Heat is on for PE exits to rebound in 2024
The pressure is building on PE firms to deal with a backlog of maturing investments, which means more managers may be receptive to lower valuations to secure deals.
PE exit activity slumped in 2023 as buyout firms chose to hold on to their investments rather than take them to market, holding out for a recovery in valuation multiples that would allow them to exit at better prices.
The value of PE exits in Q3 2023 hit the second lowest level in more than a decade, according to PitchBook's Q3 US PE Breakdown. In the first three quarters of 2023, dealmakers completed 885 PE exits totaling $183 billion, down 29% and 12.7%, respectively, from the same period the year before, PitchBook data shows.
However, the pressure to monetize investments and return more capital to investors is mounting for PE managers.
"I think for 2024, that means there's going to be this pent-up demand for exits, and people are not going to be able to sit around the sidelines," said Mahvesh Qureshi, a Hogan Lovells M&A lawyer who heads the firm's corporate and finance practice group for the Americas.
Urgency to sell kicks in
Several factors have contributed to the urgency to exit. One is that buyout funds are typically structured with a finite life, which means fund managers have to return capital to their LPs at the expiration date.
Due to the sluggish exit activity, many managers are still hoarding a stockpile of assets in funds that are nearing the end of their term life. A PitchBook analyst note estimates that 2017 vintage funds are on course to reach the maturity wall with 20% to 26% of their invested capital locked in assets instead of being distributed to investors, if the exit pace continues at the current rate.
PE managers—particularly those looking to raise their next funds—have to market certain assets for sale in order to generate liquidity for investors.
In addition, these firms typically finance their buyouts with term loans, which typically reach maturity six to seven years after the deal is closed. That means the market will see an overhang of debt maturing this year for transactions closed from 2016 to 2018, said Douglas Knoch, a managing director at the advisory business unit of Crowe LLP, an accounting, consulting and technology firm.
In the current market, a spike in interest rates and credit spreads has jacked up the refinancing cost to replace maturing debt. In certain instances, corporate borrowers may not even be qualified for refinancing as the increase in the cost of their capital structure has resulted in covenant breaches. An alternative to resolve their maturities is to market these companies for sale, Knoch said.
As more assets come to market, sellers will have to make adjustments to their valuation expectations, the advisers said.
Multiples for desirable assets will remain high, as strong competition for such assets will drive up prices. But companies who struggle to find a buyer will likely yield on prices.
Higher borrowing costs and other adverse economic conditions have also increased the challenge of running a business. Some PE-backed companies looking to divest a portion of their business to save costs will also lower their price targets to secure a transaction.
Better sooner than later as risks loom
The scarcity of PE exits in 2023 does not mean managers have not been preparing to sell their portfolio companies. Many have been simply waiting to feel the market has reached a new normal before making a move.
"It doesn't mean when you get to Jan. 2, the horses are off to the races," Qureshi said. "What it means is there's a steadiness in terms of thinking about when to go to market and let's start planning for it. It's a question of timing. It's a question of when and not if."Knoch agreed, saying he has heard from M&A advisers that there is a shadow backlog of transactions that are ready to be sold. "It's just a matter of timing," he said.
The uptick in exit activity is expected to occur in the first half of this year.
"Anyone looking to achieve an exit in 2024 is likely, and is already, in planning phases, and they would want that to conclude in the first half of 2024," Qureshi said.
She explained that companies looking to sell this year will likely bring deals to market in early 2024 to give themselves more time to respond to potential changes. For instance, some deals may spark antitrust scrutiny, which would extend the horizon to close. The upcoming US presidential election is also a timing factor that can weigh on the minds of dealmakers.