New headwinds slow private equity fundraising, deal activity

Record inflation, rising interest rates and a significant slowdown in M&A activity are creating new challenges for private equity managers and asset owners, according to a new report from Boston-based management consultancy Bain & Co.

According to the firm's midyear update, the first half was still a relatively strong one for private equity firms. Globally, private equity generated approximately $512 billion in buyout deal value during the first half of 2022, putting the industry on pace for the second-highest annual total ever, the report says. Private equity has generated $1.7 trillion of deal value over the past 18 months. The average deal size in the first half of this year was approximately $1 billion.

The report shows there is still $3.6 trillion of cash waiting to be put to work and that allocators plan to maintain or increase allocations to the asset class. These factors position private equity to weather inflation and other sources of volatility, but some cracks are beginning to show.

Report data show that fundraising has started to slow down following several years of elevated activity. Globally, private equity raised $645 billion in the first half of 2022, compared to $789 billion during the first half of 2021. Buyout funds specifically saw a steep decline, raising $138 billion in the first half of 2022 vs. $284 billion over the same period in 2021.

Fundraising isn't the only place showing signs of a slowdown. Private equity managers are positioning themselves and their portfolio companies more defensively, according to the report. Inflation is one factor, but debt financing has also increased in cost with the uptick in interest rates. The growing potential for a recession may mean it makes more sense to hold companies for longer or wait to make new investments if a fund lifecycle allows for it, the report said.

Report data shows that the exit market has changed significantly. Global buyout-backed exit value hit $338 billion in the first six months of the year, a decline of 37% from the same period a year ago, the report said. Global IPO value saw a 73% decline in the first half of 2022, falling to $91 billion. Bain said the data suggests that this will increase holding periods for companies that may not be suitable for sale to another private equity manager, strategic buyer or other investor.

Investors and private equity managers are turning to the secondaries market to manage entry and exit points in an environment where it is harder to list companies. Bain & Co. data shows that the volume of secondary transactions grew to $132 billion in 2021 from $40 billion in 2015. Activity in the secondaries market is likely to remain elevated in this environment, the report suggests.

Despite the slowdown, for investors and fund managers that can ride out the current storm there may be some bargains on the other side. "The IRR (internal rate of return) from investments made during recovery years has consistently outperformed the long-term averages, especially investments in top-quartile deals," the report said.