Seven trends for Private Equity to consider in 2023

Insight:

Relatively limited deal flow and larger PE funds becoming more flexible in sourcing deal opportunities have resulted in a highly competitive mid-market landscape.

Trends:

Globally, macroeconomic and geopolitical factors have influenced activity levels across the PE spectrum. However, we believe that better access to capital has enabled the mid-market to display more resilience.

In an inflationary environment where interest rates are the highest since 2008 and lending has tightened, private equity firms will sharpen their focus on bolt-ons to facilitate portfolio companies’ entry into new markets or geographies as well as sectors that offer relatively lower risk, such as life sciences and niche consultancy businesses.

Insight:

The amount of time taken to raise funds has been increasing, and that dynamic is likely to persist in the short term.

Trends:

In 2022, the average number of months to 'final close' hit 20 months for the first time since 2010 according to Preqin data. In some instances Limited Partners (LPs) were asking their General Partners (GPs) to push out some of their fundraising efforts because they were unable to keep up with the re-up requests from GPs raising subsequent funds.

LPs who have experienced the "denominator effect" - becoming overallocated to private

equity given public market indices - will be reluctant to make new commitments and the declining rate of exits, of course, exacerbates these dynamics.

For LPs re-committing capital, we foresee risk aversion influencing a trend towards fund managers with proven, and lengthy, track records. However, emerging managers specialising in sectors that align with LPs’ strategies and values will still attract investment.

Insight:

Fund managers are using the current market situation as an opportunity to prepare their investments for exit and execute the necessary steps to be in a position to act quickly.

Trends:

The appetite for exits has steadily declined since Q4 of 2021 as firms have opted to hold onto their investments rather than sell into a perceived weak market. As a result, some PE funds are beginning to feel pressure to divest portfolio companies and return money to LPs.

Exit planning remains integral to portfolio management, regardless of the vagaries of the wider market. This is especially pronounced when expectations around valuation multiples may be lowered and goes beyond ensuring operational and financial controls are fit for purpose.

Read: Optimising Value - The Importance of Planning

Insight:

Environmental, Social and Governance (ESG) risk assessment is still fairly nascent and private equity thrives on capturing value from innovation. Rather than being solely a defensive measure, the application of sound principles can prove a positive differentiator.

Trends:

Fund managers are incorporating ESG risk factors and policies into their due diligence, operations and brand identity. Awareness and widespread acceptance of this has resulted in the introduction of a burgeoning number of in-house teams at PE Houses dedicated to ESG as well as advisory firms enhancing their due diligence capabilities.

ESG screening is critical to value creation and risk mitigation, protecting investments from risks like health and safety violations, fraudulent governance practices and extreme weather. In turn, funds with a clearly defined ESG strategy and approach are likely to enjoy more lucrative fundraising opportunities, improved brand reputation and lower-cost capital.

Insight:

The labour market is competitive and employers' priorities are to retain existing talent and reduce hiring.

Trends:

Filling skilled roles in the UK is still a challenge, even if not at quite the same level as in the US. Indeed, the UK is a potential source of talent for US firms given its highly skilled workforce, relative wage inflation and the exchange rate. This is most noticeable in industries where people are critical and there is a strong regional capability such as Life Sciences in Northern Ireland.

Labour, interest rates and inflation are caught in a cause-effect cycle. One goal of higher interest rates is to increase borrowing costs for businesses so they cut back on hiring, theoretically slowing wage growth and impeding consumer spending, and ultimately lowering inflation.

Insight:

With high-yield bond and syndicated lenders in skittish territory, dealmakers have been turning to private credit financing - loans negotiated outside the traditional track of bank lenders.

Trends:

In the UK mid-market, there is a healthy and active debt market seeking to support PE transactions and leveraged buyouts. Lenders include private debt funds and alternative banks as well as the traditional clearing banks.

Interest rates may be higher than those offered by risk averse traditional lenders but private credit lenders are less prone to pull out of a deal at a late stage. Our recent experiences highlight you can still meet funding objectives through competitive tension to deliver innovative debt structuring solutions.

While we predict private credit will continue to gain share of debt, if economic conditions do not improve these lenders could look to prioritise deals in sectors or industries considered recession resilient.

Insight:

Effectively and actively managing operating models to achieve sustainable profitability and cash generation will be critical in gaining competitive advantage – attributes ultimately reflected in increased valuations.

Trends:

Value creation levers are being drawn into sharp focus by the pressures on constrained supply chains as well as wage, raw material and energy inflation. In addition, as government COVID loan schemes need to be repaid and changes to business rates begin to bite, astute financial management will be paramount.

Fund managers are working closely with portfolio company management teams to manage the impact on profitability and working capital cycles. This includes the development of digital transformation strategies and leveraging the knowledge of industry experts.