The outlook for private capital in 2024 is positive, as a more stable investing environment is bringing renewed optimism that M&A activity will steadily pick up in the course of 2024. Dealmaking has had a bumpy ride recently—because of a myriad of macroeconomic, geopolitical and other factors—with M&A volumes and values soaring to record highs in 2021 before dropping sharply during 2022 and 2023 to levels not seen in a decade. Private equity (PE) activity also slowed dramatically in 2023, as inflation put downward pressure on company operating margins and rising interest rates made it harder to earn an acceptable return. Furthermore, the lack of certainty around future cost of capital made it difficult to price deals. PE dealmakers in particular found financing for new leveraged buyout deals challenging as traditional lenders were navigating their own set of challenges.
However, we believe the starting bell is sounding for a resumption in M&A activity in early 2024, given inflation moderating, interest rates expected to decline and recent gains in the stock market. This is good news for private capital sitting on record levels of dry powder but also puts general partners (GPs) under increasing pressure from limited partners (LPs) to invest and make distributions from prior investments. Private capital has approximately US$12tn of assets under management (AUM), almost double what it had in 2019 before the start of the global pandemic, highlighting the significant buildup in unrealised value. It also indicates the need for many of these investments to be exited. We expect many of these investments will come to market in the next 12 months.
Private capital has displayed an extraordinary growth trajectory over the past decade. In a relatively short period of time, it has become a major driver of M&A volumes, and successive rounds of fundraising have created a source of dealmaking capital for years to come. Global private capital dry powder has achieved a compound annual growth rate (CAGR) of 11% over the past 10 years, ending 2023 with a record US$3.9tn—held across private equity, venture capital, real estate, infrastructure, private credit and other private market asset classes.
Despite the impressive growth, private capital hasn’t been immune to the volatility of the broader M&A markets. Along with decreases in new buyouts and exits, fundraising declined in 2023 by almost 30% compared with 2021 levels. However, many well-established global private capital players defied the prevailing trend, raising their largest funds ever during 2023.
The ability to raise new funding across different asset classes has varied based on LPs’ capital allocation and views around value and growth potential. For example, in 2023 fundraising declined by double-digit percentages across venture capital, real estate and infrastructure asset classes compared with the prior year, whereas buyout firms increased funds raised by 30% over the same period.
LPs view fund performance as the primary factor when evaluating GPs and deciding where to place their commitments. This makes it more difficult for newer funds to raise capital; in addition, we expect a larger number of funds may face challenges due to downward pressure on returns from a combination of factors including the elevated cost of capital, high prices paid for deals made during the pandemic and more difficult trading conditions. As a result, we expect some PE buyout funds to experience difficulties raising funding in 2024, although those with a niche focus have tended to perform well, and larger, more established funds with a proven track record of delivering above average returns will likely continue to be successful. Concerns among LPs about overallocation to private capital are expected to diminish in 2024 as valuations between public and private markets recalibrate. We believe this will lead to LPs maintaining current allocations and the potential for an increased allocation to certain asset classes or geographies and consequently an uptick in overall fundraising.
From a geographical perspective, investors are expected to follow these strategies:
"Private capital players understand the need to reinvent their business model. The landscape will evolve from financial engineering to a greater emphasis on sourcing quality deals and creating value through strategic, operational and digital transformation."
Eric Janson,Global Private Equity, Real Assets and Sovereign Funds Leader, Partner, PwC USWith the higher cost of capital, the ability to generate satisfactory returns just got harder. Dealmakers will need to adjust their investment strategies to maximise the return potential of every deal. To deliver on value creation potential—on both the buy and sell sides—private capital investors will need to build or enhance their own capabilities.
The emphasis will be on defining, validating and executing very targeted and robust value creation plans centred around improving business performance, enhancing revenue generation and growth solutions, and improving balance sheet optimisation. This will require investors to bring deep and consistent functional and sector expertise, tech-enabled and data-driven strategies, and a value creation mindset to their deals teams—all the way from deal hypotheses to close and post-deal realisation.
Sustainable investing is gaining greater prominence, with funds focusing more on incorporating sustainability into investment strategies. In PwC’s Global Private Equity Responsible Investment Survey 2023, 70% of respondents ranked value creation as a top three driver for their environmental, social and governance (ESG) activities. However, there remains a broad acknowledgement among the investor community that progress in sustainability still needs to be made across the spectrum of private capital asset classes.
We continue to see a trend towards increased specialisation within funds—either with specialised strategies or with market focus. As the higher cost of capital intensifies the focus on value creation, we expect this trend towards greater specialisation will only grow. Larger funds will likely benefit more, although smaller players that can specialise within their niche will gain an advantage. We are already seeing some consolidation and expect to see more as players struggle to differentiate themselves.
