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Private equity evolves as it addresses structural challenges
5-MINUTE READ
May 17, 2024
BLOG
5-MINUTE READ
May 17, 2024
Most private equity (PE) firms probably didn’t mind putting 2023 in the rear-view mirror, even with surprisingly positive macroeconomic drivers.
Global growth did not slow as expected. At 2.9%, the rate exceeded the World Bank’s estimate of 1.7% to start the year.i Fueled by a strong US economy, the threat of global recession subsided.ii Inflation cooled,iii slowing the trend of interest rate hikes and increasing expectations for rate cuts in 2024.
Within PE, dealmaking did not recover the same way, but is showing signs of increased activity. Buyouts dropped 15% by volume and 20% by total capital in 2023 from 2022 — which was already a down year from 2021. This was followed by a 6% year-over-year growth in estimated PE deal volumes in the US in Q1, with $126 billion deployed and $70 billion of capital raised for buyouts. In Europe, the first quarter of 2024 saw record capital fundraising equal to roughly half of 2023’s total.iv
Exits, however, were challenged, with total exit volume falling 16% year-over-year in 2023 and another 11% year-over-year in Q1 this year.v This led to a 48% decrease in distributions from December of 2022 to September of 2023,vi raising the hackles of many a general partner (GP) and their limited partners (LPs). Institutional debt became more challenging than ever. For the first time in many years, PE firms wrote equity checks larger than the debt portion of investments.
While PE firms are used to adapting their strategy to cyclical challenges, many firms kicked off 2024 facing additional, structural challenges:
Addressing these structural challenges is not as simple as flipping a switch to hire more professionals or getting bigger deals across the line. Identifying strong talent in a highly competitive market isn’t easy, required capabilities are evolving and developing talent takes time. Moreover, the pool of bigger assets ready for standalone acquisitions has been shrinking. Since 2013, the number of $2-5B revenue private companies has decreased by 12% and $1-2B revenue companies has decreased by 15%.x
As much as these obstacles can be overcome, most other firms can do the exact same thing in the drive to get bigger — leaving everyone in a race for the same talent and the same assets.
Some firms recognize these challenges and have evolved their investment approach. Specialist and mid-market firms mostly sharpened their focus, while bigger GPs have further diversified their strategies and assets.
Last year’s standout in alternative assets was private credit, with $190 billion raised and clear indications from industry heavyweights that they’re leaning into the strategy.xi Firms are entering into the capital structure in different ways to position themselves as near-term providers of stability and long-term growth partners. Another notable performer has been infrastructure, where despite a down fundraising year of $87.7 billion, firms invested $420 billion into deals.xii
Within traditional buyouts, firms looked at even more assets with a broader aperture. Although these deals often come with greater complexity, firms have developed their internal teams, adviser networks and operating playbooks to handle it. We see this most clearly with carveouts. It’s a challenging investment type that demands intensive work early in the hold period and where value can be unlocked using a wide range of operational value creation levers. The share of PE-backed carveouts across all deals was up significantly, from 7.5% in Q1 of 2022 to 10.7% in Q4 of 2023, to 12.6% in Q1 of 2024. Global carveout deal volume went up 179% and capital invested rose 136% year-over-year in 2023.xiii
A positive emerged from challenges: to get deals underwritten, firms needed to find higher-quality assets and routes to greater operational value creation.