Private Equity Firms’ Return Expectations Remain High Despite M&A Slow Down

A new survey from Churchill Asset Management found that 81 percent of PE executives expect the same returns for investments made in 2023 as they did in 2022.


Lila Barth/Illustration by II

Amid a challenging investment market, private equity firms aren’t yet willing to temper their return expectations — even as deal flow has waned.

A new survey from Churchill Asset Management found that 81 percent of PE executives expect the same returns for new investments made in 2023 as they did in 2022. Only 3.2 percent expect lower returns. Churchill, an investment affiliate of Nuveen, provides customized financing to middle market private equity firms and their portfolio companies across the capital structure. With $46 billion of committed capital, it provides first lien, unitranche, second lien, and mezzanine debt, in addition to equity co-investments, secondary solutions, and private equity fund commitments.

Churchill recently polled 95 of the private equity firms it works with about M&A deal flow, return expectations, specific strategies, and sector allocation changes in 2023 compared to 2022.

“Valuations are a little muted relative to the last couple of years,” said Jason Strife, senior managing director and head of private equity and junior capital at Churchill. “What we’ve generally observed through our equity co-investment strategy is a two turn of EBITDA correction in valuation multiples.”

Despite the downward trend in the past two years noted by Strife, private equity firms expect valuations to remain relatively steady year over year.

Private equity managers also are holding onto portfolio companies longer for a couple of reasons. Some are using continuation funds to hold onto their “crown jewel” portfolio companies, while others are choosing to wait out an uncertain interest rate and slow M&A environment before buying or selling new assets.

“There’s just simply too much execution risk in the capital markets for you to have a very robust M&A climate,” Strife said.

This will eventually bounce back, although it will take time, according to Churchill. The majority of private equity firms surveyed — 53.7 percent — said they believe M&A activity will return to normalized levels in the first half of 2024. Meanwhile, 24.2 percent said they expected deal activity to reach normal levels in the second half of 2024.

In the interim, the types of private equity deals that are getting done has shifted, said Strife’s colleague and Churchill managing director, Anne Philpott. Add-on transactions, which involve a private equity sponsor buying small companies to add to an existing platform, are gaining momentum.

The rest of the market, though, is frozen to some degree.

“Mostly what we’re seeing is when there’s a gap between buyer and seller valuations, they may hold onto that asset a bit longer,” she said. “Once the disruption in the market settles, they can get the valuation they expect.”

The use of co-investments has stayed steady, with 73.7 percent of private equity firms saying the challenging investment environment has not resulted in changes to their use of the strategy.

Although private equity firms said that their relationship with limited partners was the top consideration when making co-investment decisions, speed and the ability to provide committed equity financing ranked second and third, respectively.

As many allocators are contending with the denominator effect and have put new investments on hold, the market has opened up for PE fund investors like Churchill.

“It’s harder for private equity firms to raise funds through their own fundraising efforts, Strife said. “A lot of subscale co-investment competition is out of the market because their primary market flows are down as their distributions have waned.”