Private equity investors have remained active in 2023 though at reduced activity levels compared to 2021 / 2022 in light of the strong headwinds of rising interest rates, persistently high inflation and other geopolitical uncertainties.
For 2024, optimism remains among investors about opportunities created by volatility in the markets and private equity's ability to deploy capital in creative ways for high quality assets – this should continue to drive deal volume, which we anticipate will pick-up as we get closer to 2025.
Seller-buyer valuation gaps
The gap in seller and buyer expectation on valuation will continue to be a prevalent theme in the coming 12 months. Seller-friendly terms and high exit multiples are still deeply engrained in the minds of private equity sellers poised for exits to return cash to investors, and the valuation gap continues to be a major factor in determining the launch and timeline of auction processes.
Many sellers are likely to opt for softly marketing assets and engaging in fireside chats and bilateral discussions with potential buyers to land at the right valuation and deal terms in substitution of the glare of a full exit process. Buyers will need to remain on high alert and be willing to move quickly to execute on the high-quality assets as buyers may no longer be able to rely on the more predictable and familiar tempo of a traditional auction process.
The divergence in seller and buyer expectations on valuation will likely continue to translate into more creative consideration mechanisms such as earn-outs, seller notes and other similar value adjustment mechanisms.
Co-investments
In the face of increased cost for debt financing, private equity buyers will continue to place greater emphasis on their ability to equity underwrite the purchase price. In addition to a fund's own ability to stand behind its equity cheque, the ability to execute on co-investments to tap into additional capital will be critical to allow investors to target larger deals.
Many co-investors, such as sovereign wealth funds, are now happy to have their co-investment roles in transactions to be visible with governance rights (such as board seats and more extensive reserved matters) to actively manage their investments – a distinctly different approach to the passive LP style of investing and instead evolving into "co-sponsor" play as many co-investors gear up with a strong bench of deal professionals with differentiated market and sector focus to take advantage of the deal opportunities in an environment with more constrained levels of debt financing.
Sector focus
Strong sector focus and the ability for some private equity sponsors to actively differentiate themselves as niche investors will be a key theme in 2024. Sectors such as services and industrials/infrastructure are currently very active as are certain sub-sectors of healthcare and tech (despite overall valuation concerns in life sciences and technology) – this trend is likely to continue into 2024. Conversely the consumer and retail sectors will continue to be susceptible to volatility, with investors in these sectors focusing on counter-cyclical companies, potential turnaround investments, consumer services and iconic and resilient brands.
Funds with the ability to demonstrate strong sector track record and knowledge will not only stand out in their ability to add value operationally and achieve growth for the right assets, but also will fare much better in a difficult fund-raising environment. Financial levers and loading up on debt are less likely to convince LPs as the most attractive way of growing value for many assets and instead leveraging sector knowledge and connections to find and grow the highest equality assets will be the playbook for sophisticated investors in 2024.
IPOs
One interesting dynamic is that after a paucity of IPOs over the last two years, the US market is poised for a resurgence in the back half of 2024 (and a number of European jurisdictions, including the UK, are looking to improve their listing regimes to try to maintain a market share). A number of our clients are doing the work now to ensure companies are ready to react to even a small window of opportunity for an IPO and, for those planning exit processes in 2024, they are evaluating whether a dual track is a realistic possibility (even if seen as a stalking horse for bidders who are being pushed to the target valuation).
Take-privates
Take-privates will remain an appealing avenue for private equity investors to deploy capital. Though overall PE backed take-private transaction volume has been lower than expected in 2023, the number of successful smaller ticket size take-private deals have remained relatively steady throughout.
There were 40 UK public M&A transactions of >£100m announced in 2023, with the pace increasing through the year. Around 60% of these deals were from financial buyers (who had been largely absent from the UK takeover scene in H2 2022). With interest rates showing signs of stabilising and greater availability of debt financing in the coming 12 months, we expect PE investors to continue to actively assess public assets while valuations remain depressed (relative to global peers). Currently we see a lot of exploratory work in respect of companies listed on the small and mid-cap segments of the UK market in particular.
Carve-outs
Corporate carve-outs, whilst complex, should also continue to be fertile ground for private capital investors. Given the increasingly difficult regulatory environment, we expect more carve-outs being required to address competition concerns on large M&A and for public companies more frequent shareholder activism can also drive carve-out transactions.
In summary, while 2024 will continue to be a challenging environment in which to execute deals, particularly for larger M&A transactions, we anticipate the record levels of dry powder and pent-up demand for quality assets to translate to a busy year for our private capital clients.
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