In recent weeks, the private equity landscape has been subject to scrutiny, with various publications highlighting the issues around navigating the current private equity doldrums.
As part of an analysis conducted by Raymond James and referenced by several articles, e.g. “Private Equity Returns Have Slumped”, private equity funds last year retuned the lowest amount of cash to their investors since the financial crisis, 15 years ago. Whereas the average distribution of limited partners used to be around 25% of funds’ net asset value, the more recent results averaged 11%.
A confluence of factors has contributed to this downturn. Rising interest rates have escalated borrowing costs, while market volatility and sluggish growth in specific sectors have further compounded the challenges. Concurrently, divestitures have slowed significantly, disrupting the traditional profit model of private equity firms. The typical holding period for portfolio companies has extended from 4 years to an average of 5.6 years (“Private-Equity Firms Pump Sales Opportunities for 2024” – WSJ), highlighting the difficulty in capitalizing on timely exits.
In response to this turbulent environment, private equity firms are employing strategic adjustments:
1. Emphasis on Pricing and Profitability: To bolster short term returns, as well as recognizing the importance of positioning companies for robust exits when market conditions improve, firms are prioritizing pricing and profitability enhancements.
2. Revamped Compensation Models: With the deceleration in company turnover, there’s a notable shift towards compensating key executives based on carried interest (i.e. the payoff at the company divestiture). This aligns their incentives more closely with the success and timing of company exits, fostering a greater sense of accountability and alignment.
3. Focus on Cash and Funding Rounds: Anticipating a rebound in 2024, private equity players are bolstering their cash reserves and preparing for increased acquisition activity. Notably, Blackstone has amassed over $200 billion in cash for investment opportunities.
Amidst these challenges and adaptations, the private equity landscape remains dynamic. As an advocate for pricing and profitability improvement, I’m particularly encouraged by the heightened focus in this area. By helping companies uncover opportunities for better pricing strategies and incremental profits, we can navigate these uncertain waters yielding superior margins and strengthened pricing processes.
