work, manager selection, skillful country selection and access to attractive deal flow matters;managers are looking to a new set of countries today including Mexico and South East Asia.

For all of its potential, less than half of private equity investors find any region withinemerging markets attractive investments today.

Emerging market deal flow declined from 2009 until 2012 before starting to grow.Dry powder, measured in terms of years-of-investment has begun to rise again.

149 166 193 185 176 257 377 436 479 480 425 388 356 3990

1

2

3

4

5

6

0

100

200

300

400

500

600

2000 2002 2004 2006 2008 2010 2012

Years of In

vestmen

t

Dry Pow

der, billion

s $

Emerging Markets Dry Powder

Dry Powder Years of Investments

Source: PreqinSource: Bain Capital

7% 7% 7%12% 14%

26% 26%33%

38%

50%

0%

10%

20%

30%

40%

50%

60%

Other MiddleEast

Russia India EasternEurope

Brazil China Africa SouthAmerica

Asia

Regions within Emerging Markets Limited Partners feel Present the Best Opportunities (Preqin Survey)

V E N T U R E C A P I T A L & G R O W T H

11

V E N T U R E A N D G R O W T H C A P I T A L

12

The changing dynamics of the venture capital industry as well as innovation in technology is altering theways in which limited partners should approach venture and growth capital

Trends in Venture Capital The difficulty in returning investors’ capital has led to less capital raised and a rationalization of the industry; the number of active

venture capital (VC) funds is half that of 2000.

Successful VC firms are capturing a larger proportion of limited partners’ capital, leading to bigger funds; in 2012 over 50% of the$21 billion raised went to 11 of the 182 VC funds raised.

Developments in IT (the growth of open source software, the “cloud” and leverageable distribution platforms) have reduced theamount of seed and early stage capital needed to see a company through to its growth stage. As a result, smaller funds takingsmaller positions are better positioned to exploit these opportunities than larger funds.

The intersection of these trends suggests that smaller funds are more likely to outperform, and thus many limited partners in largerfunds will be disappointed. The evidence of fund performance by size tends to confirm this hypothesis.

Outlook: Neutral. The supply/demand dynamics of VC is improving, but the majority of capital allocated to larger funds suggests thatthe average limited partner will underperform, making manager selection critical.

 $(40)

 $(20)

 $‐

 $20

 $40

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Billion

s $

US Venture Capital Funds Annualized Cash Flows by Year

Contributions ($B) Distributions ($B) Net Cash Flow ($B)

Source: Pitchbook

Distributions continue to exceed new commitments, leading to a net outflow ofassets, letting the asset class downsize to a sustainable level given opportunities.

Small Venture Capital funds have outperformed the large end of the market.

Source: StepStone

2.6 3.44.5

2.0 2.1 1.62.3 2.4

6.1

0.8 1.8 0.80

2

4

6

8

Pre 1990 1990‐1994 1995‐1998 1999‐2001 2002‐2004 2005+

Multip

les

Performance by Fund Size and Vintage Year

<$250m >$250m

S E C O N D A R Y M A R K E T S

13

S E C O N D A R Y M A R K E T S

14

40

60

80

100

120

2007 2008 2009 2010 2011 2012 2013H1 2013H2

Discoun

t/Prem

ium to

 NAV

, Percent

Secondary Pricing

Buyout Venture All Strategies

Transaction volume continues to rise, but so does fund raising. Existing dry powderof $24.5b is about one-year of volume, while 2013 fund raising has created another$33b of dry powder yet to be called.

Venture capital portfolios trade more cheaply than buyout portfolios, reflectinggreater uncertainty about expected IRRs, and making the points that portfoliosselling at large discounts to NAV are not necessarily attractive.

Secondary market offerings continue to rise, but rising public equity markets have driven up seller’sexpectations, hurting expected returns

Supply continues to grow, the result of regulatory driven selling and the recent attractiveness of “fund restructuring” opportunities.

Over $125 billion of funds coming to the end of their life are not in a position to provide liquidity (zombie funds). With visibility to the underlying portfolio companies, secondary buyers are restructuring these portfolios, providing liquidity to

LPs and giving GPs additional time to realize value.

Secondary pricing has climbed, in part due to higher seller expectations following rising public equities.

