1. Expectations are set too high

We are in reset territory for both businesses seeking exits and buyers. Higher interest rates have made credit more expensive and lowered company valuations. The high exit multiples we saw up to 2021 meant expectations became unrealistic, resulting in high bid/ask spreads. These are no longer obtainable, so deals are not getting done and valuations are falling to meet the conditions of the new normal.

2. Sellers hit by macroeconomic uncertainties 

High inflation and interest rates mean fewer company sales. Business owners are holding out for better conditions to return, and many business performances are flat year on year as they tackle operating costs to adjust for inflation-driven price increases.

Business profitability – measured by earnings before interest, taxation, depreciation and amortisation (EBITDA) – is under pressure. Therefore, the multiples of EBITDA on which leverage is calculated are lower. Our report found that 45% of GPs reported a fall in leverage multiples of more than 1x EBITDA compared with a year ago.

An imminent UK general election will add further uncertainty for both business owners and lenders. Not least, the possibility of new rules on capital gains tax and taxing carried interest as income.

56%
of respondents said few lenders were chasing business compared with a year ago
87%
found terms were tighter

3. Higher borrowing costs 

The cost of borrowing has risen exponentially with interest rates peaking at levels not seen for a decade. Steep interest rate hikes during 2023 impacted how much debt borrowers were able to service. Also, with challenging portfolios to manage, lenders have relooked at their investment criteria and reduced their lending appetites for certain borrowers.

As a PE buyer, if you can't raise as much debt, then you can't justify paying the premiums seen over the last couple of years because your returns won’t be as high as before. Consequently, you are less likely to be prepared to pay as much for businesses.

In our report, 56% of respondents said few lenders were chasing business compared with a year ago and 87% found terms were tighter. Lower volumes of debt available from fewer lenders on tighter terms lead to lower valuations.

When private equity can't access credit to make acquisitions, trade buyers (who usually fund from their balance sheets rather than with debt) will take their lead on pricing from what they are seeing in the general market. So, if they see that private equity valuations are compressed, then they will also compress their own valuations because they know they don't need to put in as much cash to land deals.

Looking ahead, if interest rates start coming down, the cost of borrowing will fall, freeing up more cash and with it the capacity to take on more debt. Many businesses are returning to higher profitability and growth having tamed their costs. This gives a more promising outlook for valuations.

92%
of GPs still expect their current fund to make carried interest

4. General Partners face liquidity pressures

GPs who come under pressure to generate liquidity so they can repay limited partners (LPs) are accepting lower valuations to get deals done. Before, a GP might be prepared to wait a year to get a higher return on their investment. Now, they are more willing to take a lower return to achieve liquidity.

However, lower valuations do not mean GPs are losing money – they are just generating lower returns compared with previous highs. Our report found that 92% of GPs still expect their current fund to make carried interest.

5. Longer fundraising timelines

Another sign of broken processes can be seen in the time it takes to complete deals. The gap is longer between an advisor coming in to pitch and being selected to them concluding a business sale.

This slowdown in exits causes a slowdown in distributions back to LPs. They want money back to reinvest in other funds. The need is more pressing for LPs who have over allocated to private equity in recent years. It means LPs’ priority is on liquidity rather than returns.

Looking ahead, as deal volumes pick up, valuations should gradually start to rise again. Business owners looking for an exit can’t sit tight indefinitely while valuations are lower. As businesses accept the new normal, more deals should come to the table, increasing competition for assets among PE firms.

Lower valuations have created a new normal that could extend beyond 2024. But, as we are seeing, opportunities are out there. The way buyers and sellers are recalibrating both their funding outlook and their expectations demonstrates the PE industry’s robustness and flexibility. 

{[heading]} Industry insights: Navigating a changing landscape in Private Equity

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Jonathan Harvey
Jonathan Harvey

Fund Solutions

Helen Lucas
Helen Lucas

Co Head of UK Direct Lending Origination

Kate Gribbon
Kate Gribbon

Head of Financial Sponsor Coverage & Origination

Jonathan Harvey
Jonathan Harvey

Fund Solutions

Helen Lucas
Helen Lucas

Co Head of UK Direct Lending Origination

Kate Gribbon
Kate Gribbon

Head of Financial Sponsor Coverage & Origination