The State of Private Equity: A look back at Q2 2023

For much of 2023, commentary about the state of the PE market has used interchangeably pessimistic terms—bleak, depressed, melancholy, and more.

There have been a few bright spots: four exits at the end of Q2—two via M&A and two through IPOs—which offered hope of a slight recovery and confirmed PE’s “buy and build” strategy. But even though investment activity is at pre-COVID levels, it’s dominated by small add-ons. And while fundraising for the middle-market is surprisingly strong, overall, the industry remains stuck.

While conditions may recover in H2, observers suggest that things will only start moving once buyout funds exit their enormous backlog of portfolio companies, which requires serious triage and value-creation efforts. In the words of Bain Capital, “Waiting and hoping isn’t a strategy. It’s time to get moving.”

U.S. PE fundraising in H1 2023 fell by 15-25% compared to last year in terms of the number of funds and fund size, according to Pitchbook. The outperformers have been middle-market funds (between $100 million and $5 billion), which reached a record high of 60.5% of funds closed in 2023 to date.

This performance has been boosted by traditional middle-market players, such as TA Associates, Genstar Capital, and GTCR, that raised funds in excess of $5 billion. In general, middle-market funds have benefitted from their ability to close and finance deals in the current leverage-constrained environment and connect with LPs attracted to growth equity and specialist funds with access to unique opportunities.

Part of the early dominance of these smaller funds likely stems from the number of mega funds that plan to close by the end of the year but haven’t yet done so. Five megafunds have already closed (versus seven in H1 2022) but flagship vehicles from Blackstone, Apollo, Carlyle, TPG, CD&R, Vista, and Warburg have been in the market for over a year and most seem likely to reach their targets in the next six months.

The current fundraising environment means firms with good track records and long histories can raise a fund quickly—despite the industry-wide gloom and doom—but those without these attributes face a long, hard slog. TA Associates’ 15th flagship vehicle raised an oversubscribed $16.5 billion in eight months, but PitchBook’s study on fundraising showed that of the 452 U.S. buyout funds open at the end of 2022 after two to three years in the market, only about 41% had closed in the first half of 2023.

Emerging managers (those who have raised three or fewer funds) are having an even tougher time—if trends continue, they will make up 21% (by funds) and 23% (by dollars) of 2022’s first-time fund total, roughly half of the year before.

Globally, the context is equally bleak. According to Preqin, almost 14,000 funds are in the market, seeking a total $3.3 trillion of new capital. 2 But H1 results suggest that LPs have only appetite for about $1 trillion of that—a 1:3 mismatch.

The short answer is “nothing.” And that’s the problem. Despite the boost in public exchanges, a moribund IPO market and ongoing economic uncertainties have pummeled the PE exit market, sending it free-falling below the median levels even of pre-COVID days (2017-2019).

In the U.S., Q2’s exit activity showed a slight recovery in number (up 3.7% for Q1) and a 67% boost in value ($87.3 billion), posting the first quarter of valuation growth in the past 12 months. But the small recovery seems fragile and H1’s activity is less than half the level of the same period in 2022, portending continued malaise.

The backlog of companies waiting to be exited has reached historic levels. Preqin shows $2.8 trillion of unrealized value on a global basis, of which roughly half have been held for four years or longer, and this backlog is pinching LPs’ pocketbooks. 3 Bain cites a recent survey of LPs that found 60% of LPs would prefer to get liquidity by selling into a GP-led continuation process rather than holding onto the asset in hopes of a higher eventual return. 4

A recent Pitchbook analysis explores the potential impact on PE funds of the persistent exit depression as they reach the ends of their mandated (and extended) lives. Continuation funds, both for single assets and for entire portfolios, seem likely to be more common.

U.S. PE deal activity for the first half of 2023 fell by 49.2% since the quarterly peak of Q4 2021, thanks to high-interest rates boosting the cost of debt. In terms of deal count, though, H1 2023 is on track to come in close to 2022’s total. Deals are being done, but not big ones—almost 70% of H1 2023’s deal value and just over 60% of its deal count were under $100 million. Q2 beat Q1’s count total but lagged its value by 15.8%.

Of H1’s deal count, almost 80% were add-ons. Excluding add-ons, Dealogic anticipates a 41% drop in annualized global buyout deal value.

Deal pricing has dropped across the board. Median enterprise value (EV) to revenue multiples on deals in excess of $2.5 billion have fallen to 4.0x in H1 2023, down from 2022’s record-setting 4.8x. Pricing for smaller deals (below $25 million) dropped to 0.8x, equaling 2020’s level (a record at the time) but down from the 1.0x of both 2021 and 2022. Context is important, though: both these numbers match or exceed those from 2020 or earlier.

In the next half, deal values may step up, because some of the big banks have started issuing leveraged loans again, private credit funds have kept the wheels in motion, and PE funds are sitting on significant amounts of dry powder.

The slowdown in buyout activity that began a year ago looks likely to continue, due in part to macro uncertainty but also to the logjam of yet-to-exit portfolio companies. Since current market activity seems not too far off that of pre-COVID days, the industry may need to recalibrate its expectations, both of returns and of the work required to create them. With LPs clamoring for liquidity and a possible fundraising slowdown stretching into 2024, successful GPs will sort out their portfolios. Some companies will be sold to free up partner time; others will become the target of intensive value-creation campaigns. Cambridge Associates’ Andrea Auerbach argues that “today’s environment has ushered in a ‘back to normal’ era” in which GPs must improve their value-creation techniques to create profitable growth in their companies.

This is the sort of industry shake-up that venture underwent in 2001 and that the Global Financial Crisis introduced in 2008. GPs need to roll up their sleeves and create real value. As Seneca wrote, “Fire tests steel and adversity tests the brave.”

1 Information in this post was gathered from Hilary Wiek and TJ Mel, “How Tough is the Fundraising environment Actually?”, PitchBook, June 29, 2023, Tim Clarke, Rebecca Springer, Garrett hinds, Jiny Choi, and Kyle Walters, “U.S. PE Breakdown: Q2 2023,” PitchBook, July 11, 2023; Hugh MacArthur, Rebecca Burack, Christophe De Vusser, Graham Rose, and Benda Rainey, op. cit.

2 Cited in Bain, op. cit., p. 17.

3 Bain, op cit., pg. 12.

4 This is the global figure. For North American LPs, the figure was 50%. Bain, op. cit. pg. 3.