Buyers suggest that these prices can be misleading, pointing to the rise in “structured transactions”. Buyers will pay par in astructured transaction for assets about to be written up in value and with payment to be deferred, effectively reducing thepurchase price to below par.

Outlook: Neutral. Regulatory driven selling will increase the supply of secondary portfolios, but the write‐up of NAV due to risingequity markets, rising transaction prices and growing dry powder should limit returns compared to recent history.

0

10

20

30

40

50

60

0

5

10

15

20

25

30

2005 2006 2007 2008 2009 2010 2011 2012 2013

Dry Pow

der (Billion

s $)

Capital R

aised, Transactio

n Vo

lume 

(Billions $)

Capital Raised versus Transaction Volume

Capital Raised ($Billions) Transaction Volume Dry Powder

Source: Preqin Source: Cogent

P R I V A T E C R E D I T

15

P R I V A T E C R E D I T : U . S .

16

2.7 3.1 2.82.1 2.4 2.7 2.4

3.4 3.0 2.8 2.6

3.9 4.1 4.3 4.44.8

4.3

3.43.7

4.2 4.34.8

0

1

2

3

4

5

6

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Multip

les

Company Ability to Service Debt

Average Coverage Ratio (EBITDA‐CAPEX)/Interest Average Total Debt to EBITDA

Source: Standard & Poor’s LCD

2.7 3.9 4.8 5.28.6

11

0

2

4

6

8

10

12

10‐yearTreasuries

InvestmentGrade Bonds

LeveragedLoans

High Yield Second Lien PE‐backedMezzanine

Percen

t

Fixed Income Yields(March 2014)

The ability of companies to service their debt remains high, but is less attractive than inthe last couple of years. As credit markets ease, companies have taken on more debt,reducing their interest coverage.

The premium for investing in private credit strategies above public credit remainshigh relative to history.

Source: Bloomberg, Credit Suisse, Barclays, S&P LCD

Returns to U.S. focused private lending appear attractive but risks are likely to rise as the economicrecovery matures

Understanding the role of private credit (first & second lien loans, mezzanine debt) is important to understanding its relativeattractiveness. It is most often used by middle market companies to finance growth, leveraged buyouts, and refinance existing debt.

Private equity sponsors have (1) large pools of dry powder that need to be put to work; and (2) a need to refinance and recapitalizetheir large portfolio of companies in order to provide liquidity to limited partners. The large demand for private debt is being rewarded with attractive premiums relative to public market credit.

Risk to private lending appears low today; default rates are low and companies as a whole are well prepared to service debt.

Outlook: Neutral. High demand for financing and strong corporate balance sheets are providing attractive premiums for privatelending over public market credit, but default rates are low relative to history and likely to rise over time. Prospective investors mustconsider that the US economic recovery is five‐years old; the average business cycle has lasted about six years since WWII.

P R I V A T E C R E D I T : E U R O P E

17

02468101214

Percen

t

European Leveraged Loan and High Yield Default Rates

Europe HY Default Rates Europe Levered Loan Default Rates

As the European economy recovers, default rates continue to come down. Itsrecovery is a year old, suggesting default rates will remain low for some time.

Historically, European companies have relied on bank financing, but banks’ need todelever is limiting their creation of new loans.

Declining bank lending to companies and a slowly recovering economy is creating an opportunity fordirect lending strategies focused on Europe

An opportunity exists for direct lenders because European banks, the traditional suppliers of debt, are constrained while demand forloans is recovering.

Banks, under pressure to meet higher capital ratios, are reducing risk by not only reducing their lending, but shifting theirlending to larger, publically traded companies.

As Europe recovers, so does the demand for loans: midsize European businesses will need to raise 3.5 trillion euro in debtfunding over the next five years; in addition over 250 billion euros of debt will mature over the next five years.

There are risks to lending in Europe. While Europe’s recession has technically ended, no one expects its economy to recoveryquickly, and in fact there are threats to its recovery. Some EU nations are still in recession; European inflation is falling and itsmoney supply is falling, measures that hint at slowing growth.

Outlook: Positive. With declining access to bank credit for smaller borrowers, pricing appears most favorable for non‐traditionallenders to small and lower middle‐market companies.

