The Top 5 PE Predictions According to the Experts

After two years of contraction, private equity (PE) deal activity has shown encouraging signs of recovery in 2024, indicating a return to a typical growth trajectory. A decrease in overall economic growth and an increase in interest rates were the leading causes of the previous deal volume slump.

Despite the challenges, the PE market has shown remarkable resilience, recovering in the fourth quarter of 2023 and continuing through the first quarter of 2024. This rebound indicates that the PE market is not just regaining momentum but also adapting to the shifting economic environment, which bodes well for the upcoming year. This resilience should instill confidence in investors about the PE market’s stability and potential.

In this article, our Escalon experts Ankush Sharma and William Webster discuss five significant predictions for private equity in 2024, offering perspectives on the market and its trajectory. However, it’s important to note that these are predictions, not certainties, and actual market conditions may vary.

Prediction 1: Lower Middle Market Business Owners Will Start to Transact.

Driven by normalized EBITDA multiples and stabilized inflation, lower middle market firm owners will be heavily involved in private equity (PE) in 2024. For instance, we anticipate a surge in acquisitions of companies with annual revenues between $10 million and $50 million by private equity firms. This is because valuations are more appealing to sellers since inflation is now more predictable, and the median multiple for middle-market U.S. corporations decreased from 10.7x in Q4 2021 to 9.5x in Q4 2022 (source: PitchBook Data).

Business owners are not just encouraged, but they stand to gain significantly by considering entering or reentering the PE market in this environment, particularly those with revenues between $10 million and $50 million. Private equity companies also concentrate on operational improvements to increase EBITDA and profitability and maintain value even in the face of more significant market contractions. This presents a unique opportunity for business owners to enhance their operations and profitability with the support of PE firms.

Additionally, the middle market has more exit options, and direct lenders play an increasingly important role in transactions as businesses choose to use equity rather than debt. These indicators indicate a positive picture of PE activity in the lower middle market in 2024.

Prediction 2: First-Time Fund Managers Will Face Fundraising Challenges

Another significant trend in private equity for 2024 is the challenge faced by first-time fund managers. Emerging managers might need help raising funds from institutional LPs due to their lack of track record.

Institutional investors typically prefer established fund managers with proven success, making it difficult for new entrants to gain credibility and secure funding. Consequently, more prominent and established fund managers will continue dominating fundraising efforts.

Strategies for Overcoming Challenges

• Conducting Research: Identify potential investors and understand the investment landscape.
• Networking: Use connections to secure introductions to potential investors.
• Attending Events: Meet investors at conferences and events to network and gain insights.
• Adapting: Be prepared for rejections and stay flexible to secure capital.

Potential Rewards

Despite these challenges, first-time funds can often generate strong returns. A 2021 Pitchbook report found that 27% of first-time funds achieved top-quartile returns, compared to 20% of non-first-time funds. This data should serve as a beacon of hope for first-time fund managers, demonstrating that they can overcome fundraising challenges and achieve significant success with the right strategies and perseverance.

Prediction 3: 2024 Deal Flow Will End Similarly to 2023

With the market continuing to function within its current constraints, the private equity deal flow for 2024 is anticipated to resemble that of 2023. The availability of cash and interest rates, combined with market circumstances, impacted deal flow in 2023.

This resulted in a mix of financial and strategic purchasers and a concentration on mid-market deals. This tendency is estimated to continue in 2024, and market dynamics will remain mostly the same.

Factors Influencing Deal Flow

• Market Conditions: Inflation and high interest rates have slowed deal activity, especially in early 2022. This cautious trend should continue in 2024, with investors and vendors holding out for better valuations.
• Interest Rates: Elevated interest rates have made financing more expensive, reducing deal volume. In 2024, private equity firms will likely focus on value creation and optimization to manage higher capital costs.
• Availability of Capital: Despite ample capital, investors are cautious, waiting for asset valuations to drop. In 2024, private equity firms are expected to use creative deal structuring and cash management to navigate these conditions.

Trends Expected to Continue

• Strategic and Financial Buyers: In 2024, strategic buyers will focus on mid-market transactions while financial buyers remain active.
• Mid-Market Transactions: Mid-market deals will stay central, driven by demand for resilience and more innovative, data-driven investment strategies.
• Value Creation and Optimization: Private equity firms will prioritize value creation to justify higher capital costs and meet target IRRs from high-priced pandemic-era deals.

Prediction 4: Listed Corporations Will Spin Out Unprofitable Business Units to PE Funds

Listed corporations will spin out unprofitable business units to private equity (PE) funds as a strategic move to improve their share price and focus on core operations. This trend benefits both corporations and PE funds.

• Benefits to Listed Corporations

For corporations, divesting non-core assets reduces costs, enhances financial performance, and signals efficiency, positively impacting share prices. It also allows a sharper focus on core businesses, leading to better performance and competitiveness.

• Benefits to Listed PE Funds

For PE funds, these spin-offs present acquisition opportunities, enabling them to acquire, grow, and add value to these units through operational improvements and cost management. Additionally, PE funds can leverage their expertise to transform unprofitable units into profitable entities, diversifying their portfolio and spreading risk.

Prediction 5: PE-Funds Will Chase Growth Equity Deals

The buy-and-build approach has been the typical focus of private equity (PE) funds, which include purchasing established businesses and expanding them through further acquisitions. Still, PE funds increasingly gravitate towards growth equity investments due to the drop in late-stage venture-backed company valuations.

This change enables private equity funds to allocate capital to rapidly expanding businesses that have outgrown their startup stage and still exhibit substantial growth prospects. PE funds can invest in burgeoning sectors through growth equity without paying the high valuations seen in the current tech boom. PE funds can yield substantial returns by collaborating with and supporting the growth of innovative businesses.

This tactical change demonstrates how dynamic the private equity sector is, as PE companies adjust to shifting market dynamics and values in search of the best opportunity to generate returns for their investors.

The Road Ahead

Trends such as lower middle-market business owners entering the market and PE funds shifting to growth equity deals will shape the industry. Understanding these predictions can help investors and business owners navigate the market and make informed decisions in the coming year. However, it’s crucial to be aware of the potential risks, such as increased competition or regulatory changes, that could impact these trends.

Want to be diligence-ready for PE investment? Don’t miss this opportunity to learn from the best in the business at our Escalon Webinar! The webinar will delve deeper into the predictions discussed in this article, providing more insights and strategies for navigating the private equity market in 2024.

Register now for our webinar on June 26, 2024, at 2:00 PM ET / 11:00 AM PT.

Register Here

About Ankush Sharma

Ankush Sharma is a seasoned financial professional with over 18 years of experience at Escalon Services. He has a passion for innovation and a proven track record of helping businesses grow. Throughout his career, Ankush has honed his skills in process improvement, change management, and implementing cutting-edge financial systems. His passion for innovation and measurable results makes him an invaluable asset to Escalon Services and its clients. To know more about Ankush’s background, visit our website.

About William Webster

William Webster started his career working with a family office in Kansas City and has spanned stints at companies like Ernst & Young, PitchBook Data, and Tegus. He’s passionate about ensuring that small business owners can achieve the dreams they’ve set for themselves as they grow their companies. Further, his experience ensures that he has the interests of everyone, from investors to business owners, when looking to broker deals. To know more about William’s background, visit our website.

The insights and data supporting these predictions have been sourced from PitchBook Data, providing a comprehensive foundation for our analysis and projections.

Disclaimer: This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal, or accounting advice in this article. If you would like to engage with Escalon, please get in touch with us here.