With only 73 new private equity funds closed in Q1 2023, this year is on track to be the worst year for new funds since 2018. But will that trend continue, or has private equity reached the bottom of the trough? Our recent webinar, The State of Private Equity, looked at what’s happening in the world of private equity.
Here are the three biggest takeaways from panelists Jay Farber of Juniper Square, Daniel J. McQuade, P.C. of Kirkland & Ellis, Nake Grewal of Wells Fargo, and Elizabeth Weindruch of Barings.
The denominator effect isn’t letting up this year
Private equity fundraising has slowed due to many factors, including the denominator effect, which panelists suggested the industry will be talking about for at least the rest of 2023. One of the biggest factors driving the denominator effect is “so much pent-up capital from years of investments without any exits,” said Grewal.
Until exits start to happen—and Q1 2023 marked the lowest exit value since Q2 2022—LPs will be less likely to make new PE investments, partially because roughly 80% of PE’s capital comes from reinvested distributions. The exception might be those "blue chip" firms that have the name recognition and reputation to keep LPs investing the limited dollars they do have. As reported in the Juniper Square Q1 recap, funds larger than $5 billion raised 52% of 2022’s capital, and for funds less than $100 million: they raised barely 2%. How long might it take for average PE firms to raise their capital targets? Weindruch suggested that “Whereas it used to take a year, 18 months, it’s now going to be upwards of 25 months.”
While its effect may vary from LP to LP, McQuade believed that the denominator effect would continue to be a core constraint in what new investments LPs are willing to commit to over the rest of the year.
Great opportunities still exist for first-time funds with experienced teams
While she believes there are many interesting opportunities in the market right now for first-time funds, Weindruch was clear that the opportunity isn’t for first-time teams. She believed the best opportunities exist for experienced teams—those already working for an established GP—who can branch out and start their own funds. Rather than stick with a larger firm investing in multiple sectors, where one sector is underperforming and “bringing everything down,” Weindruch argued that “the best option is for them to leave and start their own firm.”
The new fund’s core team will bring decades of experience, relationships with service providers, and name recognition to get a leg up on other first-time fund managers. She suspected many of those pursuing these opportunities might start as independent GPs, rather than as a blind pool, then work their way up to funds.
Credit markets need to normalize so that exits can resume
The crisis of the regional banking system has had a sizable impact on the availability of liquidity. With regional banks becoming much tighter with their balance sheets, larger banks are seeing increased demand. In response, they’re focusing more on relationships, with a more methodical approach to deploying capital to maintain their own balance sheets. Grewal noted that where a PE firm may have previously been able to fill a deal with ten banks, it’s “now going to be filled with 15 or 20 banks because each bank is committing a smaller dollar size than they have in years past.”
So how will the industry know that credit markets are beginning to normalize? Grewal said he would look for an ease in tension when it comes to liquidity, noting that as some of that tension goes away, leverage profiles may reduce, freeing up capacity and normalizing interest rates. He hoped that over the next six months, “we’ll see balance sheets free up and things become more like an oiled machine rather than the clunky feeling we have now.”
View the full recording of The State of Private Equity webinar now.