Private Equity Monthly Newsletter – March 2024

Industry Trends

The new wave in global venture capital

It cites the trends in global venture capital funding in the final months of 2023. Despite a 15% quarter over quarter decline, hitting the lowest level since early 2020, there were some areas of growth. Funding in Europe grew modestly at 7% quarter over quarter due to investments in AI and fintech start-ups. The US secured nearly half of worldwide venture funding primarily due to significant generative AI funding rounds. While early- and late-stage deals saw a decrease, seed-stage funding grew by 17%. Corporate venture capital accounted for 20% of all funding in 2023, with an increase in the fourth quarter due to participation in AI-focused funding rounds. Generative AI start-ups saw an upswing in funding, demonstrating the technology’s transformative potential across industries. Investments in foundational technologies, including large language models, surged last year.

Source: Bain & Company

Anticipating the 2024 private capital landscape

The positive outlook for Private Capital players in Australia for 2024, emphasizes the importance of 'optionality' in both Private Equity and Private Credit. For Private Equity, diversification of funding sources, dual track processes, and execution certainty are key. Liquidity has re-entered the loan market, and sponsors should leverage this to create competition and drive better deal terms. In cases where exits at an acceptable valuation may be challenging, sponsors may need to dual track a 're-setting' of the capital structure alongside any M&A process. For Private Credit, the ability to provide a cov-lite option, flexibility on terms, and flexibility on capital solution will be crucial. Private Credit funds should focus on providing options that compete with what global sponsors can obtain in Northern Hemisphere markets. The ability to deploy across the capital structure and across the life cycle of deals will be valued by sponsors. The key for both Private Equity and Private Credit is to obtain or provide 'optionality'.

Source: White & Case

The evolution of private capital fund formation and investment

In 2023, private capital pooled funds remained a popular investment vehicle, with an expected growth in all major asset classes and an estimated US$24.5-trillion to be invested in the alternative industry by 2028.

  1. Fundraising became increasingly challenging, especially for new entrants and emerging sponsors, leading to a more investor-friendly environment with increased transparency and co-investment opportunities.
  2. The secondaries market grew due to investors' desire for liquidity and portfolio rebalancing, with US$100-billion in secondaries sales in 2022, over half of which were from first-time sellers.
  3. Despite political headwinds, ESG considerations remained important to investors, with many sponsors adopting ESG key performance indicators and viewing ESG as a value-additive factor.
  4. Continuation funds became a popular portfolio management tool, accounting for 50% of the US$132-billion secondary market volumes in 2021 and 10% of liquidity in 2022.
  5. In Canada, many sponsors expressed interest in using a limited partnership governed by Canadian laws as the fund vehicle, although this may not be ideal for funds intending to invest in property with a Canadian nexus.


Private capital markets: A 2024 perspective

In 2023, private equity investors remained active but at reduced levels due to factors like rising interest rates, high inflation, and geopolitical uncertainties. Despite these challenges, optimism about opportunities created by market volatility persists. The year 2024 is expected to be a challenging environment for executing deals, especially larger M&A transactions. However, record levels of dry powder and pent-up demand for quality assets are expected to make it a busy year for private capital clients. Key trends include a valuation gap between seller and buyer expectations, a resurgence of IPOs and take-privates in the U.S. market, an emphasis on equity underwriting and co-investments, and a sector focus on services, infrastructure, healthcare, and tech. In the private fundraising space, high rates continue to apply downward pressure due to expensive borrowing and low valuations. Regulatory costs are rising, encouraging consolidation in the private equity industry. Capital sources are shifting towards high-net-worth individuals and quasi-retail investors. Managers are adopting various methods to secure capital, and the private credit market is expected to continue growing. The secondaries market is diversifying, with increased demand for preferred equity deals and structured secondaries. Regulatory focus will continue on marketing to non-professional investors, ESG, individual accountability, financial crime, sanctions, and the UK’s divergence from EU rules.

Source: Ropes & Gray

A synopsis and the 2024 forecast of private equity

The private equity industry faced challenges in 2023 due to rising interest rates and slower growth, leading to a decline in fundraising and dealmaking. However, successful firms found ways to sustain their investment cycles into 2024. Take-privates became more attractive, especially in undervalued European and Asian markets. M&A in the technology, media, and telecommunications industry showed resilience, and ESG became both an opportunity and a challenge. The number of GP-led secondaries and single or multi-asset continuation funds increased due to adverse economic pressure. The Securities and Exchange Commission’s private fund adviser rule increased compliance obligations for private funds. In 2024, the industry will have to adjust to more complex compliance requirements and increased public scrutiny of deals. The pursuit of retail investors is predicted to intensify, and consolidation in the market is likely. It also highlights some sector-specific deals involving firms like Cerberus Capital Management, KKR, and GIC.

Source: Dechert

Market Sentiments

Big gets bigger: How consolidation is reshaping Private Equity?

