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This article is part of a series offering deeper dives into the four M&A trends PwC identified in the US Deals 2024 midyear outlook.
The recovering deals market could get a lift from private equity-backed companies as early as the beginning of 2025 as general partners respond to growing pressure to return capital to investors.
PwC's analysis of PitchBook Data, Inc. found that approximately 4,000 to 6,500 private equity exits have been delayed over the last two years due to inflation and a rapid rise in interest rates. Now there’s growing pressure from investors to return capital. We believe alternative strategies, such as net asset value (NAV) loans, are unlikely to meet liquidity demands — forcing funds to sell off businesses they’ve been hanging on to, and we anticipate important ramifications on both the buy and sell sides.
Two estimates of the supply of pent up PE exits suggest that ~4,000 to 6,500 M&A transactions may have been delayed, equivalent to up to half of annual US volume
Acquirers should prepare now to be ready to act swiftly when companies with favorable valuations hit the market. Some PE sellers should explore ways to reduce the impact of potential losses, such as through tax planning. Meanwhile, sellers with more mature portfolio companies may want to consider exiting through the public markets — a development that could provide a mini-boost to the initial public offering market. Sellers considering the public markets also should focus on value-creation strategies as companies with successful IPOs have exhibited strong cash flow profiles and a track record of revenue growth.
We see two major external factors currently holding back PE exits, including IPOs: uncertainty over the November 2024 election and the timing of potential Federal Reserve rate cuts. The outcome of the presidential and Congressional races will set the tone for regulations, tax policy and other issues for at least the next two years. Interest rate cuts from the Fed would reduce the cost of capital, making financing cheaper for market participants and could shift investor appetite toward the equity markets and IPOs for incremental returns. While the election will be held in November, the exact timing and size of potential rate cuts are still up in the air even as the Fed has signaled they are on the way. If rate cuts do happen this year, we could start seeing more PE exits by early 2025.
Growing pressure to exit
PwC reviewed PE exit rate activity since 2020 — when the pandemic and presidential elections helped change the macro environment — to historic norms based on two metrics:
- PE exits as a percentage of total M&A activity
- PE exits to buyouts ratio
Our analysis suggests a pent up demand for potentially thousands of additional exits — depending on the methodology used — or about half of total annual US M&A volume.
Other paths to liquidity don’t offer much promise to general partners who want to further delay exits. In the first three quarters of 2023, for example, continuation fund acquisitions totaled about 2% of total deal volume, according to PwC analysis of PitchBook data. Limited partners aren't comfortable with NAV lending, with fewer than half of them generally comfortable with that mechanism, according to a recent survey. And perpetual capital assets under management don’t target a high volume of PE deals.
Historically, the more popular path for PEs exiting a portfolio company was selling the business to a publicly traded corporation. But considering that current portfolio companies are significantly larger than is typical, the public markets may be better equipped to handle some of the bigger exits given public investor demand for growth companies.
Still, some portfolio companies are stronger IPO candidates than others. Investors generally look for companies that have consistent growth potential, profitability or a clear path to profitability, and positive cash flows. They also typically examine a company’s debt load and look for a compelling equity story, including KPIs and non-GAAP metrics. Finally, IPO outlooks could be based in part on investor tolerance for risk, especially if volatility were to increase in the coming months.
IPOs are not the only path forward. Some PE sponsors may also use the opportunity to make acquisitions. Many funds have significant stores of dry powder and are facing increasing pressure to put that capital to work.
Public offerings have been up in the first half of the year and, so far, those companies have performed well in post-IPO trading. If economic headwinds such as interest rates, inflation and potential election-related volatility abate, exits that include IPOs will likely become more attractive to PE sponsors and investors.
Looking ahead
Here are some suggestions for potential IPO candidates and other portcos based on what we’re seeing in the market.
- Consider new offer pricing: How new offerings were priced this year and, critically, how they performed post-IPO will be an important signal. Strong continued performance in new issues suggests there’s investor appetite for more public offerings.
- Watch for opportunities: IPOs have been generally strong across all major industry sectors so far in 2024, suggesting that the diverse world of PE-backed portfolio companies could have enticing opportunities to go public in 2025.
- Remain flexible: If the IPO market doesn’t continue to perform, or if a portco isn’t a good candidate for it, PE sponsors may have to stick with corporate buyers or pursue sponsor-to-sponsor transactions. In that case, the gap in valuations between buyers and sellers could make dealmaking difficult, putting even more pressure on general partners to find a way to exit and return capital to their limited partners. PE firms should focus on creating value in these portcos through digital transformation, such as by improving the customer experience or employee training with AI.
- Focus on the areas that can add value immediately: Transformation doesn’t have to be a rip-and-replace transformation that takes years and disrupts lines of business. Building out the appropriate skills and technologies over time can make it easier. And those that take the leap to develop advanced cloud-based digital capabilities are likely to perform better no matter how economic conditions fluctuate.
- Start your preparation early: The IPO landscape is dynamic. For organizations looking to open paths to capital through a public offering, it is critical to leverage the right insights to make the right moves at the right times. There are multiple paths to going public – IPO, direct listing, etc. How do you know which is the right path or the right time for you? You need a plan that sets you apart long after the bell rings.
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