Unpacking Private Equity Performance

Abstract

Performance analysis of private equity funds is challenging because fund ownership does not tade in a liquid market with observable prices. Instead performance analysis, especially during a funds life, must rely on observed cash flows to and from the fund and quarterly net asset value (NAV) estimates. Further complicating the analysis are the increasingly common practices of funds using subscription lines of credit (fund-level debt) and recycling capital. Even the variation in the timing of capital deployment across funds has important implications for common performance measures used to evaluate funds such as internal rate of return (IRR) and multiple on invested capital (MOIC). In this paper, we analyze a set of simulated funds to better understand how fund performance analysis is affected by these common issues. Overall, our analysis suggests that intermediate IRRs – i.e., values likely observed during fundraising periods for subsequent funds – are strongly affected by subscription lines and deployment pacing. Intermediate MOICs are only weakly affected by subscription lines, but strongly affected by capital deployment pacing. Both IRRs and MOICs are strongly affected by recycle deal accounting methodology. Consequently, LPs need to be very cognizant of these issues when measuring and utilizing fund performance measures during the life of a fund as well as when assessing ultimate performance at the end of fund life.

Keywords: private equity, venture capital, subscription lines, capital recycling, internal rate of return (IRR), multiple on invested capital (MOIC)

JEL Classification: G11, G23, G24