Private Equity Market Update

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Article by Oscar Luck

Private equity (PE) has long been a gold mine, both for their General Partners (GPs) and for the law firms servicing them. This is exemplified by the private equity powerhouse Kirkland and Ellis, which has grown exponentially over the last decade to become the highest-grossing law firm fuelled by the PE market. However, there are worries about a deal slowdown due to the rise in competition, reduced profitable opportunities, and unfavourable market conditions, which may cause a temporary or permanent downturn for the industry. Deal value has decreased significantly since the post-Covid boom, with a total deal value of less than half the value from 2021-2022. This is due to multiple factors, but primarily the unfavourable financing opportunities and market conditions; given that the majority of PE transactions operate a leveraged buy-out (LBO) structure, the global interest rate rises have reduced the possibility and profitability of such a model.

This has been accompanied by a period of severely diminished fundraising, with Bain Capital and other major players fundraising down by more than half compared to the same quarter of last year. This is partially representative of the trend away from PE towards private credit, given the greater opportunities for guaranteed profit in the current high-interest market.

Changing Fund Structure

Alterations in the ordinary fund structure for PE transactions have also accompanied declining market conditions. Investors showing less willingness to commit their capital into funds are being encouraged instead to co-invest alongside the private equity funds, providing diminished returns for the managers but potentially greater control and return for the LPs.

From the fund side, firms are attempting to make a move towards perpetual instruments that have no time restriction requirement. A major flaw in the private equity system is the regulation requiring exits to be taken despite pernicious market conditions, resulting in exits damaging to the funds’ performance. This feature of the market has led to many PE firms selling investments across their own funds to mitigate the losses that would otherwise materialise.

Alternatively, there has also been a rise in pledge models, where investors pledge certain amounts of capital and then are provided with a choice of opportunities evaluated by the PE fund. This offers great flexibility for investors and likely minimises the short-term exit requirements of traditional funds. Finally, there has also been an increase in funding from public markets by creating listed PE funds or even hybrid listed funds that use public capital to top off funds. These structures benefit investors as they provide greater capital availability, and investors are given liquidity possibilities otherwise unavailable to them.

Changing Exit Strategy

To deal with unfavourable market conditions, private equity firms are moving away from IPO exits, which dominated at the start of the year, with a greater focus on traditional sales carve-outs. As competition rises within the Private Equity markets and opportunities diminish, alternative strategies such as carve-outs provide opportunities for experienced funds to leverage their expertise to remain profitable.

Although total deal value has fallen, exits have risen substantially by 22% since the same quarter in 2022. This is primarily due to necessity rather than opportunity, reflected in the drop in IPO exits since the start of the year.

Effect on Law Firms

So, do private equity-centred law firms need to worry? In the meantime, I think the key focus should be adaptability – ensuring that the firm can deal with more complex fundraising and investing structures. If this is the case, deal quantity, at least in a short-term downturn, should remain manageable. However, mid-market firms that tend to deal with less reputable names in the industry may begin to struggle as they are noticing the fundraising decline to a much greater extent. However, as interest rates start to slow, the market may see a turnaround in early 2024 – dependent on the macroeconomic effects of the recent Israel conflict – providing a renewed opportunity for industry-wide growth.