the "golden age" of private capital is experiencing changes, with more consolidation expected in 2024
In the last decade, there has been a remarkable increase in private capital fundraising, with almost $12 trillion raised since 2012. However, the slowdown in 2023 led to uncertainty in the Private Equity industry. Nevertheless, experts predict that 2024 will mark a resurgence for PE. Will this be the year PE peaks again?
Even though the origins of modern private equity (PE) can be traced back to the years following World War II, significant developments didn't occur until a few decades later. Leading the way were Jerome Kohlberg, Henry Kravis, and George Roberts (Henry's cousin), who were working at the investment firm Bear Stearns in the mid-1960s. It was there that they learned about "bootstrap" acquisition, a strategy now recognized as a leveraged buyout (LBO), which involves a company's acquisition of another company using a significant amount of borrowed money, or leverage, to cover the acquisition cost. Kohlberg focused on identifying undervalued small companies and helping them borrow capital for expansion and acquisition of additional businesses. Together, they established the investment banking firm Kohlberg Kravis Roberts & Co., KKR. In 1976, KKR's objective was to create and manage private equity funds that used borrowed money to acquire underperforming businesses, improve them, and then sell them at a profit.
This marked the birth of private equity (PE) as we know it today, becoming a common practice in the financial and investment world. After many successful years, growth came to a halt in 2023. However, many predict that 2024 will see the pace pick up again, creating numerous opportunities for new and returning investors.
The Foundational Stone for success in PE: Fundraising
The first step in private equity (PE) is crucial for determining the success of the venture: fundraising. According to Deloitte, fundraising is a key aspect of the business model, determining the scale and feasibility of the venture. Private equity firms raise capital from investors through private equity funds, which are then used to make investments in private companies. Once the capital is raised, the private equity firm identifies potential companies for investment, such as start-ups, established private businesses, or public companies that are taken private through buyouts. The first phase of PE requires special attention, extra time, and meticulous planning, making the scouting of investors the bedrock of the entire process.
Attracting Investors
In an article released by FD Capital, finance experts emphasize the pivotal role of attracting investors in the context of private equity fundraising. It is suggested that successful private equity firms demonstrate an in-depth comprehension of their target investors and tailor their approaches to resonate specifically with these individuals and institutions. They suggest focusing on investor profiling: various investors exhibit distinct preferences, with some favouring a conservative approach, while others display a predisposition for assuming higher levels of risk.
Another important point is clearly defining their unique value proposition, explaining the benefits and potential returns associated with investing in their fund. When it comes to risk mitigation, it's vital to address investor concerns effectively. Companies must set up strong risk management frameworks and communicate them clearly.
Regulatory compliance and relationship building are crucial aspects of attracting investors during the fundraising process. It's important to adhere to regulatory requirements, as investors seek reassurance that the fund complies with relevant laws and regulations. FD Capital emphasizes the significance of these factors in gaining investor confidence. In addition, fostering relationships with potential investors, such as pension funds, insurance companies, and sovereign wealth funds, it's critical for private equity firms. These firms need to showcase their reliability and strong track record.
Current Trends in Private Equity
The landscape of private equity is constantly evolving. In recent years, there has been a significant shift towards more consolidation within the industry. As highlighted by Reuters, the "golden age" of private capital is experiencing changes, with more consolidation expected in 2024. Blackrock’s 2024 Private Market Outlook report acknowledges that geopolitical uncertainty, inflation and rising rates have led to less deal activity in the past months but they are optimistic about PE firms coming with new strategies, such as add-on acquisitions and taking advantage of depressed public equity valuations to execute take-private transactions: “In particular, public-to-private transactions accounted for about 21% of aggregate deal value through the year compared with 15% over the past five years.”
A “demand for quality” is also a key driver of activity. The report suggests that economic factors hindering progress and rising costs of capital have re-focused private equity buyers on industry-leading companies with strong cash flow and return on capital. Higher-quality sectors like technology and healthcare that have proven more resilient are priorities for investment.
Blackrock also reveals itself as “optimistic” about this year’s deal activity, predicting it will accelerate “in the near-term and produce attractive returns for private equity buyers with access to capital.” They then suggest that now is an attractive time to invest in the asset class, naming motivated sellers and access to debt as key drivers of this trend. The report highlights that limited access to the IPO market and low buy-side sponsor demand has resulted in a very low exit deal volume. A more “favourable borrowing environment” is also mentioned as a factor for an increase in loans/private debt. Finally, changes in companies’ strategies are favouring the acquisition of non-core divisions with “proven business models and untapped value-creation potential.”
Private equity plays a crucial role in the financial ecosystem by providing essential capital and expertise to businesses. This year is no exception: despite the continuing uncertainty facing investors amid higher rates, inflation, and volatility, private equity offers great opportunities for investors, with a broad portfolio of opportunities in different sectors, risk levels and investment styles. Recognising the right opportunity for the right investor is an essential skill, one that a finance professional can provide to the benefit of sellers, buyers, loaners, and borrowers alike.
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