Recession risk, rate rises drive down private equity deal volumes to
4-year low
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[June 26, 2023] By
Patturaja Murugaboopathy
(Reuters) - Dealmaking by private equity firms hit its lowest in four
years, under pressure from high interest rates, recession fears, and a
weak outlook for corporate earnings, although some analysts predict
stored-up funding will drive a near-term rebound.
Private equity deal volumes slumped 63% from the same period last year
to $293.5 billion, data from Dealogic showed.
Higher borrowing costs have led private equity to pursue fewer deals and
avoid businesses with unpredictable cash flows.
Since the start of the year, buyout firms have been unable to secure
cheap debt and have had to draw on their own funds, marking a departure
from traditional leveraged buyouts.
"Rising interest rates have made private equity deals more expensive.
Inflation has cut into target companies' profit margins," said David
D'Urso, a partner at U.S. law firm Akin Gump Strauss Hauer & Feld.
"Sellers are still expecting 2021-type valuations, which is not possible
(due to the above reasons)."
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Some analysts said an unfavourable market for initial public offerings
(IPOs) contributed to the slowdown as private equity firms found it
harder to exit investments.
This has complicated the financing environment for companies and
startups that typically get bought or rely on funding from private
equity firms, when banks have also slowed down corporate lending,
analysts said.
"The implication for companies seeking private equity funding is simply
less capital to go around, which could cause the weaker companies with
short cash runways to be unable to continue operations," said Matt
Farrell, senior investment manager at WE Family Offices.
Faraz Shooshani, a managing director and senior private markets
consultant with Verus, said late-stage startups have been hit especially
hard.
"Later-stage startups were wired to grow at all costs prior to the
downturn. Many of these companies have cut down on their cash burn
rates. The few that get funding get it at much lower valuations than
pre-downturn," Shooshani said.
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A Specialist trader works inside a booth
on the floor of the New York Stock Exchange (NYSE) in New York City,
U.S., March 23, 2023. REUTERS/Brendan McDermid
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UP TO 80% SLOWDOWN
U.S. deal volumes more than halved to $162.5 billion from last year,
while activity in Europe and Asia (excluding Japan)fell 70% and 80%
to $77.3 billion and $19.1 billion respectively, Dealogic data
showed.
Technology deal volumes fell by 75% to $16 billion, while healthcare
and finance sector deal volumes dropped 70% and 64% to $8 billion
and $7.6 billion respectively.
Fundraising by buyout firms has also declined this year as limited
partners have reduced their backing. Limited partners are investors
who allocate capital to private equity firms.
Private equity funds have raised $325 billion so far this year,
compared with $459 billion during the same period last year, data
from Preqin shows.
The boom in private credit, however, boosted private equity firms,
as they stepped in to issue debt to companies after traditional
lenders withdrew. An increase in direct lending helped to mitigate
some of the risks associated with equity investments, as private
equity firms benefited from consistent and stable returns.
Timothy Tracy, global client service partner at EY, said financing
for US and European deals from private credit funds has increased
significantly.
"The dramatic rise in private credit has been largely driven by the
tighter lending standards that banks implemented to reduce their
exposure to large leveraged loans as well as by recent bank failures
which allowed private credit lenders to fill the void," he said.
Some analysts expect private equity dealmaking to bounce back in the
near term, as buyout firms have yet to deploy a portion of the funds
they have raised over the last two years.
"As we work through the interest rate cycle and the broader economic
cycle, transaction volume will eventually increase," said Jordan
Tate, managing partner at Montage Partners.
(Reporting By Patturaja Murugaboopathy; additional reporting by
Gaurav Dogra in Bengaluru; Editing by Anirban Sen and Barbara Lewis)
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