The number of private equity (PE) exits plummeted in 2022, down from 2021’s record deal-making year, according to S&P Global. PitchBook reports that PE exits plunged to 1340 in 2022, down 25% from 2021, rebounding to the lows of the pre-pandemic decade. The 2023 midyear outlook of PwC indicates longer-term trends are the way to win in this dry exit market. – In the coming year, PE funds will focus less on their exit strategy, and the average investment horizon will lengthen.
To further illustrate the point, an estimated 16,000 U.S. companies are owned by roughly 4,500 private equity funds. While 2021 was an exceptional year for PE activity, 2022 saw a return to the pre-pandemic PE slowdown. S&P Global said, “Private Equity crossed a threshold in 2022, exiting an era of exuberance and entering a new period of uncertainty.”
As the length of time needed for firms to raise funds increases, PE funds will increase their holding period beyond the typical 3-5 years. What is a limited partner with a correspondingly limited time horizon to do?
Private equity funds have traditionally provided liquidity to their limited partners by taking a larger portfolio company public via an IPO. But the private market has increased in popularity over the past several years as companies choose to remain private for longer. In 2022, there were 42 IPO exits executed.
PwC cites the following reasons for a delayed exit strategy:
In a secondary exit, a PE firm sells its ownership in a company to another PE firm. These are also called secondary buyouts. In 2019, secondary exits comprised 40% of all PE exits. With liquidity demand on the rise, secondary buyout activity has increased, and some experts expect it to swell in the coming year. There’s a school of thinking that buyers should be suspicious of invitations to invest in a company that has already raised capital from PE investors. After all, what more could the buyer do for the company, especially if it hasn’t yet burned all the capital from the first raise?
But as companies stay private longer, secondary buyouts are an increasingly common exit strategy as there are fewer and fewer companies that have not been backed by private equity. There are more PE firms today with more capital to invest than ever, increasing the chances for a secondary exit.
Firms can easily justify being second to the table when they add value by addressing areas of expertise or concern that the last PE firm did not. And as long as the exiting LPs can justify their prices, these investments can be attractive, considering their time horizons are often shorter than initial round raises.
What is the moral of the story here? It’s more complicated than the assumption that buyers simply aren’t interested. However, PE firms still have to meet the demands of LPs who want to see their returns, and many general partners (GP) are stalling in hopes of a better payout down the line. But by creating a better secondary exit strategy now, GPs can create value for buyers much earlier and avoid a longer investment horizon.
In a 2023 report, S&P Global noted the importance of a renewed emphasis on value creation and “skilled, active private equity fund managers stand to accelerate ahead of the pack” to boost investment performance.
An article for McKinsey, by Guillaume Cazalaa, Wesley Hayes, and Paul Morgan, gave advice for PE funds:
“Because exits are critical in securing overall value, PE funds should consider how to instill the same level of discipline and rigor to exits as they apply to purchasing assets. We are encouraged by examples of great exit practices – but we also note that funds do not consistently adhere to the basic elements underpinning a solid exit: articulating a clear equity story with evidence of both the current and future potential of the asset, preparing ahead of time, and adjusting for context and buyers.”
That narrative is especially important for setting a sale price since private companies will have had little in the way of recent sales to use as comps and because GPs want to keep information about private companies, well, private, as Jean-Marc Cuvilly, a partner at Trivago, told Wharton MBA students.
“We’re dealing with a very inefficient market where pricing is really all over the board,” Cuvilly said in a colloquium called “End Game: What to Do When a Limited Partner Wants Out.”
S&P Global adds that fund managers with deep sector insights will also be advantageous during this slow environment. Managers that can “look beyond near-term uncertainly to the end of private equity’s typical 3-5 year investment cycle” will be poised to spot buying opportunities. As a critical part of value creation and risk mitigation, many experts also cite the need for fund managers to focus on ESG (environmental, social, and governance) risk factors in their operations.
Even in today’s post-pandemic market, by creating a strong value narrative and with management deeply attuned to the sector, perhaps PE funds can better appeal to both strategic and financial buyers, maintaining strong support for those private companies over a lengthier period of time – while, at the same time, letting the original LP’s exercise the freedom to explore their next intriguing investments.
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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):
This is an updated version of an article originally published on June 11, 2014, and previously updated on March 4, 2020.]
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