One of the main challenges when investing in U.S. private equity today is determining which managers will be able to generate attractive returns in the current high-purchase-price environment. Manager selection — always of paramount importance to the success of private equity programs — is even more critical in today's highly competitive and very expensive marketplace. Limited partners need to look at myriad characteristics of general partners to assess which managers are best positioned to deliver outsized returns going forward.
It is no secret that purchase-price multiples have returned to, and in some segments exceeded, the peak levels of 2007. This is primarily because of the increased number of private equity firms competing for a limited number of high-quality deals, the increasing efficiency of a more intermediated market, the high level of dry powder and the current favorable access to ample debt. One positive aspect of high multiples is that GPs are able to exit portfolio companies at attractive valuations, often with a fair amount of multiple-arbitrage helping to amplify the returns; however, GPs and their investors cannot expect this situation to continue indefinitely. Prudent GPs should plan for some degree of multiple contraction in the exit planning of companies purchased at today's high multiples.