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Where Private Equity Will Find New Deals

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Where Private Equity Will Find New Deals

Where Private Equity Will Find New Deals

A significant shift in private equity strategy will be necessary to justify new deals as macro headwinds threaten to change the tide of banner years for deal transactions and valuations.

Private markets enjoyed unprecedented growth just 18 months ago. The entire M&A market recorded a historic high of $5.2 trillion total dollars invested in 2021.1 Easy monetary policy and a roaring stock market inflated valuations that facilitated astronomic deal flow. A series of rate hikes and persistent inflation in 2022 though were followed by a gradual decrease in deal flow, and an eventual sharp drop-off compared to 2021 highs. The end of 2022 saw an exit-to-investment ratios less than .4x – the lowest figure since the global financial crisis.2


Moving further in 2023 after several more rate hikes and increasing inflation, valuations have begun to take a hit and investors will need to get creative to get the deal done.

Quality over quantity

Amidst repricing, higher quality companies will be more likely to weather the storm. Liquidity fundraising will likely take the brunt of the tightening and see down rounds, but higher quality companies with solid balance sheets will not be as likely to see valuations reduced.

The shifting economic landscape has applied a reset to private equity markets but has also ushered in a different type of investment opportunity.

Despite macro volatility and private equity deal volume down, the take-private market soared in 2022, recording 91 public-to-private transactions worth $245 billion.3 Technology, media and telecommunications companies accounted for some of the largest transactions – 8 out of the top 10 take-private deals involved tech and media companies.

Private equity was able to profit off a historic sell-off year for the tech sector, which helped to buoy sharp deal declines. Take-private activity is expected to increase in 2023 as a bear equity market continues to threaten valuations of all asset classes. Public companies who may very well be properly valued might decide the pressure of meeting quarterly earnings or paying out a dividend is not worth the trouble in this interest rate environment.

This presents private equity GPs and LPs with a significant opportunity for creative dealmaking in a year that would otherwise not present itself with as many traditional transactions. As volatility remains, firms might not secure the debt financing to secure larger deals, but multiples for public tech companies remain low and well-valued mid-size companies that could use a lifeline will be ripe for the private taking.

Additionally, the slump in tech does not mean there is waning interest in transactions overall. Other markets, specifically healthcare, are still attracting investors and getting deals done. Although deal volume fell last year between 20-30%, the private equity healthcare experiences its second strongest year on record.

Further, this is a significant opportunity for private equity firms to rethink their talent pool. Massive tech layoffs have spilled high-quality, skilled engineers, developers, coders etc. into the available labor market, and private equity companies who have decided to take transactional pause this year might instead decide to strengthen their employee base or that of their portfolio companies in preparation for the next bull market.

The year of the add-on

Exits remain low in 2023, but mergers and acquisitions will still happen – just perhaps not in the way most expected. In addition to the take-private opportunities, private equity companies will likely see a number of add-on opportunities for their platform investments and portfolio companies.

Private equity investors are holding off on larger big-ticket buyouts with high interest rates and expensive debt, but add-ons garnered robust interest last year. In 2022, add-ons comprised 77 percent of U.S private equity deals, representing a 3 percentage-point increase from 2021.4

These smaller-sized acquisitions are a smart way for private equity companies to meet their capital deployment mandates, and offer much0needed reprieve in a historic year of interest rate hikes and skittish investors.

The recent banking crisis and SVB fallout might make some investors pull away from certain add-on opportunities. Add-ons are beneficial for adding revenue in a cost-effective way, and this is often achieved through lower middle market acquisitions for portfolio companies purchased at a good price. If credit is too expensive, or banking fears cause investors to prefer to avoid the risk altogether, the potential problems of the add-on might outweigh the potential benefit.

Private equity investors still interested in add-on deals might look to the middle market for companies with solid balance sheets and good valuations to circumvent this. The end price might pull higher, but there are still companies available that may bring enough value and revenue to ride out the current rate wave until debt becomes more affordable to sustain larger deals.

In ideal economic times, organic growth through traditional investments and fundraising is preferred for the private equity market. During market downturns though, it’s difficult to make the case against the add-on, be it as it may not ideal. Overpaying for a platform deal, especially in this kind of interest rate environment, is simply worse.

Private equity transactions have slowed, but private equity markets remain robust after considerable growth. Over the past 10 years, AUM increased from $2 trillion in 2013 to $4.4 trillion just last year.5 Investors will need to get creative to get the deal done, but the shifting landscape and interest in private equity is sustainable enough to ensure dealmakers will sustain transactions – if they know where to look.

1 Refinitiv, as of December 31, 2022.

2 Based on reported PitchBook data, as of December 31, 2022.

3 Based on reported PitchBook data, as of December 31, 2022.

4 “PE turns to add-ons with large LBOs out of reach,” PitchBook, as of May 16, 2023.

5 “Three ways CFOs are adapting to emerging private equity trends,” 2023 EY Global Private Equity Survey.

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