Private Equity is Slightly Broken

As recently as 2021, the industry set a record by generating $1.4 trillion via outright sales or IPOs of portfolio companies. (A person could live on…

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Private Equity can’t find the exit.

The PE game has a standard playbook: Investors give money to firms, which buy controlling stakes in oft-struggling companies. The target companies are restructured, often with some elaborate new debt pile on their books, and then sold off at a profit, a nice portion of which is distributed back to the PE firm’s investors.

In relatively normal times, this is a straightforward way of life in financial markets — and incredibly lucrative: As recently as 2021, the industry set a record by generating $1.4 trillion via outright sales or IPOs of portfolio companies. (A person could live on that.)

Over Rated

But these aren’t normal times. As the Financial Times reported over the weekend, PE firms face their lowest investment-exit totals in more than a decade, generating just $584 billion through the first nine months of 2023.

The culprits are the same ones messing up nearly every other investment opportunity: historically high interest rates and a pullback in equities amid an increasingly risk-averse atmosphere. The 10-year Treasury note yield crossed 5% at its high this week for the first time since 2007. Meanwhile, the S&P 500 is down about 7% over the past three months, as recent economic data and earnings reports (combined with global and US political dysfunction) haven’t exactly bolstered confidence. And that’s the same environment facing potential acquirers of PE portfolio companies: they’re looking to make a profit too, after all, and wait-and-see seems to be their preferred choice for now. All of which is making PE firms scramble:

  • The FT reported that PE firms have increased their use of margin loans and net asset value financing using shares in their listed companies to fund investor distributions. But that increased debt load has prompted an industry investor group to draft recommendations calling for PE firms to justify the use of loans and disclose their costs.
  • Citing ‘dysfunction’ in the IPO markets, Swedish PE firm EQT Group said it was considering private stock sales of its portfolio companies in exclusive transactions among its 1,100 limited partners.

Cashing In: The lack of an exit hurts in other ways. The Wall Street Journal reported on Friday that some buyout firms are being forced to pony up more cash to keep portfolio companies from going under, another side effect of a high-interest-rate environment upsetting the standard PE debt strategy. Credit companies that provide debt for most PE deals are asking for more equity investments from buyout firms to offset higher borrowing costs. For PE firms, that means less profit when it’s time to offload a company, making them even more inclined to hold them longer than they want.