The first quarter of 2023 was marked by significant challenges in the banking industry, with the collapse of major players such as Silvergate, Signature, and Silicon Valley Bank, followed by the rescue of Credit Suisse. The collapse of Signature and SVB alone marked the second and third-largest bank failures in American history.
Despite this crisis, PE showed remarkable resilience. Let’s examine the factors contributing to PE's stability and explore how the industry maintained its momentum in Q1.
Mega-Deals Amidst the Chaos
Research from PitchBook shows that, amidst the banking crisis, private equity firms announced five mega-deals worth a combined $31.3 billion. Among these was the year's most significant, Qualtrics' take-private deal for $12.5 billion. While banks, venture capital, and public markets faced turbulence, the PE industry was practically unbothered, adapting to the altered financial landscape.
The ability of private equity firms to push through mega-deals can be attributed to several factors. These include their existing relationships with limited partners, access to alternative funding sources, and a strong track record of delivering returns in past financial crises.
Adjusting to Scarcity of Debt Capital
Although there were changes in how PE deals were structured, the industry remained resilient. For instance, large LBOs in the tech sector required 70% to 92% in equity in March, compared to a historical average of 48%. This shift reflects the scarcity of debt capital available for funding mega-deals, which was a consequence of the banking turmoil.
To adapt to the scarcity of debt capital, private equity firms have had to rely more on equity financing, tapping into their extensive network of limited partners to raise capital. This has allowed them to continue investing and generating returns, despite the challenging market conditions.
Some PE firms have turned to alternative sources of financing, such as private credit funds, which have become more attractive as the traditional banking sector has struggled. This has allowed private equity firms to access funding without relying on banks.
The decline in purchase price multiples also enabled recent vintage funds to buy at compelling prices, augmenting returns and compensating for the lack of debt leverage.
Resilient Fundraising and Performance
PE deployment demonstrated signs of stabilization in Q1, following a 38% peak-to-trough decline in quarterly value. Fundraising fell less than some predicted, with $66.8 billion in funds closed. Furthermore, performance steadied after negative returns, as indicative returns from public PE managers pointed to modest appreciation in the final quarter of 2022.
Private equity firms could maintain fundraising momentum due to their strong track record, reputation for stability, and the confidence of limited partners. The success of PE fundraising can also be attributed to the diversification of their portfolios, focusing on sectors that have proven to be resilient during the crisis, such as healthcare, technology, and renewable energy. In fact, healthcare private equity had its second-best year in 2022, in terms of volume and value.
This diversification has given investors confidence in private equity firms' ability to navigate the current financial landscape. At the same time, global pension funds increasingly look to private assets to build resilience.
Lessons Learned and Future Outlook
The challenges faced by the banking industry in Q1 2023 have provided valuable lessons for the private equity sector. As a result, PE firms have become more vigilant in their risk management, focusing on portfolio diversification and enhancing due diligence processes. This proactive approach has contributed to the industry's resilience during turbulent times.
The reliance on alternative funding sources, such as private credit funds, has expanded the financing options available to private equity firms. This development may shape the industry's future, as it reduces dependence on traditional banks and opens up new opportunities for growth and deal-making. With a record $3.7 trillion in dry powder, the private equity sector is well-positioned to continue its growth trajectory.