3.03.54.04.55.05.56.06.5

Bank

 Len

ding, A

nnual G

rowth 

Rate (P

ercent)

European Bank Lending to Non‐Financial CorporationsAnnual Growth Rates

Source: Europe MFI Source: Credit Suisse

R E C O M M E N D A T I O N S

18

R E C O M M E N D A T I O N S

19

U.S. Buyout European Buyout Emerging Markets Buyout Secondary Market Venture Private Credit

Pricing Conditions

Prices for large and middle‐market LBOs are high relative to their history, though more attractive for middle market deals than than for large deals.

Purchase price multiples are  high, but in part because earnings are cyclically depressed. As growthand earnings recover, purchases over the next several years  will appear more attractive.

Conditions remain similar to a year ago.  Strong fundraising relative to opportunity set is leading to large capital overhang and rich pricing.

Strong equity markets and increased distributions to LPs have pushed purchase prices up. General Partners suggest that “structured” transactions that delay payment to sellers effectively reduces the purchase price.

Fundraising appears to have settled at a more sustainable level. Decreasing commitments and improved industry dynamics are producing more favorable pricing.

The premium for investing in private credit over public credit is wide relative to historical averages, in both the U.S. and Europe, but the risks associatedwith these premiums are different and changing.

Macro Environment (Beta)

Conditions are similar to a year ago.  Rising public equity markets, inexpensive financing and dry powder is putting upward pressure on price multiples.  Slowerthan average economic growth will contribute to longer holding periods,  effectively reducing expected returns.

European recovery is expected to be uneven and slow, favoring northern over southern Europe. 

Over the intermediate‐term, faster economic growth is a tailwind to value creation, but in the near termmarkets are recognizing differences in macroconditions across countries  that have implications for expected returns.  In the near‐term, private equity faces  the same headwinds that developed markets struggle with: an overhang of capital, slowing growth and challenging exits. 

Fundraising and strongpublic equity markets have in the short‐run made the market less attractive, but changing market dynamics (regulatory driven selling) will, in the medium‐term, favor buyers of secondary portfolios..

Developments in information technology have reduced the amount of seed and early stage capital needed to see a company through to its growth stage.   As a result, smaller funds taking smaller positions are better positioned to exploit these opportunities than larger funds.. 

Its relative attractiveness  varies with where credit is in its market cycle.  Five years into its recovery, U.S. credit markets are late in their cycle, while European credit cycle is in its earlier stages.  In addition, European banks,   are under pressure to raise capital ratios, leading them to lending to companies.

Manager Environment

High purchase prices and low economic growth means manager driven value creation will be key to strong returns; favoring small and middle‐market deals where managers have more levers to create value and exit options

A bifurcated economic recovery suggests that successful General Partners will be those that identify high quality, global companies with limited exposure to on‐going European risks.

Successful managers will be those that recognizedifferences in country risk and that are skillful  in country selection and company selection. Managers are looking to a new set of countries today including Mexico and South East Asia.

As the market matures, LP interests will be more efficiently priced. Managers with access to proprietary deal flow and strong underwriting efforts will outperform.

.

Managers that have demonstrated earlier success are raising larger funds at a time when small allocations are needed by technology firms.

The absolute returns to private credit appear attractive, but today, as the credit cycle reachesits top, the risk return profile  is less attractive. With many “new” managers raising funds, the challenge for investors is to identify managers with the skill set and experience to implement the strategy in a manner that reflects the desired risk‐return profile they seek.

Outlook Negative (Large)Neutral (Mid‐market) Neutral Neutral Neutral Neutral Neutral (U.S.)/Positive (Europe)

M A R K E T E N V I R O N M E N T

20

M A R K E T E N V I R O N M E N T : R E T U R N S

21

0.83x 0.75x 0.65x 0.32x 0.70x 0.33x 0.29x 0.25x 0.14x 0.09x 0.11x

0.38x0.37x 0.47x

0.75x

0.92x

0.84x 0.98x 1.01x 1.17x1.01x 1.04x

1.22x1.11x 1.12x 1.06x

1.62x

1.15x1.27x 1.26x 1.31x

1.09x 1.14x

0.00x0.20x0.40x0.60x0.80x1.00x1.20x1.40x1.60x1.80x

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Global Average Venture Capital by Vintage Year

