Private equity investors entered 2023 wondering if the slowdown in deals would continue. Total M&A activity involving private equity dropped by about a third last year amid a broader dip in deals across the board.
Last year was characterized by rising interest rates and a cratering stock market, which challenged many PE funds. However, U.S. PE firms still hold $1.1 trillion in dry powder, something that could facilitate more dealmaking activity this year.
With inflation still raging and the economy on uncertain ground, public financing is hard to come by. That could open up an opportunity for PE to fill the void.
Public companies will look to PE to raise cash
Public companies in a multitude of industries are preparing for a slowdown. The technology industry has seen a huge number of layoffs in the past several months, and banks are setting funds aside to weather the potential storm.
With recession looming, public companies are especially eager to raise additional cash while preserving growth opportunities. One way to do this is through take-private deals, in which a PE firm purchases a public company’s stock.
Normally, the price is too high for these kinds of deals, but that’s different this year. According to Institutional Investor, “the enthusiasm over take-private deals is largely fueled by the massive public market sell-offs in the technology industry, along with the large amount of dry powder held by private equity firms.”
If a public company would rather divest only a single business unit instead of the entire company, they can look into a carve-out. In these types of deals, a company either sells an equity stake in one of its businesses, or sells the entire business unit outright. These can be useful when a company is looking to focus on its core operations, and gain liquidity by capitalizing on a non-core business.
Competition outside of PE has waned
With public markets suffering heavy losses in the past year or so, many companies have shelved plans to go public through an IPO. Special purpose acquisition companies (SPACs) have also lost their luster after a recent boom in popularity, dropping nearly 48% since the start of 2022.
The shift from public to private ownership has been underway for decades, and with these liquidity events unavailable, that pattern is likely to carry on. According to EY, “PE-owned companies have outnumbered publicly held companies since around 2012, and the trend continues as the private equity industry expands.”
Scott Nuttall, co-CEO of KKR, echoed this point in the company’s earnings call late last year, saying “in an environment like this, companies still need capital. And we find private capital tends to have less competition at a time like this. Public markets are more difficult. Corporate M&A is more challenged. So, we’ve got a lot of capital to put to work. Companies still need it.”
Diversity in PE stands to increase
Despite many high-profile layoffs in recent months, competition for talent throughout the economy remains fierce. In order to get great people, companies need to go beyond compensation—prospective employees are looking for diversity, equity & inclusion (DE&I) programs that enable strong career progression.
According to McKinsey, the current state of diversity in PE is a mixed bag. The industry is “more ethnically diverse at junior levels than corporate America for the past few years,” yet “only about 16 percent of men and roughly a fifth of women in [MD or equivalent] roles are people of color (POC).”
Companies aren’t just looking to make progress on diversity initiatives to source talent, although that’s a key reason. Institutional investors are also much more likely to invest in PE funds that employ diverse teams.
The findings are clear—to attract investment and top talent, the PE industry needs to improve diversity metrics. Expect firms to do so in 2023.
Although the last several years have been bumpy, a number of tailwinds could mean a big year to come for private equity. In an environment with reduced competition from other investors, PE firms that pounce on strong opportunities to deploy capital this year will come out on top.