My ears were left ringing over the weekend with the looped soundtrack played by many GPs and market commentators on the state of the Global Private Equity market that I had listened to during the preceding three days at SuperReturn in Berlin.
The much hoped for big recovery and flushing out of the system by the much-needed return to deal volumes isn’t going to happen in 2025. Many observed that it is extremely hard to call when the sustained period of volatility that we have now been in for some time is going to end. The recent protectionism and de-globalisation agenda coming out of the new US administration means that we remain in the midst of a tumultuous period. One US GP observed that at a minimum “consistency in approach is needed to help settle nerves”. Some were less bearish and expect an H2 2025 recovery although there is little to no evidence to support this sentiment. As one seasoned investor pointed out, we are in a period of “disorder with danger and excitement” no doubt alluding to the well-known fact that periods of instability have often generated the best returns for GPs.
So what were GPs saying about the drivers of this sentiment that 2025 is going to be a big disappointment for most?
The macro environment is making many “pause for thought as the risk bar is higher”. We have certainly seen the impact of this through the typical period taken to complete a transaction extend from three months to more like four or five months. Not since the immediate aftermath of the GFC have I witnessed a period where people are digging so deep into the weeds of a deal that they sometimes don’t re-emerge or, if they do, are covered in mud by the time a deal finally signs.
“Rates to stay higher for longer” and “a hoped-for bail out afforded by lower interest rates isn’t going to happen and will result in a dispersion of GP performance as a result”. There is no doubt that the current cost of debt capital is high, even higher for those who didn’t hedge before base rates jumped. The grins on the faces of those LPs with investments in private credit strategies said it all. As one GP commented “if you look at the short end of the curve debt capital is still very expensive”. As someone else bemoaned, “rates really matter if you are pursuing a buy-and-build strategy, you’re 6 times levered and paying 11-12% and your interest cover is tight…”. Put differently, “fewer businesses are able to grow out of their current capital structures”. I did hear someone offer a plausible excuse for those deal doers who have been caught out by this dynamic in that “generals always prepare to fight the last war”. One went further saying that “not enough GPs are realising that some of their investments are not what they thought they were, and they need to exit these and focus on redeploying into those that will work”.
No one, however, was looking for any sympathy. One GP observed, “if you’ve paid 16x-20x with 6x debt then 400-500 basis points extra cost on your debt isn’t really going to impact your IRR”. All-in-all, there is absolutely no doubt that, from a return on performing loans perspective, we are in a golden age for direct lenders.
The impact of all the above on exits is clear to see – we are at an all-time high of c.$4 trillion of unrealised NAV globally. The industry desperately “needs full exits to unblock the system”. We can see the impact that cost of credit and the resulting cap on leverage is having here but, there is also the thorny matter of portfolio company holdings values. When the debate on this commenced there were lots of people looking at their shoes and checking their emails to avoid acknowledging the message we were all hearing. One panellist put a value on it: “US and European valuations are 16-22% too high. If you have a bid from a secondaries fund in the 80s to 90s, hit it!” As the conversations continued, someone added that in the sale processes they have been engaged with, “no one is selling as offers are way below the marked values of assets”. Of course there are exceptions to this general market statement. “Top quality assets are changing hands” but, given the weak IPO market, this isn’t really returning capital to LPs who are just seeing their exposures switch to other GPs through these trades.
So how is this all going to play out?
One commented that fundraising in the current market is tough, really tough. You have to have “two times as many meetings to raise 70% of the capital”. This doesn’t apply to everyone though. One panellist referred to their proprietary categorisation matrix that they apply to the c.7,000 GPs that they analyse. Ranked from category 10 at the top to category 1 at the bottom, there are just 6 firms in category 10 and only a further 9 in category 9. Having scale, multiple investment strategies and global presence gets you into the top tier with sector or category killer status only getting a GP as high as category 8. As put by the panellist, these top 15 firms out of the universe of 7,000 have raised c.35% of the total capital raised over the last 10 years. Scale is your friend regardless of the market we find ourselves in. The big will just get bigger, and LPs will no doubt consolidate their commitments to fewer GPs.
Set against this backdrop there remains a vast amount of undrawn LP commitments to the sector given the fundraising spike witnessed in 2021-2022. So how is this capital going to be deployed? One proffered the view that there will be a lot of extension requests to current fund investment periods. The argument made was that this would push the need to raise a new fund out to 2026/27 when commentators think that the global macro and exit markets will start to normalise – the argument being that such a move works for both LPs and GPs. “Realisations are the acid test of the performance of our business” said one global GP CEO, so anything to help achieve this will be in the interests of most GPs.
Hanging around and waiting for things to improve isn’t really a strategy. As one interviewee said “you are either paving the way or in the way”.
Continuation Vehicles will continue to provide a partial solution and currently account for 13% of all exits in Europe according to one investor. The same investor said that since October 2023 they had invested over €8bn into CVs and they love them, not least because the GP commit levels in these deals was c.35% given that GPs tend to roll 100% of their economic interest in these trades.
Last, but by no means least, we then have the structured credit solution of NAV financings. There is no doubt that structured GP financings can play an important role in the current market that is sub-optimal from an exit perspective. Layer on the capital-intensive nature of the buy-and-build strategy that has become the dominant investment strategy in mainstream European private equity, the ceiling that high base rates beneath expensive direct lending margins has on company cash flows and NAV borrowing soon becomes your friend. Whether NAV proceeds are used to contribute equity at the portfolio level for expansion or deleveraging, to finance tuck-under acquisitions or more transformational M&A to buy down a platform’s entry multiple ahead of exit, or to provide incremental bridge investment capital during an extended fund-raising process, NAV loans provide flexible, cost-effective liquidity solutions to drive value for Private Equity GPs.
Newbrook is particularly well placed to assist our GP clients to access management company, continuation vehicle and fund-level liquidity solutions and would be happy to further discuss the detail of our capabilities in this regard.
I can’t finish this musing without some wise words from Bono who presented his contribution to The Rise impact fund. Central to his belief on impact is “where you live shouldn’t determine whether you live”. He also proffered the main parallel he had identified between being in a rock band and working in a professional business environment and summarised it as “you are defined by the company you keep” – very wise words indeed.