DPI RVPI TVPI

1.79x 1.47x 1.32x 1.24x 0.78x 0.52x 0.48x 0.46x 0.25x 0.16x 0.09x

0.20x0.36x

0.39x 0.49x

0.64x0.75x 0.81x 0.88x

0.97x 0.98x 0.98x

2.00x1.85x

1.72x 1.71x

1.43x1.28x 1.29x 1.35x

1.22x 1.15x 1.07x

0.00x

0.50x

1.00x

1.50x

2.00x

2.50x

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Global Average PE Fund Return Multiples By Vintage Year

DPI RVPI TVPI

While investors in early vintage funds (pre-2004) have been made whole (their DPI:Distributions to-Paid-in-Capital are greater than one) they still have significant amountsof unrealized value (RVPI: Remaining Value to Paid-in).

As a group, no vintage year funds since 2001 have yet to make limited partnerswhole. All DPI’s are less then one. Potential returns, as measured by TVPI (realizedand unrealized value) are also low across all vintages.

2013 was a good year for distributions, but 2005 to 2008 vintage funds have yet to return all of theirinvestors’ capital

Funds raised during the years leading up to the Great Financial Crisis paid high prices for portfolio companies that lost value duringthe downturn. As a group, these funds have struggled to return capital.

Many are starting to see a recovery in the value of their portfolio companies but as their life‐spans are winding down, limitedpartners are seeking liquidity and the funds’ ability to generate “carry” for their general partners is limited. These have becomeknown as “zombie funds”.

Zombie funds have become targets of secondary funds. The secondary funds provide liquidity to limited partners while creatingnew economics for general partners to actively manage the portfolios to their conclusion.

Source: Pitchbook Source: Pitchbook

M A R K E T E N V I R O N M E N T : R E T U R N S

22

During most vintage years since 2001, top quartile buyout managers haveoutperformed top quartile venture capital funds.

Bottom quartile PE (Buyout) funds have consistently outperformed bottom quartileventure capital funds.

Evaluated as a whole, private equity returns have been average for some time, but skilled managershave delivered attractive risk-adjusted returns over time.

Academic research suggests there is persistence in general partner performance over time, and thus manager selection matters. Areview of performance by quartile reveals double digit differences in performance between the top and bottom quartile funds in bothbuyout and venture capital.

A review of fund performance by quartile reveals that: Bottom quartile buyout funds have consistently delivered superior absolute performance relative to bottom quartile venture 

capital funds.   Top quartile buyout funds have generally outperformed top quartile venture funds.

These results raise a question about the role of venture capital in a client’s portfolio in the absence of skill in fund selection; shouldlimited partners ignore venture and invest only in buyout?

-15%

-10%

-5%

0%

5%

10%

15%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

PE vs. VC Bottom Quartile IRRs by Vintage

PE Bottom Quartile VC Bottom Quartile

Source: Pitchbook Source: Pitchbook

0%

10%

20%

30%

40%

50%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

PE vs. VC Top Decile & Quartile IRRs by Vintage

VC Top Quartile VC Top Decile

PE Top Quartile PE Top Decile

M A R K E T E N V I R O N M E N T : F U N D R A I S I N G

23

The increase in fund raising was driven by an increase in commitments to buyoutfunds as well as to energy and mezzanine focused funds.

2013 fund raising not only saw its best year since 2008, but the return of “mega”funds. Nearly half of committed capital went to funds that raised more than $5billion.

Source: Pitchbook

Positive net-cash flows to limited partners helped fund raising in 2013, but it also saw the return of“mega” funds-those that closed with more than $5 billion of committed capital

After four years of weak fund raising, the amount of capital raised and the number of funds closed reached post‐financial crisis highs.

The primary explanation for a recovery in fund raising is an increase in distributions to limited partners, giving them new capital tocommit to private equity. Other explanations include an under allocation to private equity relative to investors’ policy statements giventhe outperformance of public market equities since 2009.

The increase in fund raising was accompanied by a rise in the proportion of assets committed to “mega” funds (those with more than$5b of committed capital). One explanation is that limited partners are reducing the number of managers they invest with to those thathave been the most successful in the past.

One implication of more capital being allocated to mega funds is the likelihood of more “larger” deals being done than in the last fiveyears.

