Calling all LPs! Thanks for joining me (John Bailey, Co-Founder at OneFund) for another edition of Capital Call. A bi-weekly private equity newsletter from LPs for LPs. 

The mission of Capital Call is to deliver concise, top-notch insights and updates from the private markets tailored to what matters for LPs. 

This week we will be looking at: 

• A Recap: ‘Q3’s Exit Slump Delays Recovery’

• Fundraising updates and VC/PE reports

• GP Perspectives from Lofti Karoui & Justin Vogt

Join me for our last webinar of 2023!

Tuesday, November 14th at 1 pm, Chris Tayeh of Thompson Creek Wealth Advisors and I will sit down to discuss managing liquidity in alternative investments.

This is our last webinar of the year so I hope you are able to join us.

This is a topic extremely important to alts but something many investors new to the asset class don’t always think about. Despite PE & VC outperforming the S&P over the last 20 years, there is a reason institutions and endowments allocate roughly 15% to 20% to PE & VC instead of 50%+.

Join below! We are looking forward to it.

Q3’s Exit Slump Delays Recovery

Instead of maintaining the growing deal momentum of the first half of 2023, private equity activity entered a cooling environment in Q3, breaking below the $200 billion deal value threshold for the first time in years contrary to what most analysts predicted.

Pitchbook’s 2023 Q3 US PE Breakdown finds that Q3 saw a disappointing 41% decline in PE exit value, marking a sharp reversal from the 44% year-over-year uptick seen in Q2 and delaying the impending rebound of PE activity until 2024.

In this week’s capital call, I’ll dive into where deal activity remains, updated market predictions, and other Q3 PE trends that matter to LPs.

M&A Recovery to be Delayed, but Rebound still Imminent

It is important to note that while the Q3 figures appear disappointing and drive a negative outlook, Pitchbook predicts the anticipated recovery will just be pushed back to early 2024 rather than be delayed for years. Trillions of dollars in dry powder, consisting of $1.4T for private equity sponsors and corporate cash positions, are currently assessing deployment opportunities.

In addition, lower valuation multiples in the private market could cause cash-rich public strategic buyers to acquire at scale. Pitchbook finds the average EV/EBITDA multiple for public companies to be 13.2x in Q3’s twelve-trailing months compared to just 8.7x for private M&A transactions, providing strong opportunities to conduct accretive acquisitions. The strengthening valuations of public corporations will likely cause a rebound in public acquisition activity that was previously dampened by poor stock market performance.

LPs and GPs looking to offload assets should assess which strategic public corporations could be potential buyers over the coming quarters. Those with strong cash positions and recent valuation increases will be better positioned, and will offer higher purchase bids than sponsors.

Growth Equity Projected to Overtake Platform Buyouts

The growing strain on debt financing has shifted focus towards deal structures with less dependency on leverage. Nearly 80% of buyouts in Q3 were add-ons, and other capital solutions such as leveraged loans and NAV lending continue to gain further traction. 

Recently, growth equity has gained rapid traction and now accounts for 15% of all US PE deal value compared to just 7% last year. A notable rebound for the asset class. With momentum expected to continue growing, growth equity is projected to outnumber platform investments for the year for the first time ever.

LPs interested in deploying significant capital in the near term at higher risk thresholds should assess opportunities to invest alongside growth equity GPs, as it is one of the few areas of the private capital market expected to see substantial deal growth over the next quarter while other strategies pause until 2024.

Fundraising Fuels Optimism

I found the above chart interesting and wanted to include it in this week’s newsletter as well. Pitchbook highlighted optimism for the fundraising market and I feel that way as well, especially considering the attractive multiple highlighted earlier. However, what is notable is how few funds are bringing in the dollars. Look the the blue dot in 2023. There has been a flight to larger managers amidst the uncertainty in the market. As an LP, I am actually looking at smaller managers a lot right now. Many small and emerging managers will not survive this fundraising cycle and the ones that do will be better positioned because of it.

Updates from Across the Ecosystem

Fundraising

📈 KKR raises $3bn for 3rd Next-Gen Tech Growth Fund

📈 Astira Capital Partners Wraps up Inaugural Fund at $675m

📈 Five Elms Eyes $850m Target, $1bn Cap for Latest Growth Equity Fund

Reports

🔬 Goldman Sachs: What the Volatile Bond Market means for Investors

🔬 Pitchbook: Q3 Global M&A Report

🔬 Blackrock: Targeting resilient portfolio construction with alternatives

GP perspectives:

Lotfi Karoui (Chief Credit Strategist, Goldman Sachs)

Lofti Karoui, Goldman Sach’s Chief Credit Strategist, expects LBOs to return in 2024. He points to the record amounts of dry powder paired and more deals financed with equity and cash, creating an inflection point in transaction financing where PE investors return to target cash-generating businesses and improve operations like a textbook buyout structure. He predicts 2024 will still be a high cost of debt year though, with transactions structured with more equity than typical. 

When asked if Karoui foreshadows bubble risks with the rapid growth in PE fundraising propping up the ‘shadow banking’ system, he dismisses concerns. Karoui explains that some asset managers may face financial distress due to the high cost of leverage and the risk of facing margin calls, but that risks for the broader financial system should be manageable since asset managers have a far greater ability to deal with financial distress compared to the public side.

Cahn believes AI only generates $75B today, which uses generous assumptions, leaving a $125B+ gap that needs to be filled for each year of CapEx at today’s levels. Though there’s a large opportunity for the startup ecosystem to fill this hole, this major gap implies a technological overbuild that will likely incinerate capital, while paving the way for future innovation at the same time. For investors, there’s likely a significant opportunity to deploy capital in certain, strategic AI companies, but be wary that many firms operating in this space will burn significant capital over the next few years without much to show for it.

Justin Mazeka Vogt (CEO, Evermore Industries)

Justin Mazeka Vogt brings up an important operational insight for LPs and GPs looking to operate in the lower middle market.

Doing deals at this check size is much more about operational expertise rather than financial engineering, and investors in the space must have strong ops teams to execute successfully.

Investors may see the enormous EBITDA and multiple expansion realized on select LMM deals and look to venture into the space but don’t see the laborious operational tasks that fueled those returns.

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