The trend towards consolidation among GPs is also being accelerated by a trend in which LP commitments are coalescing around a smaller number of larger managers. When LPs place greater value on fund performance and existing relationships, the more established players will tend to benefit, and new entrants will find it harder to compete. However, we still see a role for established mid-market GPs which can present an interesting proposition to LPs, enabling them to diversify allocations across large and mid-market positions.
We expect to see an increase in GP stakes deals—where GPs use LP-raised capital to buy interest in another GP—in 2024. For GPs selling stakes, these deals help them find partners who can bring additional capabilities to their firm, provide an injection of capital and solve succession planning needs. The GP staking firms (i.e. those funds doing the investing) in turn benefit from gaining an interest in the other fund’s returns and balance sheets. While most GP stakes investing is primarily focused on PE, these GP stakes funds are also looking to diversify their portfolios, both geographically and by type of alternative capital manager.
Private capital firms are facing growing regulatory pressures, in particular around anti-competitive behaviours. Private equity has greater reason to proceed cautiously with investing strategies due to greater scrutiny from regulators in the US, the EU and other jurisdictions. For example, the US Federal Trade Commission (FTC) and Department of Justice (DOJ) have signalled their intent to enhance antitrust enforcement with respect to certain private equity activities, particularly those related to rollup transactions and where dealmaking may lead to unfair competition. Recent concerns raised by the US Financial Stability Oversight Council about private equity involvement in the insurance sector, and whether it could play into systemic risks to the broader economy, may also result in increased regulatory scrutiny for private capital firms.
Additionally, a wave of ESG regulations are taking effect, including the EU’s Corporate Sustainability Reporting Directive (CSRD). Those regulations, along with updates to the Alternative Investment Fund Managers Directive (AIFMD) in Europe and persistent challenges related to cybersecurity, data protection, anti-money laundering and know-your-client checks, are causing many fund managers to reassess their approach to compliance, particularly in the context of dealmaking.
The CSRD modernises and strengthens the rules concerning the social and environmental information that companies must report. A broader set of companies will now be required to report on sustainability. CSRD provides companies with greater insights into sustainability performance and the ability to steer and make data-driven decisions on cost optimisation and efficiency. We expect this will afford those companies a competitive edge and lead to value creation opportunities. As investors increasingly expect private equity and sovereign wealth fund firms to integrate sustainability into their investment strategies, they increasingly recognise the impact of sustainability not just on themselves but also on their portfolio companies.
The introduction of the Pillar Two tax framework means that certain multinational enterprises will be subject to a global minimum effective tax rate of 15%, regardless of the jurisdiction they operate in. It is reshaping the foundations for private capital clients from both a compliance and deal modelling perspective. The impacts are far-reaching and require private capital players to take a proactive stance to be successful. With the globalisation of tax through new regulations, scarcity of skilled people and complexity of tax reporting, the demand for tax data centralisation, digitalisation and cloud transformation is on the rise.
Additional regulations and compliance add complexity to owning assets and may also be a strain on companies’ existing technology infrastructure and systems. Together with the need to create a compliance function which can meet new reporting requirements, this is likely to add additional costs, either for the funds themselves or the companies they invest in.
Sovereign wealth funds (SWFs) are entering a new era where they are looking for higher reward, higher risk investing opportunities and as a result are increasing their allocations to private markets. In 2022, buyout activity by SWFs more than doubled compared to 2020 levels. Although buyout activity has dropped back to 2020 levels in 2023, we believe this is due to the challenging M&A environment, not a sign of a shift in strategy away from alternatives.
In 2024, we expect SWFs will continue to strategically deploy their capital across more diverse asset classes and focus on building out and scaling their sector expertise, geographic presence and operational capabilities—using data and analytics to better inform investment and portfolio allocation decisions.
SWFs will likely continue to build out more direct investment capabilities. However, the transition from a more passive investment strategy—such as investing in the secondary market or as a LP—to a more active one requires different expertise and capabilities, which many SWFs do not currently possess. Doing more co-investments, in which the SWF invests alongside a PE partner, and a greater number of direct investments, in which the SWF is effectively competing against PE, will require a balance of collaboration and cooperation between SWFs and PEs. It remains to be seen whether other SWFs will follow one Middle East-based fund which has established investment vehicles in a typical GP/LP model to allow fundraising and management of capital on behalf of other investors. This would be new territory for SWFs.
With the uncertainty around interest rates and inflation now seemingly in the rear view mirror, we expect to see a rebound in M&A activity in 2024. Whilst the exact timing remains uncertain and will vary by sector, private capital players are poised to take advantage of a more stable economic environment. The record levels of dry powder, a backlog of portfolio companies, and continued demand from investors of all types, will fuel dealmaking in 2024 and the years ahead.