Private equity investors say activity is starting to pick up this spring, despite not seeing a decline in interest rates from elevated levels that has held back deals the last two years.
Jeff Helminski, the founder and managing partner at Auxo Investment Partners, noticed a marked pickup in activity about mid-March for the Grand Rapids-based private equity firm. Helminski reports improved activity in both volume and quality, or “deals that are a good fit for us.”
“And it has continued ever since,” Helminski said.
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Helminski believes that greater certainty in the U.S. economy’s direction and a general acceptance that interest rates — even if they do start to come down — won’t decline significantly in 2024 have started bringing more sellers into the market who have been waiting for a better rate environment and improved valuations.
“The world has largely coalesced around the belief that interest rates aren’t coming down in any material way any time soon, so from a liquidity and cost standpoint we have what we have to play with for a while. This is the environment that we have to live in,” Helminski said. “I expect the second half of this year is going to be much stronger than it was in both in the first half and last year.”
Others in the private equity and M&A field offer similar perspectives.
“We have cautious optimism,” said Jeff Johnson, managing director Jeff Johnson at Grand Rapids-based Blackford Capital.
Blackford Capital is looking at “a number of new platform investments and some add-on investments for our existing platforms,” Johnson said.
“In general, I think the sentiments, at least among a lot of the investment bankers that we’re working with, is that the second half of the year should be much stronger and more enthusiastic than the first half of the year,” he said. “They’re feeling as though there’s going to be a more robust pipeline in the back half of the year because sellers have been through a couple of tough years, and they don’t expect a tremendous sea change. They feel like this is probably the right time.”
Still, there remains “some overhangs in the marketplace and deals are taking longer to get closed for a whole host of reasons,” Johnson said.
A sector that’s held up well among investors has been manufacturing, while the consumer sector “has been very lukewarm at best,” he said.
“There’s enormous interest in kind of old economy, industrial, manufacturing businesses,” Johnson said. “That’s where people want to take a look at deals. There’s a lot of investor interest.”
LV2 Equity Partners LLC noted in an April newsletter that “market dynamics in 2023 appear to have spilled over into 2024,” with lingering economic uncertainty, high material costs and interest rates, lower consumer confidence, and geopolitical concerns. Those factors slowed M&A activity in 2023.
Higher debt costs caused “buyers to be more prudent in what they will pay for a business,” LV2 reported.
In the last few months, however, “we have observed positive activity that leads us to believe deal volume and valuation multiples will improve as we progress through 2024,” LV2 said.
After hitting a peak in 2021, with 9,760 reported deals worth $1.2 trillion, private equity investing experienced two down years in 2022 and 2023, according to PitchBook. Deals in the U.S. last year totaled $706.3 billion across 8,115 transactions.
PitchBook recently reported 2,105 U.S. private equity deals in the first quarter of 2024 for $145.4 billion.
Deal activity nationally in the first three months of 2024 “continued to move mostly sideways with estimated deal count slightly elevated relative to the past four quarters and deal value moderately lower,” according to PitchBook’s first quarter analysis on U.S. private equity.
Eyes on interest rates
Investors entered 2024 hopeful for sustained interest rate cuts this year after a series of increases beginning in 2022 to fight high inflation. Amid stubborn inflation, the Federal Reserve Open Market Committee on May 1 opted again to hold the benchmark federal fund rates steady.
Economists at PNC Bank expect the Fed still may make two quarter-point rates cuts this year, followed by three more in 2025, although “inflationary pressure coming from goods producers appear set to put that outlook to the test,” they wrote in a recent economic briefing.
The start of a lower rate environment could create a psychological boost to the market and “just create a lot of enthusiasm and people will feel a whole lot better about starting to invest again,” Johnson said.
“If the rate environment starts to go the other direction and people kind of feel like we’ve bottomed out on this and the momentum is starting to shift, then that’s going to be, I think, a catalyst to start seeing deployment number go up.”
While any downward movement in interest rates is welcome, Helminski at Auxo Investment Partners said a full point decrease is needed “before you get something truly meaningful in terms of the financial impact,” he said.
The market conditions in 2023 and pullback by some sellers particularly affected the quality of transactions, said Greg McGowan, managing director and founding partner at investment bank Woodward Park Partners in Bloomfield Hills.
“It really comes down to supply and demand, and private equity isn’t going to do a deal just to do a deal,” said McGowan, who also expects improved deal flow in the second half with more strategic buyers in the market and the continued higher use of earnouts and seller financing.
“I think you’re going to see private equity be more active in 2024,” he said. “You’re going to see more people start to just come to terms with where the market’s at and start transacting.”
Middle-market outliers
However, outliers to market trends have been deals in the lower middle market, which “has really continued pretty much unaffected, particularly this year,” said M&A attorney Tracy Larsen at Honigman LLP in Grand Rapids and leader of the firm’s Transactions and Counseling Practice Group.
Activity involving investors making bolt-on acquisitions for existing platform companies in their portfolio has also held up, Larsen said.
“We’re very busy in kind of the lower middle market PE, add-on space,” he said. “We’ve also seen an in increase in private equity funds positioning themselves for their next platform (or) private equity funds looking to sell platforms.”
Add-on acquisitions since interest rates began rising two years ago “have emerged as a pivotal mechanism or sustaining the momentum of the PE sector amid the challenges of tightened credit conditions and market volatility,” PitchBook noted in its report on first quarter activity. “These strategic transactions enable PE sponsors to persistently deploy capital by focusing on smaller, more manageable deals, thereby navigating through a period where the lending environment constrains the execution of larger platform buyouts.”
Larsen believes the lower middle market “will continue to transact largely because people are perhaps a little bit more flexible on their terms.”
The estimated $1 trillion in capital the private equity funds on the U.S. have available to invest, or “dry power,” will also begin to drive activity, he said.
“There’s certainly a ton of dry horsepower in the private equity industry,” Larsen said. “And you know the old saying: ‘It’s not a question of whether they’re going to invest, it’s when they’re going to invest.’”
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