Outlook for Private Markets in 2023
By Bernard Lam on the 16th January 2023Private Equity
In the face of rising market volatility, rising interest rates and geopolitical tensions, private markets have a challenging year ahead. Private market participants will have to look for alternative strategies amid a tightened debt market, face markdowns in private valuations and expect longer holding periods.
Strategies shift amid tightened debt market
Leverage for buyouts has become increasingly difficult to secure via public markets, concurrently, many banks with hung debt have struggled to sell on the secondary market. This has led to the growth in popularity of the earnout mechanism, which is predicted to be a feature going forward. An earnout provision entitles a seller to additional compensation down the road if the sold business achieves certain financial milestones. It has gone from a situation where earnouts were not widely accepted to one where it’s almost becoming commonplace on most deals.
Markdowns in private valuations
Another challenge PE managers will face are markdowns in private valuations. They will have to take down rounds, which means they will have to accept financing at lower valuations and as a result, will see the value of their portfolio decrease. However, such markdowns in some cases can be healthy. A reset in valuation could set more reasonable growth expectations,with a focus on bottom-line profitability for companies. The companies that will be adversely affected by these markdowns are those growing unsustainability..
Expect longer investment horizons
Funds are also anticipated to keep onto their portfolio investments for a longer period of time, as valuations decline and exits become more difficult. Although holding periods have shrunk in recent years, we're likely to see a return to 4 to 6 year holding periods as it takes longer to generate value before realising gains. No one can predict how long the current wave of volatility will persist, but it is clear why it is occurring. While interest rates are rising, corporate balance sheets and consumer expenditures are declining. Investors are unsure if or when the taper will occur because of the geopolitical uncertainties.
The private markets today will have to come to terms with a new normal, which means an increase in internal bridge round, down rounds and investors seeking more favourable terms.