With more private equity capital available than ever before, valuations are high — and competition is even higher.
According to PitchBook’s 2021 annual PE breakdown report, which was released on Wednesday, U.S. private equity deals surged in 2021, surpassing $1 trillion in total deal value, an increase of more than 50 percent over the previous record set in 2019. In particular, GP stake deals — in which investors buy passive minority stakes in private capital managers — and the growth equity deal-making space grew significantly in the past year.
As a result, industries experienced intense competition for deals and endured elevated multiples. This forced PE firms to largely narrow their focus to companies with “compelling industry growth trajectories and attractive business models,” thereby perpetuating the competition within industries.
In the report, PitchBook analysts flag the behavioral health industry as one with record-breaking valuations in 2021, a phenomenon that the authors refer to as “runaway valuation growth” due to promising margins. Other industries with record-breaking valuations in 2021 included healthcare (with $733 billion in deal value) and software ($947 billion).
“We’re definitely seeing a lot of sellers’ markets across different industries and a lot of competition to deploy capital,” Rebecca Springer, PitchBook senior analyst, told Institutional Investor. “Some folks may be concerned about what returns are going to look like down the road for capital that was deployed in this environment. If firms didn’t have a value-creation plan that worked and multiples don’t go much higher, what are they going to be able to do with those assets?”
At the same time, Springer said, firms are doubling down on sector expertise and operational plans to improve the companies they invest in. This includes incorporating environment, social, and governance (ESG) factors as a way to add value to their assets. “It’s a high-pressure environment for firms to be deploying capital,” Springer said. “But I think you’re also seeing a lot of strategic and sophisticated strategies as a result.”
The report said that in 2021, GP stake deals continued to flourish. While large players such as Dyal, Petershill, and Blackstone have long dominated the space, last year saw an influx of stake sales from mid-sized firms. “We’re in the next phase of private equity, where there are fewer firms being started but still a lot of capital being allocated to the space,” Wylie Fernyhough, PitchBook senior analyst, told II. “So there’s increasing consolidation and/or strategy expansion in the middle market.”
Fernyhough said there’s an increased willingness among firms to sell as they look for opportunities to expand their business models from a “mono-lined buyout firm” that has a mid-market focus to a firm with “three or four strategies that are all somewhat relevant and intertwined.” He added that limited partners (LPs) also became less skeptical of GP stake deals in 2021 than they have been in the past. The sheer amount of capital pumped into these deals requires more trust from the LPs and more flexibility in terms of using alternative practices, such as bringing in an outside manager. Moving into 2022, PitchBook remains bullish on the GP stake space.
“The whole landscape in GP financing is changing and continues to change,” Fernyhough added. “I think there’s going to be a lot of growth capital injected into a number of GPs.”
In fact, the number of growth equity deals “dramatically expanded” in 2021, with growth equity deal value activity hitting $113.4 billion in 2021, a big jump over the $78.3 billion recorded in 2020. PitchBook analysts attribute the expansion to a convergence of factors, including the fact that companies are remaining private for longer and that venture capital mega-rounds — which are often fully funded by growth equity firms — have risen in frequency over the past year. Additionally, PE firms are investing in “high-growth” sectors of the economy, such as tech and healthcare.
“The thing that stood out to me the most [in the report] was the breadth of activity,” Fernyhough said. “The amount of private capital looking at every angle in the industry is really interesting.”
Fundraising also had a strong year, but it didn’t break any records — a fact that PitchBook analysts attribute to its general “lumpiness.” Instead, the authors believe that much of the funding raised in 2021 will be deployed in the coming year. “We’re expecting 2022 to be really record-breaking,” Springer said.
The fundraising environment is one that favors large managers and funds, Springer said, so many LPs are looking to allocate more to private equity and are looking to do so with managers with whom they have a previous relationship. While the fundraising space is still healthy, many middle-market, first-time, and emerging managers are having difficulty acquiring capital. “They feel like they’re being squeezed out by the larger funds,” Springer said.