While we saw some bright spots for private equity at the end of Q2—particularly with four noteworthy exits—the latest data from Pitchbook shows that Q3 2023 dashed the hopes that Q2 had teased. The PE-backed IPO window remains closed, exits fell to their lowest level of any quarter since the global financial crisis (excluding 2020), and fundraising is nearly 13% below 2022 while time in market averages 15.6 months.
This past quarter, deal activity was focused on smaller, equity-heavy growth or add-on transactions. Secondary and continuation funds, which offer alternate liquidity routes, have gained traction, although the complexity of these deals may limit their widespread adoption.
Here’s where the industry finds itself as we look back at Q3 2023.
Mid-market & specialist funds are making the most of a bad situation
While last year set records, overall U.S. PE fundraising in Q3 2023 has slumped, with the total capital raised down by 12.9%, according to Pitchbook.
Five megafunds closed in Q3, bringing the total for the year to 11. Apollo’s $20 billion fund, which held the title of “largest U.S. PE fund of 2023” for a brief time, was dethroned by the $26 billion of CD&R’s seventh flagship vehicle. Their closure will boost 2023’s total fundraising numbers and rearrange the proportional share of smaller funds. Unfortunately, the average time a PE fund spends in the market has risen to 15.6 months, the longest since 2011. Even some prestigious names—Silver Lake, Carlyle, and BDT & Company—have been out fundraising for longer.
Mid-market funds (between $100 million and $5 billion) have generally benefited from their ability to close and finance deals in the current leverage-constrained environment. They continue to outperform, reaching their highest proportion (58.7% by number) year-to-date of any year since 2009. They account for 50.1% of capital raised this year, a noticeable increase from 2022’s 47.8%.
Meanwhile, specialist groups made up 20.2% of the total fund count thus far, up from 15.4% in 2022, a sign that some LPs are turning to specialist funds for access to unique opportunities.
The rise of secondaries
Along with specialist and middle-market funds, secondaries have been popular with LPs, as shown in the reception given Blackstone’s $22.2 billion Strategic Partnership fund and Goldman’s $14.2 billion vehicle. Continuation funds are also gaining traction. Almost $5 billion was raised for this strategy in Q3: $2.7 billion by Blackstone alongside its recent secondary fund and $1 billion each in vehicles managed by One Equity and Insight Partners.
The exits that aren’t
Q3 started with anticipation, given the three PE-backed IPOs listed at the end of June and one in mid-July. By the end of September, three were trading above their listing price. However, uncertainty about a potential government shutdown kept sponsors from pulling the trigger on the 19 PE-backed companies that have filed or are considering S-1s. Given the ongoing geopolitical and domestic turmoil, whether these companies will list has become an open question.
During Q3, 275 PE-backed companies exited. The $44.1 billion these transactions generated registers as the lowest figure in more than ten years, excluding pandemic-frozen Q2 2020. By value, over half of these transactions occurred through sales to corporates (trade sales). The year-to-date exit value is 43.7% lower than 2022.
Sponsor-to-sponsor exits have continued the decline they first showed at the start of the year, reflecting ongoing economic uncertainty, difficulty setting valuations, and the challenging lending market. Many PE firms expect this trend to reverse based on the amount of dry powder from the past two years.
In the interim, both LPs and GPs are using alternative methods to achieve liquidity. LPs are turning to secondary funds with their GPs’s blessings. GPs use continuation vehicles (also known as GP-led secondaries) to retain promising assets until the exit market strengthens. While this approach addresses liquidity issues, issues around conflicts of interest with LPs have arisen.
Deal activity fumbling toward a bottom
U.S. PE deal activity for Q3 2023 stalled out, dropping values to their lowest levels in six years, excluding the pandemic’s onset in 2020. Quarterly deal counts are down by 34% from the Q4 2021 peak and values by 54.7%. As Pitchbook observed, “Dealmaking has clearly yet to find a bottom.”
The largest deals have suffered the most, likely due to their reliance on leverage, which has fallen to 43.7% (loan-to-value) from a 10-year average of 55.0%. Such leverage that is available comes from the broadly syndicated loan market and private credit funds.
Add-ons and growth equity deals have taken over where large deals have fallen off. Growth equity comprised 15.0% of all U.S. PE deal value, while add-ons accounted for 76% of the quarter’s activity.
Deal pricing has cracked, which may be a good thing
Deal pricing has dropped across the board. Median enterprise value (EV) to revenue multiples fell to 2.0x on a trailing twelve-month basis, from 2022’s 2.4x. For deals in excess of $2.5 billion, the median EV/revenue is down to 3.2x, from 4.8x in 2022, but in line with 2019-2021. Pricing for smaller deals (below $25 million) is relatively unchanged from 2022, at 1.1x.
The overall correction suggests that sellers have accepted the recent reality and are becoming more flexible in their price demands.
Glass is half…something
Commented Axios’ Dan Primack, “If you saw a dealmaker over the summer, odds are that they were on vacation.” Global M&A activity in Q3 was at its lowest level in a decade, and the mixture of global uncertainty, oil price rises, and Congressional mayhem augur for continued malaise.
But U.S. activity through Q3 was much less dismal, and attitudes among U.S. M&A professionals were much more optimistic, according to a survey by Grant Thornton. Resoundingly, respondents expect deal volume to increase in the next six months. Much of this will be driven by greater numbers of small deals as pricing expectations on both sides become aligned.
In addition, deal makers have become resigned or accustomed to higher interest rates. Increasing the equity component of deals was a strategy cited by 45% of respondents, while 66% were exploring alternative financing methods, including net asset value financing and co-investing with minority partners, along with longer holds and negotiating refinancing packages.
A recent academic paper found that such debt renegotiation support helped PE-backed companies come through downturns like this stronger than their non-PE-backed peers.1 Thanks to their PE sponsors, these companies tend to increase market share through acquisitions, especially add-ons, and to restructured borrowing arrangements.
In such a situation, GPs are still called upon to roll up their sleeves and create value. LPs are looking for signposts that indicate a resumption of exits, which will restart the PE flywheel. Until then, the industry is still stuck in the mud–but we hope the tow truck, in terms of more realistic expectations and more creative responses to high interest rates, is on the way.
1 Shai Bernstein, Josh Lerner, and Filippo Mezzanotti, “Private Equity and Portfolio Companies: Lessons from the Global Financial Crisis,” Journal of Applied Corporate FInance, Summer 2020.