Organic Value Creation Takes Priority for Private Equity as Economy Turns — BDO’s 2023 Private Capital Survey

• 79% of fund managers and operating partners say asset prices will rise by September 2023
• Applying equity relief to portfolio companies is fund managers’ primary capital deployment strategy
• More than 80% of fund managers and operating partners have turned down at least one deal due to ESG concerns

Faced with challenging financing conditions and rising asset prices, private equity fund managers are focusing on their current portfolio companies to drive organic value creation.

According to BDO’s 2023 Private Capital Survey, four-in-five (79%) fund managers and operating partners surveyed expect assets to trade higher in the next six months. When asked where they plan to direct the most capital during that time, they identified “applying equity relief to portfolio companies” as their number one priority.

This and other findings of the survey, which polled more than 400 U.S. private equity fund managers and operating partners, 200 portfolio company CFOs, and 50 portfolio company board members, describe a private equity ecosystem adjusting to the new economic reality of high interest rates and inflation.

“With continued economic uncertainty following more than a year of rising interest rates and the increased cost of capital, fund managers remain focused on prioritizing their companies hit hardest by the soaring cost of debt and operations,” said Matt Segal, National Partner – PE Assurance. “Funds that strike deals in today’s environment are making sure they have a clear path to creating value that isn’t dependent on rising equity markets.”

Deals in the Current Economy

High valuations and apprehensions about financing remain chief concerns of those surveyed, making new deals a low priority for capital deployment, a trend that has remained primarily steady over the last year. Instead, fund managers are focusing primarily on applying equity relief (17%).

Fund managers and operating partners cite risk exposure uncovered during due diligence as the primary challenge to closing deals in the current environment. This year’s survey also confirmed that deal risk is changing. For example, environmental, social, and governance (ESG) risks can ruin private equity investments. More than 80% of fund managers and operating partners report they have turned down an investment opportunity because of ESG concerns. This finding suggests ESG risk may be a leading indicator for broader business risks.

Portfolio Company CFOs

The majority of portfolio company CFOs are new to navigating the current economic climate. Many are traversing high interest rates and inflation for the first time in their careers. According to the survey, three in five (60%) CFOs surveyed started working in their current roles less than 10 years ago, during or after 2013 — five years after the financial crisis.

Labor shortages are also a pressing issue for portfolio companies. Almost half (47%) of portfolio company CFOs report they are understaffed in critical roles. These findings point to a deeper problem: private equity funds and their portfolio companies struggle to find the advanced financial and leadership skillsets required to execute their value creation plans.

Value Creation

In addition to talent management, top-line growth is a key focus of value creation. More than 47% of fund managers and operating partners and two in five (45%) CFOs and board members say top-line growth is most important to them over the next year. They are also largely aligned in their approaches to achieving that growth — namely, prioritizing revenue.

“Doubling down on value creation over the next several months will be critical for funds and portfolio companies in resilient growth mode,” said Jim Clayton, Management Consulting Principal, Private Equity National Co-Leader, and Private Equity National Advisory Leader. “The margins for success are slim. Decisions made today could mean the difference between effectively executing a transaction that generates returns for limited partners a year from now or pushes a portfolio company closer to default.”

Exit Landscape

Although financial sponsors remain the top path for exits in 2023, far fewer fund managers — 41% versus 55% in 2022 — view their fellow funds as potential homes for their portfolio companies over the next 12 months. Strategic buyers, which more than half (52%) of funds plan to pursue as an exit for their portfolio companies, dropped to fourth place at 33%. Given the challenging economic conditions, carveouts jumped from last place in 2022 to second place in 2023, rising by 16 percentage points.

To dive deeper into the insights from the BDO 2023 Private Capital Survey, download the full report here.

BDO’s 2023 Private Capital Survey polled 405 U.S. private equity fund managers and operating partners, 200 portfolio company CFOs, and 50 board members. The survey was conducted by Censuswide, an independent market research firm, in March 2023.

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