May 23, 2024

The Disparity – How M&A Volume in 2023 Affected Private Equity Fundraising

As we continue to analyze last year’s key takeaways through the lens of private equity, this post will take a deeper dive into the fundraising quandary that plagued 2023.

As discussed in part one of this four part series, the 2023 M&A market was down 60% from its peak two years earlier. The contraction of deal flow created a domino effect and the market experienced a series of aftershocks. The 500 basis point increase in debt caused uncertainty and sellers held onto companies longer than anticipated. This slowed the ability of PE firms to return capital to the Limited Partners (”LPs”) and the LPs were then unable to redeploy this capital back into the PE community. This all set the stage for a very difficult fundraising environment in 2023.

As expected, the 2023 market did not impact all firms equally. An article by Bain & Co. titled Private Equity Outlook 2024: The Liquidity Imperative, writes that the global leveraged buyout (”LBO”) category brought in $438 billion of capital that year alone. This puts the 2023 LBO volume in the top 50% of the yearly buyout volume of all time – seemingly contradicting the 2021 – 2022 signals. In addition, LBO funds raised ~$400b from LPs – the third-largest annual tally in history! At first glance, it would seem that PE firms and LPs alike simply overcame the prior years’ challenges. However, of the 1,700 PE firms that raised capital in the LBO market category last year, 20 firms accounted for half of the ~$400 billion and the other 1,680 firms split the remaining half. This trend highlights a larger issue concerning LPs and the level of trust – or lack thereof – within the middle market and lower middle market. The largest firms received an ever-increasing share of available LP capital. However, this perceived flight to safety / flight to quality via size is not a guarantee for the LPs to achieve their fiduciary obligations. The highest returns are often found with the GPs that can see around corners – not just those with the deepest pockets!

To combat this stretched timeline for LPs to get their capital back (to then redeploy) some GPs deployed a Net Asset Value Loan. These PE firms essentially took out new loans against their current portfolio assets (that already had outstanding debt) and gave this capital to the LPs. Some view this procedure as risking their future to simply buy some time with LPs and encourage them to reinvest in their upcoming fund. This cross-collateral hazard was highlighted at the Milken Institutes Global conference earlier this month.

Basic supply and demand suggest that there are more companies to acquire in the middle market than in the bulge bracket ecosystem and even more assets to acquire in the lower middle market than in the middle market. The ultimate arbiter of success is the ability to drive differentiated alpha and that holds true in any segment of the market. While all 1,700 PE firms rely on financial engineering to generate an optimal capital structure, operational insights provide a differentiated lever to pull to drive value creation at every corner of the market. In 2023, Lancor’s Advisory Business (”LAB”) clients owned a wide variety of assets. The largest firms had portfolio assets with $1b+ in EBITDA (take privates) and the smallest were “buy and builds” with only a concept, a seasoned management team, and a precise plan to drive value – and all sizes in between. Our clients have bought into the need to bring operational insights to their investment committees and believe this genie is not going back in the bottle. The key to raising new capital is the ability to drive outsized returns and the best way to do this is to have an operationally proven plan before deploying capital. The LAB is uniquely positioned to help with this and, as we co-invest with our PE partners, the returns prove the thesis.