Private equity appears to have made it through the failure of Silicon Valley Bank and others last month unscathed. Or has it?
Deal volume fell 9.3 percent to 2,711 transactions, even as the value of deals rose 11.7 percent in the first quarter of 2023. Within seven days of SVB’s demise and the other turmoil it caused, private equity firms announced five mega buyouts worth a total of $31.3 billion. That included the largest of the year: taking Qualtrics private at $12.5 billion. “Clearly, PE dealmakers were undisturbed by the events that preceded and followed the SVB meltdown,” PitchBook said in its quarterly private equity report.
But while the number of deals and their size have remained close to flat in recent quarters, transactions themselves have materially changed. “A lot of firms are getting more creative and finding ways to get deals done,” said Kyle Walters, an associate private equity analyst at PitchBook.
Regardless of what is going on in the banking sector or markets more broadly, the cost of capital is up, money raised needs to be deployed, fundraising is getting tougher, and private equity firms are pulling out all the stops to smooth the way for transactions.
A handful of mega deals in the first quarter helped raise the total value transacted, but deals are generally shrinking in size. Smaller deals are more “digestible,” easier to finance, and can “keep the leveraged buyout (LBO) machine functioning,” PitchBook said in its report.
Many more deals are add-ons, or acquisitions by existing portfolio companies, which are easier to borrow against and can generate some revenue and earnings growth to cover the escalation in interest costs.
Private equity firms are also doing more growth equity deals, which are smaller and don’t rely on debt. Buying smaller pieces of larger companies has seen a resurgence. “PE firms are also buying up founder-owned private companies more than ever before as a percentage of overall deal flow,” according to PitchBook.
All-equity, club deals, especially at healthcare-focused firms, and co-investments are also happening more frequently. That’s a way for private equity firms to shrink the checks they write. Co-investment fundraising was up in 2022 for a third consecutive year, while the rest of fundraising was flat to down, according to PitchBook.
There aren’t many other things private equity firms can do to keep deals happening as the asset managemenet industry waits to see the impact of a possible recession, Walters said. Private equity might have only delayed some of the inevitable.
“Whether all of these adjustments that PE has made on the fly will hold up in a recession remains to be seen. Some of the industry’s best returns were generated from recession-vintage funds. However, PE has a much larger portfolio heading into this potential recession than prior ones, and LBO-related debt ratios have been higher for longer than in prior cycles,” PitchBook said.
However, PitchBooks says it is unlikely that a severe downturn and earnings contraction would significantly strain private equity firms’ ability to service higher debt expenses.
“In the base case, we see PE completing its transition and having more liquidity options than ever before. Traditional sources will join nontraditional sources that PE has innovated in their absence. IPO deals will start flowing again, banks will start lending again, and PE will restock its enormous store of dry powder.”