“Deal activity was on track for another record-setting year, until the wheels came off,” was how Bain Capital described the state of private equity in 2022.
In the investment firm’s latest executive summary, Bain’s private equity chair Hugh MacArthur noted that dealmaking showed no signs of slowing in the first half of the year, following the breakneck speed of the industry in 2021.
That was until the US Federal Reserve stepped in and fired what he called “the shot heard around the world” in the shape of a 75 basis point rate hike in June.
As we now know, there was plenty more where that came from, not just from the Fed, but from the Bank of England and European Central Bank, who all drove their base rates up to highs not seen since the 1980s.
Runaway inflation brought the era of cheap money to an unceremonious end, and investment in private and public companies alike plummeted in the second half of the year.
Global political instability and supply-chain disruptions surely didn’t help either.
A slowdown in dealmaking has had “a cascade effect” on the exit market, with exit deals dropping over 50% in the second half of 2022 compared to the first half.
With the price of debt used to finance deals skyrocketing, private equity, firms which had been accumulating vast sums of dry powder for years, have now found themselves unable or unwilling to deploy.
According to MacArthur, this war chest of dry powder consists of a record US$3.7tn in cash, with one trillion earmarked for buyouts alone and US$2.7tn earmarked for “other forms of private capital”.
Crunch time
Now private equity firms are facing a crunch: Pressure to deploy that stored cry powder is mounting, but so is competition for deals, leading to higher and higher asset prices.
This will lead to increased scrutiny on fund managers who will have to prove they can generate profits without cheap debt and a growing economy, noted MacArthur.
Tighter financing costs are also altering the shape of deals. Transactions are being financed with 70% equity and 30% debt instead of the usual 50%-50%, with the structure most prevalent among smaller and medium-sized deals, according to Bain’s annual report.
In harsh private equity conditions, what do MacArthur and crew at Bain Capital suggest? Don’t panic, seems to be the word.
“The winners didn’t panic last time around. They properly assessed their risk scenarios, created mitigation plans, and set themselves up to accelerate out of the downturn.”