The Private Equity Market Has Stalled — And There’s No Easy Fix

Bain & Co. compares the current PE environment to the GFC. One Crucial Difference: Lower rates aren’t coming to bail out indebted companies.

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Illustration by II

With $3.2 trillion in assets waiting for an exit plan sitting in their portfolios, private equity funds are facing market woes unlike anything since the financial crisis of 2008, according to the 2024 global private equity report by consultant Bain & Co. But this time around, the industry may not have the Federal Reserve coming to its rescue.

“The word for this market is stalled,” Hugh MacArthur, chairman of Bain’s global private equity practice, said in the report. “The culprit was the sharp and rapid increase in central bank rates.”

According to Bain, “the numbers are all very GFC-like: Deal value and deal count have fallen 60 percent and 35 percent, respectively, from their peaks in 2021. Exit value is down 66 percent, and the number of funds closing is off by nearly 55 percent.”

Even as it compared the current period to the era following the global financial crisis, Bain noted that “it’s safe to say the private equity industry has never seen anything quite like what’s happened over the last 24 months.”

“Getting unstuck is job one in the year ahead,” he said.

That is going to be a challenge.

Unlike today, after the financial crisis interest rates plummeted, “the economy slowly stabilized, and private equity was able to claw its way back from what many predicted would be its unraveling,” according to Bain. “The resulting period of growth in the years that followed created a private equity industry that is vastly larger and more complex than anyone in 2008 could have reasonably expected.”

In fact, Dan Rasmussen, a former private equity executive whose hedge fund, Verdad Capital, includes strategies that replicate the asset class, thinks “something more worrisome is happening underneath the hood.”

In a recent analysis, he suggested that many private equity-backed companies can’t be easily sold or taken public because they are highly-leveraged — and their performance has been crushed by rising interest rates.

Borrowing rates for the median sponsor-backed company rose from 4.9 percent in 2022 to 7.2 percent in 2023, while the median S&P 500 borrower’s costs only moved from 3.2 percent to 3.7 percent, according to Verdad’s analysis.

Rasmussen noted that private equity lagged public equity markets last year by a large margin, citing Cambridge Associates data. “The easiest explanation is that this is simply the result of smoothing: PE firms didn’t much mark down their portfolios when the market sold off in 2022 and then didn’t have to write them back up as much in 2023,” he said.

Verdad analyzed a universe of North American companies that includes all sponsor-backed private companies with public debt and all public companies with sponsor ownership greater than 30 percent that have gone public since 2019. The firm’s analysis showed that sponsor-backed companies have generally grown faster than public companies. But not in 2023.

Higher interest rates are one plausible explanation, according to Rasmussen. “Private equity firms are significantly more leveraged than public companies. And while public companies tend to borrow long and fixed, private equity-backed companies tend to borrow short and floating, often borrowing in the private credit market rather than issuing bonds.”

PE-backed firms generally have much lower margins than public companies, so this rise in interest costs has meant that the median PE-backed company is actually generating zero free cash flow, according to Rasmussen.

Bain found that interest coverage ratios have dropped from 2.9x in 2022 to 2.4x. “Those are the lowest levels since 2008 and suggest that, for the average buyout-backed portfolio company, paying off interest has already gotten significantly harder,” the consultancy noted.

The consultancy also noted that “close to $300 billion in leveraged loans is coming due by the end of 2025, dialing up the pressure on these portfolio companies.”

Also troublesome is what Bain called a “record-high number of aging unexited companies in buyout portfolios” that has “stanched the flow of capital back to investors.”

“Barring a sharper-than-anticipated drop in rates, sellers will continue to face high hurdles to unloading companies to strategic buyers, other sponsors, or the public markets,” according to Bain.

Without getting distributions from those sales, investors have been hard pressed to commit more money to private equity, leading to the fundraising shortfall. Bain said that the amount of capital raised in 2023 was the lowest since 2018, down 20 percent from 2022, and almost 30 percent below the record high reached in 2021.

While investors are still bullish on private equity, Bain said that “as a practical matter, increasing allocations will come down to cash flows. LPs have been cash flow negative for four out of the last five years, as unexited assets began to pile up.”