Private Equity Still Looking To Achieve Growth in a Tight Deal Market

2021 was a tough act to follow in private equity (PE) deal volume, and it’s safe to say we’ve since crossed the horizon into a new period of uncertainty. But even though headwinds and inflation put a damper on PE activity in Q1 2023, PE dealmakers are still moving ahead — albeit with a more critical eye. 

Data from Global Private Equity Dealmaking 2023, featuring market data from PitchBook, indicates that general partners (GPs) are still sitting on record levels of dry powder while they find their footing in a turbulent market.  

The state of PE in 2023 

Given recent stress in the banking sector and the high cost of capital, it’s not surprising that PE fundraising and exits are slow. And if the muted deal volume of Q1 2023 is any indicator of what is to come, the next few quarters could represent a significant decline from previous years.  

As firms acclimate to these challenging conditions, there’s still reason to believe they will find opportunities for inorganic growth. So how can fund managers deliver value to their investors in a suboptimal dealmaking environment?  

Internal transformation 

While the “buy-and-build” strategy has historically comprised the majority of total buyout activity, current economic obstacles to organic growth could bring even more focus to add-on deals. So far in 2023, add-ons represent 76.6 percent of global PE buyout deal count and 62.2 percent of deal value.  

With budgets being less flexible, add-on deals allow firms to multiply the value of their existing portfolio companies with cheaper transactions that carry lower risk and draw less scrutiny from limited partners (LPs).  

Source

Enhancing technology offerings and exploring new market opportunities helps companies stay relevant, especially in fragmented markets like the B2B and IT sectors. The B2B sector, whose presence in the add-on market has grown steadily since 2020, accounts for more than 54.8 percent of global add-on deal value to date in 2023. IT ranks third highest at 11.2 percent and is consistently in the top three.  

Add-ons can also be advantageous for target companies, allowing them to add more value and achieve better outcomes than through other exit strategies — i.e., initial public offerings (IPOs) and secondary buyouts — which are less viable in the current environment.  

Navigating high borrowing costs 

While deals above USD one billion still represent the lion’s share of aggregate value, high borrowing costs and low company valuations are bringing attention to smaller deals, which pose fewer financing challenges. To date in 2023, deals under USD 500 million represent 24.7 percent of total deal value — up from 17.4 percent in 2022.  

Market conditions are also exerting downward pressure on valuations. And while this gives firms exposure to discounted prices, there is still the matter of debt financing. The median debt percentage in buyout deals has dropped by five percent from 2022 through Q1 2023, continuing a downward trend that began in 2018. Since traditional lenders are reluctant to finance large deals in a high interest rate environment, GPs may turn to private credit firms and larger equity contributions for leverage.  

Looking ahead 

Will financing challenges and revised investor allocations amid the current unrest create liquidity pressures for PE firms? Either way, GPs will leverage their expertise and capital to execute deals. But it will be interesting to see whether they opt to mitigate risk or seek out more disruptive opportunities. 

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