Many individuals at large institutions that trade in the public markets are turning to private ownership and pursuing majority equity positions in lower middle-market companies and even creating their own funds. This public-to-private trend is partially being driven by current and expected public market volatility over the next few years, combined with individual business circumstances, all with the expectation for a brighter future. The recent stock market instability is presenting attractive opportunities for companies that may perform better in the private market. Private equity and private investors have ample capital available to them at a time when public market valuations are sinking. The interest is coming from both private equity funds and strategies, as private markets are gaining ground on public markets. Take-privates are on pace for the second year in a row at $100 billion or more in deal value. That is a first for the industry in more than a decade.
According to data from Pitchbook, private-equity and venture-capital-backed market caps have grown faster than those of the public market in recent years. In 2017, the midpoint of the estimated market cap for private strategies was 8.1% of the value of public markets. By 2021, that number will grow to 12.4%. And S&P Global reported that the total transaction value of global take-private deals with private equity involvement over the last five years had increased significantly. It surged from $37.42 billion in 2017 to $223.4 billion in 2021. Over that same period, the number of take-private deals jumped from 39 to 60.
PE-led deal activity is finally feeling the impacts of rising interest rates over the past year, and it is no small feat that we are close to 2021 levels this late into 2022. Fiscal and monetary stimulus drove a flurry of deal activity for most of 2020 and all of 2021. A
better comparison would be to liken today’s activity to the three-year period prior to the COVID bump. Even so, activity in Q3 is flat to slightly up versus what was considered normal from 2017 to 2019, which then was viewed as an intense pace for U.S. private equity deal-making. It is impressive that, through the first seven months of 2022, the PE deal count was ahead of 2021's hectic pace, even during a hostile time. Additionally, fundraising has been surprisingly close to the pace in 2021, when a record $366.1 billion was raised for PE strategies.
More private equity players are looking for companies that have high-quality fundamental operations that they can own over a long period of time for an attractive return, even if the stock currently has a lower valuation due to market economics or if they are flying under the radar of Wall Street analysts simply because it’s not worth their time to cover them.
Also, in some cases, public companies with hundreds of millions in revenue are seen as risky because there is not enough daily liquidity to draw institutional investors. This changes when the company becomes private because they are no longer subject to the nature of the capital markets.
Additionally, investors are seeking public businesses that have solid business fundamentals but may have made a slip-up that can be rectified once private, as well as C-suite leadership that adaptable to a long-term private ownership mindset rather than cater to shareholders’ expectations of quarterly results.
Taking a company private also offers other advantages without pressure from shareholders. Public companies come with a great deal of bureaucracy, quarterly earnings expectations, red tape, corporate governance, and regulatory issues. They also often have people involved that are not as intimately engaged with the core operations of the business. Private ownership permits more engagement, knowledge, incentives, and an overall different way of thinking about the business and its long-term goals. Private firms can also devote more resources to R&D, capital expenditures, and pension funding.
According to studies reported by the Securities and Exchange Committee (SEC) in the U.S., $10,000 in a retirement fund that earned 7% annually from the S&P 500 over 30 years would see an ending balance of $76,123. But if that $10,000 were invested in an average.
PE buyout fund (which earns 3.7% above the S&P 500 annually), the ending balance would be $211,071.
Keep in mind that there may be hurdles to the public-to-private strategy because of inflation and rising interest rates, so the cost of financing could be more expensive for companies that must be purchased with cash. Also, the larger the private markets get, the more scrutiny they face, which can limit access to them. Less access means that retail investors miss out on opportunities for excess or uncorrelated returns. Even so, there are still many solid options that can be taken private and benefit from a simpler investment strategy for growth, and the SEC is recommending increasing access to private markets.
While public markets have been volatile, the M&A market remains strong. There is still plenty of capital to be invested in private equity, so deal-making should stay strong into 2023, depending on what happens with the economy moving forward. Most of the volatility in 2022 has calmed, and the market is doing better than expected. Gray areas are starting to clear up when it comes to valuations, earnings, and revenues. Multiples are still high in general, but there is uncertainty regarding whether they will stay as high as they’ve been over the past 12-18 months. PE firms still have abundant capital to invest, and lending remains open and fairly affordable. However, firms are paying more attention to businesses' earnings capacity and how much they have recovered from supply chain issues and other disruptions.
A common mistake that businesses make is trying to do everything themselves by using internal resources. This can result in failed deals or lower returns because they didn’t have the right expertise or resources for proper due diligence and negotiation tactics. So they wind up with a deal that they shouldn’t have, or they get far lower returns because the complicated deal process wasn’t conducted properly. Having the right people and processes in place, such as the guidance of an M&A advisory, can help companies avoid costly mistakes.
Americas: Sam Smoot at +1 (813) 898 2350 / Smoot@BenchmarkIntl.com
Europe: Michael Lawrie at +44 (0) 161 359 4400 / Enquiries@BenchmarkIntl.com
Africa: Anthony McCardle at +27 21 300 2055 / McCardle@BenchmarkIntl.com
ABOUT BENCHMARK INTERNATIONAL:
Benchmark International is a global M&A firm that provides business owners with creative, value-maximizing solutions for growing and exiting their businesses. Benchmark International has handled over $8.25 billion in transaction value across various industries from offices across the world. With decades of M&A experience, Benchmark International’s transaction teams have assisted business owners with achieving their objectives and ensuring the continued growth of their businesses. The firm has also been named the Investment Banking Firm of the Year by The M&A Advisor and the #1 Sell-side, Privately Owned M&A Advisor in the World by Pitchbook’s Global League Tables.