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Five ways private equity’s rebound will change the industry

On May 23, 2024, Accordion’s CEO & Founder Nick Leopard appeared in Forbes to answer what you can do right now—while the world waits for a recession that may not arrive.

 

This article first appeared in Forbes in June 2024.

The “most anticipated recession in history that hasn’t happened yet” still hasn’t happened. What’s more, it looks like the long-projected 2023-2024 recession likely won’t happen given record-low unemployment, reasonable macro growth and surging U.S. public markets.

The question for private equity (PE) stakeholders who have been bracing for the worst is … what now?

What now in the wake of a particularly rough year that saw a 37% reduction in deal value, a 44% decline in exit value and 38% fewer buyouts? The what now is a highly motivated group of sponsors who are incentivized to make deals for two compelling reasons:

Record High And Record Old Dry Powder

Buyout funds alone are sitting on a record $1.2 trillion in dry powder. Twenty-six percent of that arsenal is four years old and up. Add that to a towering $3.2 trillion in unsold assets, which has stanched the flow of capital back to limited partners, and you have an environment in which general partners (GPs) are determined to start buying, even if conditions aren’t ideal.

Stabilizing Interest Rates
Having waited out the 525-basis-point rise in interest rates, which was the sharpest monetary tightening in decades, PE partners have taken the nine-month period of stability as a sign to start deal-making again. While a reduction in rates may no longer be in the cards, as was originally projected, should the Fed ultimately cut rates later this year, I expect to see even the more cautious PE players get back into action.

Everyone—by which I mean all the industry pundits—says that these two intersecting factors will bring on a PE rebound. What no one is talking about, however, is the nuances of that rebound. And make no mistake, PE going forward will be different than PE from the past, in five specific ways.

1. EBITDA, EBITDA, EBITDA

Buyout funds, on average, have essentially ignored margin growth as a driver of value over the last decade and have, instead, been carried by multiple expansions. (The top two median indexed value creation drivers for global buyouts have been multiple expansion and revenue growth. Margin expansion accounted for less than 1% of drivers.) But now, because price multiples have dipped, sellers can no longer rely on multiple arbitrage. Instead, they must fixate on performance, finding ways to meaningfully move earnings before interest, taxes, depreciation and amortization (EBITDA).

That means getting sharper at finding and pulling the value-creation levers that generate organic growth. Don’t just take my word for it. A recent McKinsey piece also notes how, in a new macroeconomic environment, with interest rate pressure, “buyout managers need to focus on operational value creation strategies for revenue growth, as well as margin expansion to offset compression of multiples and to deliver desired returns to investors.”

2. Sell-Side Readiness

Unlike years past, when sponsors had a defined timeline for a sale, the hold period is now fluid, and more based on windows of market opportunity. That means portfolio companies need to get ready now, to be exit-ready on demand. And the shape of what defines exit readiness has also changed: Sellers must now show all the levers they have pulled to drive EBITDA growth and quantify the value creation plan to demonstrate that substantive opportunities still exist for the next buyer.

3. Transformation

As part of that sell-side readiness, or as a separate initiative to improve performance, the new PE paradigm means that sponsors will be more willing to invest in proactive initiatives to find and unlock hidden value. These “transformational” initiatives will span the gamut from digitization strategies to finance process modernization to data analytics. Moreover, the success of these types of CFO-led transformational initiatives will be determined by the willingness and ability of PE-backed CFOs to look beyond their traditional financial reporting responsibilities and dive into both operational and financial efficiencies to improve working capital.

4. Investor Communication

Because PE has been a multiple expansion game, GPs haven’t before needed to communicate to limited partners (LPs) how their portfolio management teams use the tools at their disposal to act as trusted stewards of investor capital. But LPs are no longer satiated by the old playbook, nor are they lulled into complacency by anecdotal conversations about a single portfolio company. LPs are looking for funds that can show quantifiable evidence of leveraging value-creation drivers like working capital improvement, margin expansion and enhanced visibility. GPs will not only need to embrace these drivers, they will need to learn how to communicate their use if they want to succeed in a more scrutinized fundraising environment.

5. New Types Of Turnaround

Yes, turnaround has been the story of PE since … well, in some ways since Covid. Last year alone there were 104 bankruptcy filings among PE-backed companies, the highest ever recorded. But this new crop of distressed companies is different. Many businesses were financed with an outsized level of leverage at a time when interest costs were significantly lower than they are now, and these businesses can’t sustain the high levels of leverage with current capital costs.

So we are, for the first time ever, seeing a wave of restructuring needs that are purely interest rate/debt load driven. In other words, for many of these businesses, it’s not a broken business as much as it is a broken capital structure. In those cases, sponsors will use the transformation tactics they have employed to unlock hidden value to resuscitate the company, rather than immediately turning to a formalized bankruptcy process.

The recession may not have happened, but the anticipation of it nevertheless shaped a changed future for PE. The multiple, multiple, multiple formula for PE success is now a relic from a bygone era when markets were less volatile and performance was more guaranteed. The sector will now need to focus on growth from other areas (revenue, working capital, operational efficiencies, data and analytics) to continue to drive returns. Since this may not be muscle memory for sponsors, they’ll need to find partners to help unlock value and employ different tactics to articulate this newfound approach to investors.

Council Post: Five Ways Private Equity’s Rebound Will Change The Industry

There is a highly motivated group of sponsors who are incentivized to make deals for two compelling reasons.

forbes.com

About Nick Leopard

Nick Leopard
Nick Leopard
CEO & Founder

Nick is the CEO & Founder of Accordion, a private equity-focused financial and technology consulting firm. Since founding Accordion in 2009, Nick has grown the company to serve more than 300 of the world’s premier private equity firms and their portfolio companies – providing services that span the entire CFO function. Accordion is headquartered in New York and has ten offices across the United States. Before Accordion, Nick worked at BHC Interim Funding, Bear Stearns, and CapitalSource Finance. Nick earned his BS in Finance from Saint Joseph’s University.  Read more

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