Buyouts
Charts: PE firms perform financial feats
April 20, 2023
The first quarter of 2023 opened the year with unpleasant surprises and challenges for private equity, including a string of bank failures, a slowly reopening leveraged loan market and an unfavorable fundraising environment.
But these adverse market conditions didn’t hinder PE-backed transactions in the US as managers found ways to eliminate these threats and get deals done, according to the Q1 2023 US PE Breakdown.
PE firms in the US did more than 2,000 deals totaling $261 billion during Q1 2023. While the volume of deals declined 9.3% quarter-over-quarter, it remained well above pre-pandemic levels.
To manage the headwinds they faced in Q1, PE managers set their sights on smaller target companies, favoring deals that were less reliant on leverage or required smaller equity contributions. Dealmakers increasingly leaned on nontraditional sources of capital to make up for the lack of funding.
The appetite for add-ons—the purchase of a smaller target for a PE-backed platform company—has risen. In the first quarter of this year, add-ons made up 48.2% of total US PE deal value—the highest percentage since Q2 2020—and platform buyouts constituted only 40.8% of all US PE deals, the lowest since Q3 2020.
The growing interest in add-ons is not only driven by managers' inclinations to pursue small-scale deals that are more digestible, but also by their desire to drive the growth of portfolio companies through acquisitions as valuation declined, said Tim Clarke, lead PE analyst at PitchBook.
"If you have a brand-new fund, you can compensate for the lack of leverage by buying assets at steep discounts," Clarke said.
But for an existing portfolio, the only way to keep its valuation is to strike more add-ons to help grow the company's revenue. In this way, the PE owner can get compensated for the loss in the company's value that results from an industry-wide contraction in private-market valuations, he said.
The proportion of growth equity investments—which involve buying minority stakes in companies—also remained steady at 11%. Such a strategy is typically less dependent on debt financing and requires a smaller equity check compared to an LBO for a similar sized target.
PE firms are finally paying less for acquisitions.
The three-month rolling median EV/revenue multiple for PE deals in North America and Europe slipped to 1.7 for in Q1 2023 from 2.4 in Q4 2022, according to the report. PitchBook analysts say this metric provides a broader look at the market’s valuation than the more common EV/EBITDA multiple because it allows them to include more technology companies—many of which have yet to generate meaningful profits—for the analysis.
"That’s a pretty steep decline," Clarke said. "It says that companies in general are starting to lower their prices to sell, and we’re starting to see a better clearing price."
Many PE firms have resorted to alternative sources of capital to close the financing gap created by limits on the available cash and debt.
Net asset value (NAV) loans, which allow investment managers to borrow against the value of a fund's portfolio, rose in popularity last year as more PE firms tapped the liquidity tool to land debt financing or equity investments for add-ons.
Deal volume in the NAV financing market has grown by 50% during the 12-month period ending in September 2022, according to estimates from 17Capital, a specialist lender focusing on NAV financing. The firm expects the market to reach $300 billion by 2025.
Co-investments, in which limited partners participate in a transaction alongside PE investment managers, is another solution that has grown in appeal for PE firms hoping to reduce the size of equity checks written to deal targets. Fundraising for PE co-investments held up steadily in 2022. While the total capital raised for the strategy has declined from 2021 to 2022, it is still maintained at an elevated level by historic standards, according to PitchBook data.
Furthermore, some PE buyers are asking sellers to provide financing or include earnout provisions, PitchBook previously reported.
But these adverse market conditions didn’t hinder PE-backed transactions in the US as managers found ways to eliminate these threats and get deals done, according to the Q1 2023 US PE Breakdown.
PE firms in the US did more than 2,000 deals totaling $261 billion during Q1 2023. While the volume of deals declined 9.3% quarter-over-quarter, it remained well above pre-pandemic levels.
To manage the headwinds they faced in Q1, PE managers set their sights on smaller target companies, favoring deals that were less reliant on leverage or required smaller equity contributions. Dealmakers increasingly leaned on nontraditional sources of capital to make up for the lack of funding.
The appetite for add-ons—the purchase of a smaller target for a PE-backed platform company—has risen. In the first quarter of this year, add-ons made up 48.2% of total US PE deal value—the highest percentage since Q2 2020—and platform buyouts constituted only 40.8% of all US PE deals, the lowest since Q3 2020.
The growing interest in add-ons is not only driven by managers' inclinations to pursue small-scale deals that are more digestible, but also by their desire to drive the growth of portfolio companies through acquisitions as valuation declined, said Tim Clarke, lead PE analyst at PitchBook.
"If you have a brand-new fund, you can compensate for the lack of leverage by buying assets at steep discounts," Clarke said.
But for an existing portfolio, the only way to keep its valuation is to strike more add-ons to help grow the company's revenue. In this way, the PE owner can get compensated for the loss in the company's value that results from an industry-wide contraction in private-market valuations, he said.
The proportion of growth equity investments—which involve buying minority stakes in companies—also remained steady at 11%. Such a strategy is typically less dependent on debt financing and requires a smaller equity check compared to an LBO for a similar sized target.
PE firms are finally paying less for acquisitions.
The three-month rolling median EV/revenue multiple for PE deals in North America and Europe slipped to 1.7 for in Q1 2023 from 2.4 in Q4 2022, according to the report. PitchBook analysts say this metric provides a broader look at the market’s valuation than the more common EV/EBITDA multiple because it allows them to include more technology companies—many of which have yet to generate meaningful profits—for the analysis.
"That’s a pretty steep decline," Clarke said. "It says that companies in general are starting to lower their prices to sell, and we’re starting to see a better clearing price."
Finding alternative capital sources to close the funding gap
The decline in valuations presents an opportunity for managers—but only if they can overcome increased difficulty securing buyout debt, a tougher fundraising environment and the prospect of fewer exits.Many PE firms have resorted to alternative sources of capital to close the financing gap created by limits on the available cash and debt.
Net asset value (NAV) loans, which allow investment managers to borrow against the value of a fund's portfolio, rose in popularity last year as more PE firms tapped the liquidity tool to land debt financing or equity investments for add-ons.
Deal volume in the NAV financing market has grown by 50% during the 12-month period ending in September 2022, according to estimates from 17Capital, a specialist lender focusing on NAV financing. The firm expects the market to reach $300 billion by 2025.
Co-investments, in which limited partners participate in a transaction alongside PE investment managers, is another solution that has grown in appeal for PE firms hoping to reduce the size of equity checks written to deal targets. Fundraising for PE co-investments held up steadily in 2022. While the total capital raised for the strategy has declined from 2021 to 2022, it is still maintained at an elevated level by historic standards, according to PitchBook data.
Furthermore, some PE buyers are asking sellers to provide financing or include earnout provisions, PitchBook previously reported.
Featured image by Chloe Ladwig/PitchBook NewsRelated read: Q1 2023 US PE Breakdown
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