It discusses the trend of consolidation in the European Private Equity sector. Fundraising in this sector has been robust, with around €120 billion raised across 117 funds, largely driven by mega funds. The top five funds accounted for over half of the total capital raised, indicating a trend towards larger, more established fund managers attracting most investor interest. This trend is leading to a concentration of funds in the hands of a few large players, with smaller firms struggling to raise sufficient capital. The PE sector is also facing increased regulatory scrutiny and compliance costs, making it challenging for smaller firms to bear these costs. This pressure is incentivizing smaller firms to merge with larger entities. Succession planning is another factor contributing to consolidation, as founders of boutique firms approach retirement and initiate succession plans, making them attractive for larger PE acquirers. It predicts consolidation opportunities for the next 5 to 10 years, allowing existing players to solidify their positions. However, this consolidation could lead to less competition, higher fees, and reduced choice for investors. It also mentions several specific instances of consolidation, such as General Atlantic adding a sustainable infrastructure strategy, BlackRock's acquisition of Global Infrastructure Partners, and Wendel's acquisition of IK Partners.

Source: EY

Alternative investments in 2024: What to monitor?

The investment strategy for 2024, highlights the potential of private markets to deliver competitive returns and diversification benefits. It suggests that private equity has a history of delivering returns irrespective of economic conditions. However, the global interest rate reset post-pandemic has posed challenges. It advises investors to balance growth opportunities with the leverage that may be embedded in them. It also mentions that higher interest rates have resulted in higher yields for investors and that infrastructure investments are growing rapidly due to their ability to deliver diversification benefits and consistent returns. It emphasizes the importance of due diligence and fund selectivity. It concludes by stating that the value of the investment may fall or rise, and investors may get back less than they invested.

Source: JP Morgan

Investing in private credit: Balancing yield and risk

There is a growing prominence of the private credit sector in 2024, a niche that is drawing significant interest for its alternative investment potential. Private credit, defined by lending to companies often bypassed by conventional banks, offers higher returns but also comes with heightened risks such as lower borrower creditworthiness and investment illiquidity. The author, Gianluca Sidoti, shares his experience advising clients to diversify their portfolios by investing in sectors like tech and renewable energy, which have shown robust growth and resilience. To mitigate risks in the private credit market, a diversified fund approach is recommended, spreading the risk across various sectors and borrowers. Emphasizing senior secured loans within this strategy can further safeguard against capital loss. The evolving economic recovery landscape presents distinct opportunities within the private credit market, especially in sectors characterized by innovation and resilience. Success in private credit investment requires meticulous due diligence, understanding of market dynamics, and economic indicators. The integration of technology and data analytics into private credit investing is revolutionizing the sector, enhancing the precision of credit assessments and portfolio management.

The dynamic regulatory landscape of the private credit market necessitates a vigilant and informed approach. The commitment to private credit investing is inherently long-term, and the increasing emphasis on sustainability within this investment domain highlights the importance of incorporating environmental, social and governance (ESG) considerations into investment decisions. It concludes by emphasizing the value of strategic advisement in navigating this complex market.

Source: Forbes

Private markets: A slower era

It discusses the state of private markets in 2023. It highlights a slowdown in fundraising and deal activity, with full-year fundraising declining from 2021's peak due to rising financing costs, an uncertain growth outlook, and a less active deal market. Performance in most private asset classes remained below historical averages for a second consecutive year. Despite these challenges, limited partners (LPs) remain committed to private markets, with many planning to maintain or increase allocations over the medium to long term. It also notes a trend of investors favouring larger funds and known names, with fundraising concentration reaching its highest level in over a decade. New manager formation fell to its lowest level since 2012. Private markets assets under management totalled $13.1 trillion as of June 30, 2023, with dry powder reserves increasing to $3.7 trillion. In terms of specific asset classes, buyout and venture capital diverged significantly, with VC being the fastest-growing and highest-performing PE strategy from 2010 to 2022. PE buyout entry multiples declined, and technology multiples have declined by nearly three turns in the past two years. Real estate faced challenges due to demand uncertainty, slowing rent growth, and elevated financing costs. Private debt proved to be the most resilient asset class, posting the highest returns among all private asset classes through September 30. Infrastructure fundraising declined by 53%. It also highlights the slow progress in diversity within private markets firms and the excitement around the potential of generative AI in optimizing various aspects of private market operations.

Source: McKinsey & Company

The emerging strategic M&A play in private equity

There is a high impact of rising interest rates on the PE industry. Over the past decade, ultra-low interest rates have benefited the PE industry, leading to a quadrupling in size since 2010. However, central banks have recently been raising interest rates faster and higher than anticipated, making PE investments less appealing due to higher opportunity costs and greater uncertainty around returns. This has led to investors recalibrating their exposure to the PE sector and increasing pressure on PE firms to return capital. In response, some PE firms have resorted to continuation funds or borrowing more to fund distributions to investors. However, these tactics are not sustainable, and PE firms will likely need to start selling assets at lower valuations. This situation presents opportunities for strategic acquirers who can buy quality assets at more reasonable valuations. It concludes by suggesting that well-capitalized players who are willing to act quickly may reap significant rewards in the current market environment.

