After the boom in the buyout sector was ended by higher interest rates, geopolitical tensions and increased market volatility, private equity firms will have the worst year for selling their portfolio companies since the ’90s.
According to PitchBook, in the first nine month of this year, firms that buy out companies generated $584bn by selling them outright or taking them public.
This amount is almost $100bn less than what was raised by the industry during the same time period last year, and nearly two-thirds lower than the $1.4tn record generated in 2021 when borrowing costs were still low and US stocks were still in a bull run.
The higher interest rates have hurt the initial public offering market and companies are now hesitant to make acquisitions. Data shows that the last time buyout companies made less money from their portfolios was in 2013.
These figures highlight the challenges facing private equity firms in their attempts to monetise investments and return funds to investors. This includes the largest pension funds and sovereign wealth fund around the world. Singapore’s GIC warned that the golden age of buyouts had passed in July.
A senior executive in the industry said that many buyout firms are still looking for “2021 prices” when valuing portfolio companies. However, potential buyers and public investors want valuations that reflect higher interest rates and a weaker economy, as well as a largely stagnant IPO market.
Private equity firms have to use unconventional methods to realize profits for their investors when they are unable to sell portfolio companies at the prices they desire.
Investors are increasingly funding distributions by using margin loans or net asset value financing, secured against their listed company shares or asset portfolios.
David Martin, partner at Linklaters, said that private equity groups are becoming “more creative” when it comes to finding new ways to generate money for their investors in the face of a tougher environment.
Institutional Limited Partners Association (ILPA), an industry group representing private equity investors, has questioned the willingness of buyout groups to take on additional debt. The group has been preparing recommendations to ask buyout groups for a justification of the loans they use and how much it will cost.
In a further sign of the challenges facing the industry, EQT Group – one of Europe’s biggest buyout firms – announced this week that it would be holding private stock sales for the portfolio companies in light of the difficulties of the IPO markets.
Companies are increasingly turning to continuation funds. This involves selling assets from older funds into newer ones. During these asset transfers, investors in the fund are usually offered the opportunity to cash out.
Recent survey of 200 UK private equity executives revealed that continuation funds are viewed by private equity firms as a more viable option than an IPO, or auctioning an asset.