The pandemic provided a significant boost to the private equity industry.  Fueled by a COVID-induced technology boom, 2021 was a record-breaking year with $1.2 trillion in deals. [i] Then, 2022 turned out to be the second biggest year in history, with almost $730 billion in private equity transactions.[ii]  As we get started in 2023, where is the industry likely headed?

Will Private Equity Continue with Its Strong Momentum?

With two back-to-back record years, 2023 is eagerly anticipated.  What will it hold? 

The last half of 2022 may hold some clues.  While the first six months included carried-over momentum and yielded significant activity, the second half had a definite change in character.  Exuberance was replaced by newfound caution as sagging public markets dampened investor interest across the board. 

However, taking a closer look, the situation might not be as bad as it seemed.  Despite the decrease in announced deals in the second half, 2022 still closed out above pre-pandemic levels.

Private Lending to the Rescue

Traditional financing was more difficult to find once turmoil hit the financial markets.  A July 2022 Financial Times article notes that tens of billions of debt has been stranded on bank balance sheets. [iii]  With institutional investors and asset managers practicing caution, many loans have become difficult for banks to place.  This challenge has subsequently decreased their appetite for PE lending. 

Fortunately, there was one source that came to the rescue.  That’s private credit.  Direct lenders have been happy to fill the void.  In fact, as 2022 closed, private lending made up most of the financing for private equity deals.

Of course, the syndicated markets will likely stabilize and return to a more normal state. However, many firms find these direct deals to be faster and more flexible, so direct lending is probably not going away anytime soon. 

Continued Focus on the Middle-Market

Another reaction to the post-Covid financial market dislocations has been a shift toward more middle-market deals.  This has already been seen with this segment off to a strong start in 2023. [iv]

This makes sense.  Take-private transactions have been challenged by the ability to get financing, even though many valuations are more attractive.  But with middle-market companies, there’s always supply, and smaller deals are usually far easier to put together.  

Add-On Deals Continue to Gain Momentum

Since 2018, add-on transactions have been a growing source of deal volume.  According to EY, add-ons grew to 60% of total private equity transactions in 2022 from 48% in the previous year.  [v]

As the economy continues to struggle, this trend will likely continue into 2023 and beyond. 

Specialists will Thrive in the Private Equity Industry

In today’s hypercompetitive landscape, specialization pays.  Investors are attracted to teams with a clear strategy that provides a competitive edge.  Whether it is an industry focus or specializing in a specific approach (i.e., carve-outs), having a better-defined process or target can pay off. 

Small firms can gain a foothold by focusing on an industry that they know well.  With large firms, we’re seeing more specialization of teams to exploit those same opportunities.

Target Industries for Post-Covid Private Equity

While technology has fallen out of favor on Wall Street, it is still a popular theme in private equity.  Institutional investors are still eager to support it, with the sector accounting for more than 26% of the industry’s total deal value in 2022. [vi]  Lower valuations have created better buying opportunities.  Specifically, cybersecurity has been a significant area of focus in tech, along with the continued favoring of SaaS and tech-enabled services.

With the Ukraine war spiking interest in energy, this sector received significant private equity industry attention last year, which is likely to continue.

Infrastructure has also been an area of high interest.  The industry has seen innovative deals where corporations strike up arrangements with PE firms to provide flexible access to capital.

An Expected Continued Slowdown of Exits

Private equity exits slammed on the brakes in 2022 as the financial markets suffered.  PE-backed IPOs plummeted from 196 in 2021 to only 52 globally in 2022, according to Preqin. [vii]

This absence of exits will likely impact growth.  According to Pitchbook, about 80% of private equity investment capital comes from reinvested distributions. [viii]

What about Venture Capital?

Unsurprisingly, venture capital has experienced one of the sharpest drops in two decades post-COVID. [ix] While private equity investors are keen to support established businesses, investors are less enthusiastic about taking a chance on startups in a harsh macro environment.

However, activity is expected in a few areas, including clean energy supply chains[x].  Startups in this space can expect more interest from investors as the world continues to grapple with recent energy shocks.

Key Takeaways

While trends are shifting in this post-pandemic environment, the private equity and venture capital industries will continue to evolve to meet these challenges.  For private equity, firms will look for opportunities to add value in industries they know well.  With venture capital, firms will likely focus on what is working, giving the broader investment climate more time to recover.  Both areas have opportunities and threats, and industry participants will carry the pandemic’s lessons forward as they attempt to differentiate themselves in 2023.