Private Equity’s Playbook in the Current Market
Private equity firms continue to face a challenging dealmaking environment, which has caused firms to reconsider how they deploy their committed capital. Persistent interest rate hikes have made it more difficult to pursue large platform transactions that typically require a substantial amount of debt, putting great stress on private equity’s traditional leveraged buyout (“LBO”). As of February 2024, the cost of debt for middle market transactions has effectively doubled in the last two years when the Fed began implementing rate hikes.
Source: SPP Capital Partners, FRED, S&P Capital IQ
The impact of high interest rates on LBOs is being further exacerbated by a pullback in activity from the broadly syndicated loan market, which has historically been the go-to source for larger LBO financings. Private credit funds have helped fill in for publicly financed loans to support platform investments, however it has not been enough to keep activity from falling below historical levels.
Source: Pitchbook | LCD
Despite facing a challenged M&A market, private equity firms are still pressured by their limited partners to continue deploying funds. Robust fundraising over the previous two years has propelled private equity’s available funds for investing activities to all-time highs, further pushing financial sponsors to put their money to work.
* Data as of 3/31/2023 – Source: Pitchbook
M&A continues to be private equity’s primary outlet for investment activity; however sponsors have shifted towards prioritizing smaller add-on acquisitions which require less debt to finance and can often be done through existing credit facilities. Certain private equity firms have also transitioned towards growth equity investments where debt is typically not required for the transaction. While both of these strategies help firms deploy capital, a material increase in platform investments will be needed to deplete the massive base of dry powder these firms have during their investment horizon (typically the first five years of their fund’s life).
Source: Pitchbook
While it remains to be seen whether improving macroeconomic conditions and steady interest rates will revitalize platform investment activity in the near future, we anticipate that the buy-and-build strategy will continue to dominate the activity for private equity investments for the foreseeable future.