Private equity executives have expressed concerns that a significant majority of funds launched during the sector’s recent boom will fail to meet their originally projected returns. Industry insiders estimate that between two-thirds and 90 percent of funds that began acquiring companies from 2019 to 2021 are unlikely to deliver the targeted internal rates of return (IRR).

The surge in dealmaking during the Covid-19 pandemic years was driven by optimistic growth forecasts and historically low interest rates, prompting buyout firms to pay elevated prices for assets. “2021 was such an exuberant year, and a lot of people really invested a lot of money in that year, at very high multiples. So it’s very hard to see in the current environment that they will meet their targets,” said James Brocklebank, managing partner at Advent.

Despite a downturn spanning four years, many funds continue to delay asset sales to avoid locking in losses, according to executives speaking at the Private Equity International Mid-Market (IPEM) conference in Paris. This hesitancy has implications for returns, as IRR relies not only on the value of sales but also on the timing; deferred exits can weigh on performance metrics.

Several senior dealmakers forecast that funds deploying capital between 2019 and 2021 may end up generating average IRRs in the range of 7 to 8 percent. Others suggested low double-digit IRRs are possible, still substantially below the typical high-teen return targets expected after fees are taken into account. This contrasts with the previous decade’s average, when funds returned approximately 25 percent of net assets annually to investors. Over the last four years, this figure has fallen below 15 percent.

One consequence of the subdued exit activity is a reduction in distributions to investors. Consultancy Bain & Company reported that buyout firms exited $386 billion in holdings during the first half of 2023, a decline compared with the same period in 2022. Investors have expressed a desire for liquidity but remain reluctant to accept substantial discounts to current valuations. Roger Vincent, founder of Summation Capital and former head of private equity at Cornell University’s endowment, noted, “If they see that discount, they will assume the valuation methodology is flawed.”

Scott Kleinman, co-president of Apollo Global Management, described the companies acquired between 2018 and 2022 as “good companies bought at too-high prices.” While he anticipates earnings growth over time could lead sponsors to exit at reasonable total values, he cautioned that IRRs are expected to fall short of original expectations due to the elongation of holding periods.

Overall, the private equity sector faces challenges in meeting return targets amid a persistently complex macroeconomic environment, overvalued acquisition prices during the boom years, and investor pressure for both liquidity and accurate valuations.