 ‐

 50

 100

 150

 200

 250

 300

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Billion

s $

PE Fund Raising by Fund Size 

Under $100M $100M‐$250M $250M‐$500M $500M‐$1B $1B‐$5B $5B+

Source: Pitchbook

 ‐

 50

 100

 150

 200

 250

 300

'04 '05 '06 '07 '08 '09 '10 '11 '12 '13

Billion

s $

US Fund Raising by Strategy

Buyout PE Growth Co‐Investment Restructuring Mezzanine Energy Other

M A R K E T E N V I R O N M E N T : D E A L F L O W

24

Buyouts represent a declining portion of private equity deals as GPs see greateropportunity to add value through add-ons and in the growth/expansion stage of venture.

Within US buyout, acquisition of private companies remains the biggest portion ofdeals. Sponsor-to-sponsor transactions have stabilized with recovery of the IPOmarket.

Source: PitchbookSource: Pitchbook

Changes in the make-up of completed private equity transactions suggests General Partners arefinding new ways to generate value for their limited partners

PE‐acquisition of privately held companies continues to dominate deal making. Sponsor‐to‐sponsor transactions which grewsignificantly following the financial crisis have stabilized as sponsors turn to a recovering IPO market for better exit values.

Leveraged buyouts continue to drop as a share of total private equity deals, reflecting a change in how general partners believethey can best create value.

“Buy and build” strategies and taking minority positions in growth/expansion deals have grown in importance.

An increase in capital allocated to growth/expansion deals reflect a change in the nature of venture capital funding. Early roundfunding needs to develop new technology have got smaller but more capital is necessary to see those companies to profitability.

0%

20%

40%

60%

80%

100%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

US Buyout Deals by Source

Private‐to‐Sponsor Sponsor‐to‐Sponsor

Carve‐Out Public to Private

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Q1

US Private Equity Investments by Deal Type

Buyout/LBO Add‐on Recap

PE Growth/Expansion PIPE Platform Creation

M A R K E T E N V I R O N M E N T : D E A L F L O W

25

The share of deals under a billion dollars has risen in importance as GPs engage inbuy and build strategies within buyout, and minority growth/expansion deals.

Add-on deals continue to grow in importance as GPs seek to create value throughbuy and build strategies.

680 867 1107 799 508 725 881 883 838 245

10561300 1476

1047

575

882904 967

757

171

39% 40% 43% 43%47% 45%

49% 48%53%

59%

0%

10%

20%

30%

40%

50%

60%

70%

0

500

1000

1500

2000

2500

3000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014*

Buyouts:  Add‐ons vs Non Add‐ons

Add‐on Non Add‐on Add‐On % of Buyout

0%

20%

40%

60%

80%

100%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014Q1

Investments by Deal Size

Under $25M $25M‐$250M $100M‐$500M

$500M‐$1B $1B‐$2.5B $2.5B+

The changing economics of private equity deals is forcing General Partners to look for new ways tocreate value, leading to changes in the composition of completed private equity deals

The share of smaller deals, specifically under a billion dollars, has grown the last couple of years, reflecting changing privateequity economics.

The increase in capital raised, dry powder waiting to be put to work, and recovery in public equity markets has put upwardpressure on purchase price multiples. In an environment of slow economic growth, General Partners must find other ways togrow portfolio company revenues and earnings to support exit values.

“Add‐ons” , typically smaller deals, reflect an attempt by General Partners to create value by “bolting” portfolio companies ontoone another in “buy and build” strategies. They believe that synergies arising from putting companies together will createvalue.

Source: Pitchbook Source: Pitchbook

M A R K E T E N V I R O N M E N T : D R Y P O W D E R

26

 ‐

 20

 40

 60

 80

 100

 120

 140

 160

2006 2007 2008 2009 2010 2011 2012 2013

Billion

s $

US PE Dry Powder By Fund Type and Vintage

Buyout PE Growth Co‐Investment Restructuring Mezzanine Energy Other

The majority of dry powder in US focused funds is held by buyout funds($400b), and the majority of that in recent vintage funds with several years leftin their investment periods.

The majority of US dry powder dedicated to buyout is held by funds with greater than$1 billion, The limited number of mega buyout deals in which to put capital to worksuggests General Partners will seek out new investment strategies.

Source: PitchbookSource: Pitchbook

Growth in dry powder has negative implications for purchase price multiples, expected IRRs and thecomposition of future private investments

In the competition between fund raising and new deal flow, fund raising continues to win. The result is a rise in the dry powderGeneral Partners have to put to work.

