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Ashley Vardon on Private Equity: Fundraising, Pricing, Valuations, and Interest Rates

2023 presented many challenges to managers in the private capital market and in many ways 2024 couldn’t come quickly enough as it presents an opportunity to not only reflect but also look forward to perhaps a more optimistic 12 months ahead.

Reflecting on 2023 the market encountered challenges around fund raising, particularly for emerging managers and start-ups in the venture capital space.  Unprecedented levels of inflation sent ripple effects across the market with the increasing interest rate levels affecting the ecosystem of alternative assets.

Recent statistics issued by Preqin highlighted that in 2023 only 874 private equity funds closed, compared to in excess of 1,400 annually in previous years. Meanwhile aggregate capital raised by real estate funds globally fell by 19% year on year to $107.7bn in Q1–Q3 2023, compared with a 17% drop between 2021 and 2022 (Preqin 2024 Global Report: Real Estate).

In addition, funds have taken longer to raise; in North America, the proportion closing after more than 24 months leapt from 31% in 2022 to 57% in 2023.​​​​​​

 

Fundraising

The back-drop of the macro-economic environment also adversely affected attracting new capital for fund raising activities.  With investment into the public equities market dropping off, significant institutional investors were finding themselves reviewing the diversification of their portfolios and finding themselves overweight in the private capital market and reticent to deploy further capital to newer ventures.

While fundraising in the private capital space globally more or less matched that of 2022, it was predominately the larger established mega funds who were driving this number, setting a similar trend with the public markets where the larger players in the market (the magnificent seven) were attracting what capital was available in the sector.

Depleted deal flow activity also contributed played its part with fund raising attempts of existing managers, with historic funds being delayed in returning the capital required to allow managers to set off on their next fund venture.

 

Pricing and Valuations

Pricing of deals also proved problematic.  With the negative impact of market comparisons impacting valuations, there was a broadening of the gap between the prices buyers and sellers were looking to agree upon.  Many managers looking to hold on to some of their key assets and not wanted to sell at a perceived under value due to the uncertainty financial environment.

Where deals could be agreed and pricing aligned, higher levels of interest rates contributed to increased costs of debt, leading managers to scale back on leveraged buyout activity and look for more creative ways to fund and get deals over the line.  In the fight for liquidity in an illiquid market, managers in the secondary and more opportunistic space were still active looking get deals done; however, still faced the same challenges on pricing.

As we look forward to 2024 and on the back drop of such a challenging 12 months, there are some question marks as to how the private capital market will recover, particularly following the fund raising records the industry set in 2021.

 

Interest rates

The macro environment continues to evolve and cannot be predicted but as we exit from winter and enter Spring what are the green shoots to look for.

The interest rate hikes have had an impact and inflation globally is stablising.  Many forecasters are looking at Q2 2024 as a likely time where we might see interest rates coming down.  It remains to see whether it is the US or the Eurozone which blinks first but indication is that it may well be Europe and the UK which will need to grasp the nettle.  While it is expected that any reduction in interest rates will be managed with a keen eye on inflation numbers, this is welcome news for the alternatives industry.

We should expect to see a divergence during the year on pricing which may kick start much needed deal flow activity and there will be fund managers out there looking to pick up investments at favorable pricing, particularly from sellers looking for liquidity.  There is still a significant amount of dry powder across the market as a whole, from significant fund raisings over the last 3-5 years, therefore there may be a keenness to utilise capital and leverage deals later in the year, if there is an indication that interest rates will start to decrease further over time.

Whilst some of the larger players have still achieved recent successful fund raising in 2023, for a vast majority of managers 2023 was time to undertake cost rationalisation exercises and look and their operating model for the future.

Moving into 2024 we may see a lot of this come to fruition with the industry having gone through technological advances over recent years.  The industry is now consistently moving forward with the use of AI which is making more data accessible to managers and investors to analyse.   With the investors ever increasing demand for secure, more detailed and timely data available in tabular and mobile device form, managers and administrators alike are becoming more cognisant that to continue to move with this times in this market, there a need to evolve and invest in technology and analytics.

For Managers they will be looking to also optimise technology and AI for the benefit of their own regulatory and compliance obligations and also for those of their portfolio companies.

 

The year ahead

So looking to go to market in 2024, what can we expect.

We can expect a cost-conscious technology driven manager to be looking to take some advantage of the some market uncertainty and acquire some opportunities where pricing is at a perceived under value or to take advantage of some of the liquidity challenges.  Managers will also been keen to demonstrate continued alignment with investor sentiment toward the environment and sustainability.

New products may also continue to be utilised, exploring further the trend of more evergreen fund structures and continuation vehicles to allow managers to retain their star portfolio investments but also provide liquidity opportunities to their investors.

The secondary market is likely to continue to be active with wider deal flow hoping to show more normalised activity in H2.  For more emerging managers or start ups they will be looking to take advantage of a potential realignment of portfolio diversification of institutional investors, as inflation stabilises and interest rates looking like they will be adjusted in H1.

Whilst there are some positive indicators out there, the environment remains challenging and there is unlikely to be a material positive shifts in the market during 2024.  Globally there is still political instability, with 2024 being election year in both the US and UK, together with ongoing conflicts in Ukraine and Israel effecting market sentiment.

From an administrator perspective, there will be a need to continue to work with managers and support their journey through 2024 and provide solutions to some of their more operational and technological pain points.

According to S&P Global Market Intelligence and Preqin data, there was an unprecedented $2.59 trn of dry powder in the global private equity pot – an 8% rise on the previous year.

So, some reasons to be optimistic but the green shoots will need to be closely monitored.

 

Ashley Vardon joined JTC in 2023 and has over 20 years’ experience in financial services. Within his role as Senior Director, Ashley is responsible for supporting the delivery of client services across the Jersey funds team.

Prior to JTC, Ashley worked as Head of Private Equity for a well-reputable fund administrator. Ashley has specialist expertise in private equity, venture capital, real estate, alternative assets and fund related structures.

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