Exit options for private equity, and the subsequent returns to investors, are looking particularly dire at present. According to PitchBook figures cited in a Financial Times report, private equity firms managed to raise some US$584 billion from exits in the first three quarters of 2023 through IPOs, trade sales or other exit mechanisms. That’s over $100 billion down on the same period last year.
The FT quotes Singapore sovereign wealth fund GIC stating that a golden age for private equity had ended, also reporting that private equity funds were still seeking 2021 prices for their assets despite changing circumstances.
It’s easy to understand, then, why Nordic private equity firm EQT Group is looking at private stock sales of its portfolio companies rather than floating them in dismal market conditions. Continuation funds, designed to pick up assets and hold them for longer than the original target investment period, are another popular alternative.
“GPs [general partners] and LPs [limited partners] have become increasingly attracted to the continuation fund market as an alternative to more traditional exits given uncertainty in public markets and headwinds in credit markets,” according to a recent study by Orrick. Indeed, a December 2022 white paper from Neuberger Berman noted that continuation fund deals accounted for some 80% of GP-led transactions in 2017-2021 out of a GP-led volume that increased five times over that period, at a 48% compound annual growth rate.
But continuation funds have raised conflict of interest concerns given that the buyer and the seller GP are often connected, if not the same, and that decisions around pricing and value may be affected. Indeed, the US Securities and Exchange Commission introduced new rules in August requiring GPs to give fairness opinions to the deal’s ultimate investors, the LPs, in any deal they initiated which offered LPs the opportunity to trade their holdings in for investment in a new vehicle.
It’s worth noting that continuation fund deals soared during the fat years of private equity, with cheap money plentifully available and exit markets welcoming. The justification given was that firms wanted to hold on to their best-performing assets rather than lose their money-making capabilities. Now that the lean years have come, one wonders about that justification. After all, a continuation fund provides a handy option to kick an issue further down the road.
Meanwhile, the underlying geopolitical and macroeconomic conditions dictating the exit environment don’t look likely to change any time soon. If anything, they might even get worse.
All in all, the kinds of private equity returns seen in the past might never be seen again. That might trigger some hard thinking among institutions about how much they want to commit to the asset class – and among private equity firms about their business model.
