In an interesting new paper from a couple of young business school professors (Makiaho and Torstila (2016)), recent evidence from the European equity buyout universe suggests that the holding period of private equity investments has lengthened, from about 2.6 years in 2000 to about 6 years in 2015. What’s behind the shift? Is the shift ongoing or just a transitory component of the current business cycle environment? Here’s a review.
Background
First, some background. The following is from page 20 of Mikiaho and Torstila’s paper, representing the average time of exited portfolio companies by exit year.
In the year 2000, the average number of years of holding portfolio companies was just 2.6 years. That was at the height of the technology bubble, something that eventually burst. When the bubble did burst, the length of time increased to 3.6 and 4.0 years in 2001 and 2002 (i.e. the recession years).
From 2003 to 2006, the holding period floated in the narrow range from 3.9 to 4.7. In 2007, at the height of the global housing boom, the holding period surpassed the 5 year mark to 5.1 years. Since passing the 5 year mark, the average holding period hasn’t gone lower, increasing to 5.5 during the global financial recession, then declining to 5.1 years in 2011, and then expanding again, ending 2016 at about 5.9 years.
Source: Makiaho and Torstila (2016)
Possible Explanations for the Trend
What is causing the upward drift in the holding period of private equity investments in Europe? Perhaps the answer to this question lies in a complex mix of management involvement, an increased number of buyout funds, and exit market conditions. A brief discussion of these three possibilities follows.
Management Involvement
One potential explanation is management involvement. The thinking behind this factor is that when management is more actively involved, there may be increased willingness to hold on to a project for a longer period of time. The authors find that buyouts with management involvement have a 43 percent lower exit hazard rate. The following regression output (table 5 of the author’s report) summarizes the empirical “evidence” of this argument. For individuals with less of a background in statistics, circled in blue are the results on management participation. The positive “coefficient” means that there may be a statistically significant relationship between management participation and length of time (in months) of holding on to an investment.
Source: Makiaho and Torstila (2016)
Increased Competition in the Buyout Universe
Another potential explanation is that there’s increased competition in the buyout universe. Various studies have indicated that a record number of new buyout funds were raised prior to the global financial crisis, and that these funds have performed on par or slightly worse than public markets. The authors “show that private equity holding periods are likely to be longer when there are more new entrants in the buyout market.”
Exit Market Conditions
A third potential explanation for the lengthening of the holding period is exit market conditions. The idea behind this is that credit market conditions and “hot” or “cold” private equity activity may affect the holding period of investments.
Conclusion
In the past few years, we’ve seen increase in the length of time private equity firms are holding on to their company investments. The holding period has gone from a low of 2.6 years in 2000 to 5.9 years in 2015.
What’s behind the increase? Among the many potential explanations, three possible explanations include increased involvement of management, an increase in competition in the buyout universe, and changes in the exit market conditions.
Comments on this entry are closed.