There were roughly 250 U.S. focused private equity funds raised between 2005 and 2007, raising $222 billion, according to data from Preqin. This compares to only 38 U.S. focused funds raising $32.1 billion in 2009.
Dréan says that many of the new entrants were “me too” operations raised by institutional investors with little direct investing experience, and whose returns have been dreadful.
“Most of these funds will have a tough time going forward. It will be difficult as to their next fundraising,” he says.
Another factor that could lead to a shakeout? The bubble’s overinflated valuations (up to 12x EBITDA)and leverage multiples (up to 9x EBITDA). With the recession, the same businesses are now selling for much lower prices, sometimes as low as 6 to 8 times EBITDA. But they still have to pay off the debt. Dréan estimates that PE portfolio companies will have to pay off or refinance $460 billion of leveraged loans between 2012 and 2014.
“They won’t have enough equity value to pay back the debt,” Dréan says.
If the debt isn’t repaid or refinanced, [the companies] “will have to go away from their current owners,” Dréan says. This means that creditors, in some cases, could take over the companies. Several buyout shops–Warburg Pincus, Sun Capital and DLJ Merchant Banking to name a few–have seen some of their portfolio companies file for bankruptcy protection.
Dréan estimates that as many as 50% of funds could disappear in the next three to five years. “This is a guess,” he says. “The shakeout will be huge.”