A more granular look reveals that General Partners are sitting on nearly a trillion dollar in global dry powder, over $600 billion of itdedicated to US‐focused funds and over $400 billion of that dedicated to US buyout funds (nearly 5‐years of deal flow).

A legitimate concern is that General Partners, anxious to put that capital to work before their investment period ends, will bid uppurchase price multiples. Others suggest that the composition of dry powder makes its potential impact on purchase pricemultiples less serious. Specifically, that within the pool of buy‐out focused dry powder, only approximately $100 billion is in fundswhose investment period is nearing an end. More than half of dry powder has been raised in the last two years.

Three‐quarters of the dry powder is held by funds with more than a billion dollars. As there are generally not enough large buyoutdeals to put this much dry powder to work, it is likely these larger funds will seek out other types of transactions including add‐onsand minority growth expansion deals.

 ‐

 20

 40

 60

 80

 100

 120

 140

 160

2006 2007 2008 2009 2010 2011 2012 2013

Billion

s $

PE Capital Dry Powder by Fund Size

Under 50M $50M‐$100M $100M‐$250M $250M‐$500M $500M‐$1B $1B+

M A R K E T E N V I R O N M E N T : E X I T S

27

 $‐

 $50

 $100

 $150

 $200

 $250

 ‐ 100 200 300 400 500 600 700 800 900

Value of Exits, B

illions

Num

ber o

f Exits

PE Exit Flow by Type and Value

Corporate Acquisition IPO Secondary Buyout Capital Exited ($B)

After two strong years of exit activity, 2014 is off to a slower start. A recovery in exit price multiples has rewarded partners in earlier vintage fundsbut those high prices are an impediment to returns for new buyers.

Source: Pitchbook Source: Pitchbook

Rising public equity markets, lots of dry powder and aging sponsor-owned companies contributed toa strong exit market

Corporate acquisitions continue to provide the majority of exits for private equity owned companies, but 2013 saw a small declinein its overall contribution to exits, the result of a recovery in the IPO market.

With general partners holding lots of dry powder on one hand and an aging portfolio of companies on the other, the growth insecondary buyout (also known as sponsor‐to‐sponsor transactions) exits is not surprising. They have grown from 25% of all exits in2009 to 39% in 2013; and the average median secondary buyout size has increased from $150m in 2011 to $379m in 2013.

The increase in 2012 and 2013 exits has reduced the ratio of new privately held companies‐to ‐exits, but it is still greater than one,meaning the number of privately held companies continues to grow.

The combination of high purchase price multiple in a low growth environment and lots of companies needing to be sold will lead tolonger holding periods for companies, hurting expected returns.

7.1

7.5

6.7

8.6

9.2

8.1 8.1 8.1

7.3

8.9

6.0

6.5

7.0

7.5

8.0

8.5

9.0

9.5

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Median Valuation/EBITDA At Exit

M A R K E T E N V I R O N M E N T : P R I V A T E E Q U I T Y E X P O S U R E

28

9631238

1704

2275 22792480

27763036

32733466

0

500

1000

1500

2000

2500

3000

3500

4000

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Billion

s $

Private Equity Exposure

Source: Pitchbook

The value of private equity controlled companies now exceeds the market cap ofthe Russell 2000.

2012 and 2013 were good years for portfolio liquidations and distributions tolimited partners, buy holding periods continued to rise.

The growth in sponsor owned portfolio companies has negative implications for returns to futureinvestments in private equity

Ten years ago, private equity firms controlled nearly 2300 companies worth about $960 billion. Today, private equity controls over7000 companies worth nearly $3.5 trillion.

The rate at which private equity sponsors are acquiring portfolio companies is faster than the rate at which they are beingliquidated. Historically, private equity owned portfolio companies are held for around four years before they are turned over andliquidity provided to limited partners. Today, the average holding period exceeds 6‐years.

Rising holding periods in the absence of above average revenue and earnings growth, leads to smaller distributions (TVPI) andlowering realized IRRs.

Source: Pitchbook

4.23.8 3.7 3.5

3.9 3.9

4.7 4.95.3

6.0

0

1

2

3

4

5

6

7

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Years

Private Equity Median Hold Period