Source: Private Banker International

Market Opportunity/Challenges

Unlocking opportunities in the private middle market through direct lending

The volatility in global markets over the last five years due to events such as the COVID-19 pandemic, the rise of US interest rates, a short-lived US regional banking failure crisis, and increased global geopolitical conflict. These events have led to declines in fixed income securities, a drop in M&A volumes and valuations, rising default rates, and the threat of a pending recession. It also highlights the challenges of depressed M&A volumes and underperformance at the borrower level due to high debt service burdens. It further discusses the growth potential of middle market companies in the US economy, driven by cyclical factors like M&A activity and non-cyclical factors like the need for organic growth capital. It emphasizes the importance of robust portfolio management and monitoring to mitigate risks.

Source: Man Institute

The road ahead for direct lending

The direct lending market has witnessed strong growth over recent years. The direct lending market is evolving into an important financing vehicle to support the transformation of small- and medium-sized enterprises across multiple sectors of the European economy.

  1. The size of the private debt market globally is expected to grow to an all-time high of US$2.8 trillion by 2028 with direct lending constituting roughly half of the total debt market.
  2. Direct lending offers financing opportunities for the European transformation, such as in the digital transformation, where small- and medium-sized enterprises play an important role.
  3. From a geographical perspective, Benelux and the Nordics are catching up with the traditional direct lending core markets of the UK, France, and Germany
  4. Geopolitical risk and muted economic growth have meant the sector focus for direct lending has been skewed towards non-cyclical sectors with technology and healthcare dominating the deal pipeline. A pick-up in lending to consumer facing sectors is now beginning to emerge.
  5. We expect margins in direct lending to follow the repricings seen in the liquid market implying further tightening ahead. The driving force behind a more aggressive pricing strategy is the demand for deals that is anticipated to far exceed supply.
  6. Sustainability linked loans have also become a route to support sustainability ambition among lenders and borrowers. These introduce certain KPIs such as carbon emisison reduction or energy efficiency targets to the borrowing costs of the loan.
  7. Efforts are underway to improve sustainability data collection, monitoring and verification which should introduce more transparency into the sustainability linked loan market where issuance has dropped significantly since its 2021 peak.

Source: DWS

Sector Update

Navigating software private equity in 2024

The software investing environment has seen significant changes in the past five years, with a period of intense investment followed by challenging years. Currently, there is a significant volume of dry powder available, CIOs have reopened spending, and rebalanced valuations have led investors to reengage on potential transactions. Five key considerations for software investors have been identified:

  1. The slowdown of private markets in software is seen as an opportunity for investors.
  2. Generative AI is driving disruption and innovation across software segments, with an estimated $250 billion of potential spending on gen AI applications.
  3. CIOs are expected to continue to spend on software, with spending likely to increase in cybersecurity and data and analytics as companies develop their gen AI capabilities.
  4. Investors are rethinking their software investing approach, exploring long-term bets, carve-outs, and take-privates.
  5. Software companies contemplating exiting in the next 12 to 36 months could consider implementing improvement initiatives for value creation.

Investors and software companies are considering pricing and packaging, go-to-market effectiveness, cloud "FinOps", R&D effectiveness and productivity, and M&A as disproportionate priorities in 2024.

Source: McKinsey & Company

AI Scope/ Trends

Futuristic finance: AI's seductive power in reshaping private equity

Currently, AI is primarily used for data analysis, deal sourcing, and risk assessment, with firms like KKR & Co. and Blackstone leading the way. AI's ability to process vast amounts of data helps identify investment opportunities and assess risks. However, there are still many untapped areas where AI can be utilized, such as due diligence, personalized investment strategies, real-time portfolio optimization, regulatory compliance, and ESG criteria analysis. Despite challenges like data privacy and ethical use of AI, the integration of AI into private equity is seen as a transformative force that can lead to innovation, efficiency, and growth. It concludes by encouraging firms to embrace AI and explore its potential.

Source: Forbes

AI: Revolutionizing the private equity landscape

There is a transformative impact of AI on private equity and principal investment spaces. It highlights how AI can enhance deal sourcing, deal insights, process management, and exit automation management. Generative AI can reduce the time spent in deal sourcing by private equity firms by 50-60% and provide a 6-7% productivity gain and a 3-4% revenue uplift. It features a conversation between Emerj CEO Daniel Faggella and Bhuvanesh Abrol, US Private Equity Consulting Leader at Deloitte, discussing the potential impact of AI on private equity operations. They discuss the use of AI-driven bots for expedited diligence and focusing AI adoption on top-line growth and outcome-driven impact. Bhuvanesh emphasizes the importance of data analytics and AI in understanding market trends, company performance, and potential value-creation themes. He also highlights the potential use of conversational AI engines to address simple queries and interactions. It discusses the importance of AI in exit strategies for investments and the need for a comprehensive data strategy to leverage AI’s potential holistically through the entire organization.

Source: Emerj

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