Several hundred funds have closed or are not now raising new funds, said Marshall Sonenshine, chairman and managing partner of New York investment bank Sonenshine Partners LLC.
Too much money chasing too few deals has caused funds to bid up prices and bid down returns, he said.
“There have been some spectacular failures and many disappointments in the credit crisis period,” he said.
The higher prices private equity firms are paying will make it more difficult for these firms to make the returns their investors expect and to raise their next fund, Mr. Can said.
“The question for general partners and primary investors is that sellers (of companies) are getting pretty full value. They are not selling cheap,” Mr. Can said.
One reason for the high prices is the overhang, he said.
U.S. private equity funds as of Dec. 3 had a combined $375 billion in assets, net of fees, left to invest from the $915 billion those funds raised from 2005 to 2010, according to research released last month by Cambridge Associates LLC.
The clock is ticking on that mountain of unspent capital, putting pressure on private equity firms to invest the money before the investment periods and/or extensions expire.
“Private equity managers have a lot of money they have to put to work, and that has to impact the quality of the deals,” said Jeffrey MacLean, CEO of Seattle-based consulting firm Wurts & Associates. “We look at the overhang as one indication of what kind of valuations we are likely to get from private equity.”
All things being equal, Wurts executives prefer asset classes that are cash starved because that's where investors can get return from beta, rather than relying on alpha, he said.
Wurts executives “focus more on mezzanine and distressed debt as better ways to play the private markets,” he said.
“We want to invest when there is no money on the sidelines waiting to get into it,” Mr. MacLean said. “That's not the case in private equity. On a risk-adjusted basis, private equity probably isn't as attractive as it once was.”
Another reason for the skyrocketing sales prices is inexpensive leverage. “Leverage is almost free,” Mr. Can said.
Low interest rates mean that a buyer can pay more for companies, he said.
But industry insiders say there are other reasons private equity managers are paying higher prices.