PE dealmaking is coming back - what does it mean for limited partners?

Welcome to Capital Call! The OneFund newsletter.

This summer Bain and Company came out with their mid-year PE report which essentially highlighted what a lot of us have been seeing in the market - PE dealmaking, which bottomed out in 2023, is beginning to make a comeback.

The current environment is likely good for investors deploying into the asset class and especially good for those waiting on distributions, however, it is investor beware as not all funds are the same. Where you deploy your capital is just as important as when you deploy it.

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PE activity is coming back. Why should LPs care?

In 2021, deal count, exit count, and number of funds closed began to decline after the pandemic investing euphoria eased. However, 2024 has seen a marked leveling off in deal count and exit count while interestingly the number of funds closed continues to decline.

While the prospect of deal activity returning is exciting for those in the industry, is this something that LPs should even care about?

The answer is yes, but not for reasons one may think. Increased deal activity does not magically mean the LPs will see higher returns. What this does indicate, however, is that 1) distributions may begin to rise (finally), 2) the PE industry will become more concentrated, and 3) funds are going to be making more investments.

1. Distributions may rise in the years to come

The decline in deals over the last couple of years, while I believe a boon to long-term returns for investors today, has meant that investors from 5 or 10 years ago have struggled to see distributions from their investments. This may be changing. Deals don’t just mean companies are being bought, they’re also being sold. The proceeds of those sales can finally start to flow back to investors.

While it will take time for this to make its way to LPs, there is strong potential here for the trend in distributions to turn around in the near future.

2. The PE industry is becoming more concentrated

While deal count and exits are leveling out, the number of funds that are successfully fundraising is continuing to drop. This is good.

I can’t tell you how many funds I’ve talked to over the past year that were run by folks who made it big in crypto in 2017 and thought “hey, I’m an investing genius, I’m going to open a venture fund”. Shockingly, they were not investing geniuses.

Many of these funds (and others) are failing to raise successive rounds as LPs became more discerning with their limited capital in 2021 and 2022.

3. Funds are making more investments

With fewer funds successfully raised and the general flight to quality from LPs, funds that survive are deploying their generally growing capital pools into a larger number of portfolio companies as they seek quality assets where they can deploy capital.

What’s interesting is that this trend long predates the events that have caused the previously discussed trends. Bain has shown, from an admittedly small sample size (see below), that the average number of companies in a fund’s portfolio has roughly doubled from 2013 to 2023.

I’m a fan of this. Diversification is important even in private markets. What LPs need to look for when diligencing funds, however, is how funds are increasing the number of investments that they make. Are the funds making more investments in the spaces they know and understand, or are they expanding to new niches that they have little experience in but are “hot”, like AI?

It’s important to answer these questions to both get a sense of whether you can trust a manager with your capital and also whether they fit into one’s broader portfolio.

At the end of the day, I’m excited that deal-making is on the rise. It’s good for the health of the sector and for generating distributions for LPs (that’s what this is all about, right?). However, its important to keep in mind how this is fundamentally changing the landscape for LPs and how to stay ahead of these changes.

Thank you for reading.

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