The private equity market is currently facing liquidity challenges as holding periods for investments are longer than expected. A significant number of global buyout-backed companies have been held for four years or more, leading to a demand from limited partners (LPs) for capital returns.
A survey conducted in mid-2024 showed that 73% of sponsors anticipate an increase in activity, reflecting cautious optimism. High-quality assets, often referred to as 'trophy' assets, are changing hands, although there is a valuation mismatch between sellers and buyers for the median company. This has led GPs to explore secondary markets and continuation funds as viable options to distribute capital to LPs. Secondary transaction volumes have increased by nearly 60% year-over-year, setting the stage for a record-setting 2024.
In the current environment, traditional drivers of private equity returns, such as multiple expansion and cost-effective financing, are becoming scarce. As a result, GPs are focusing on mid-market companies and employing buy-and-build strategies to create value. By integrating smaller add-on acquisitions, firms can lower the entry multiple of their platform investments, making them more attractive to potential buyers. This approach not only enhances the overall valuation at exit but also helps recover the multiple expansion that has been challenging to achieve recently.
Corporate carve-outs are also gaining traction as GPs seek to acquire undervalued assets from larger organizations. These assets may be non-core or underperforming business units that are perceived as inhibiting growth within the larger entity. The trend of divestitures from larger companies has accelerated, providing opportunities for private equity investors to enhance their portfolios through strategic acquisitions.
The venture capital landscape is experiencing a downturn, with reduced fundraising activity compared to previous years. Established, well-known firms are favored by LPs in the current environment, resulting in over USD 1 billion funds accounting for a significant portion of all venture funds raised this year. Despite the decline in venture capital investment, there is still capital flowing to founders, surpassing levels seen in most decades prior. However, the pace of mega-deals has slowed significantly since 2021. Themes related to artificial intelligence are emerging as potential drivers for future mega deals, indicating that there are still opportunities for investors.
The implications of the evolving private equity landscape are significant, especially as expectations for a more active initial public offering (IPO) market in 2025 arise. This could have a cascading effect over several years, benefiting smaller funds and companies as capital flows back to LPs and is reinvested in the market. However, the current fundraising environment remains challenging, with larger funds holding most of the dry powder, making it difficult for smaller and first-time funds to attract capital.
As the private equity sector adapts to these challenges, innovative liquidity solutions and strategic acquisitions will be crucial in meeting investor expectations. The interplay between market conditions, investor sentiment, and the strategies employed by GPs will shape the future of private equity and venture capital, influencing how firms navigate the complexities of the current economic landscape.