The past few years have gone on record as being one of the most fertile dealmaking environments in the history of private equity. According to Bain & Co., 2022’s first half buyout deal value totaled $512 billion, second only to — you guessed it — 2021. But today tells a different story. With a recession looming and the cost of debt rising, deal flow has taken a sharp turn south.

While no firm will enjoy what is expected to be a sparse deal landscape in the year ahead, those with perhaps the most concerns are emerging managers — first-time funds who still need to make a name for themselves, and make a sufficient IRR for their investors to ensure there will be an opportunity to raise a second fund.

Mergers & Acquisitions spoke to several newer fund managers to get their take on the current environment, where they face their strongest headwinds and how optimistic they are going into 2023.

New Private Equity Firms, New Enthusiasm

Over the past five years many PE new firms launched, some with great fanfare. Most famously, this past September American socialite Kim Kardashian co-founded SKKY Partners, which plans to invest in consumer and media companies. In October Brian Sheth, the former president of Vista Equity Partners, launched Haveli Investments, a private equity firm focused on technology. Haveli received $500 million in committed capital from Apollo Global Management Inc.

Other budding private equity firms received much less press but jumped into the crowded playing field. For one, Christopher Bodnar, previously a vice chairman at real estate investment company CBRE Group Inc., teamed up with Brue Baukol Capital Partners in 2022 to form Prescriptive Capital, a Denver-based firm focused on real estate development and acquisition opportunities in the medical office, life sciences and senior housing arena.

“There are a lot of tailwinds in our sector,” says Bodnar, the firm’s CEO. “The healthcare industry is recession resilient and has proven to perform well in historic downturns.” In its first deal, announced in September, Prescriptive Capital is working with developers to build a three-story medical office building in Texas.

In 2021, Vlad Besprozvany, who got his start in PE as a Thoma Bravo associate, launched Nexa Equity, a San Francisco-based PE firm targeting lower mid-market software and financial technology businesses.

While launching a PE firm during a pandemic presented obvious challenges, it also provided opportunities for some organizations. For instance, Nexa Equity saw that many investors who traditionally targeted lower mid-market, vertical software companies started to raise larger funds and target bigger companies during the pandemic.

“What I saw was a gap forming in the lower end of the software buyout market where we could focus,” says Besprozvany, the firm’s managing partner. Nexa Equity has already made numerous investments, most recently investing in HomeTown Ticketing, a school event ticketing platform.

Hurdles and Headwinds

Despite the hoopla and massive deal flow in recent years — and the infectious excitement of it all — launching a private equity firm takes experience and stamina. “To be successful, you need to have a steady keel, a great team and a lot of pure grit,” summarized Buddy Gumina, founder and managing partner of Grant Avenue Capital, a health-care-focused private equity firm in New York. Launched in 2019, Grant Avenue targets companies with about $5 million to $25 million of Ebitda, in various subsectors of healthcare. “We’re working with founders who serve markets that are slow to adopt technology,” he said.

Since its inception, Grant Avenue has done more than 30 acquisitions, and most recently announced the launch of Helios Clinical Research. “I believed at the time and certainly believe more so now that there’s an extraordinary opportunity in the lower middle market,” Gumina noted.

But like most PE founders, Gumina has faced numerous challenges, particularly as the firm was building its brand in the midst of a global pandemic. “The inability to get out and visit prospective founders and companies and even bankers for that matter was difficult,” he states.

The same was true for David Moross, who co-founded HighPost Capital LLC in 2019. Moross, the firm’s chairman and CEO, spent a lot of time creating a team that would have chemistry, work well together and share the firm’s mission. “We were all systems go and Covid hit,” he says. Despite this setback, however, HighPost built its team, raised over $535 million in capital and did three deals during Covid. The firm, based in West Palm Beach, Fla., invests in the sports, media, lifestyle and wellness sectors, and most recently invested in Magic Spoon, a health-focused cereal company.

For Besprozvany, the most taxing charge in starting a PE firm “was really being able to build the plane as you’re flying it,” he says. “We were hiring a team, chasing our first deal or two and lining up capital more or less at the same time.” What’s more, he stated, it takes time to build a firm’s reputation, and it’s important to be “thoughtful about your first couple of hires and investments” as it can set the tone for the future.

Bill Green, founder and managing partner of Climate Adaptive Infrastructure (CAI), a San Francisco-based private equity firm that funds large, low-carbon infrastructure investments in the energy, water and urban infrastructure sectors, says his firm’s toughest struggle since launching in 2019 has been “keeping up with the massive deal flow that we’ve been experiencing in the sector”. His firm looks for investment opportunities in the $25 to $250 million range, and only takes stakes in companies that pass CAI’s rigorous screening process. “If it doesn’t meet our definition of low-carbon infrastructure, we will not make the investments,” he says.

Taking a Pause in 2023

While deal flow was historically strong in 2020 and 2021, the market has slowed, which has created further challenges for new funds that are building their brands and getting their operations off the ground.

Public market exits have pretty much stalled, valuations have dropped and experts predict a possible recession. Global fundraising also declined sharply during the first half of 2022, compared to the same period in 2021, Bain reported. “It’s harder to raise money than it has been in a long time, since Covid came in,” says Moross.

Uncertainty around inflation, a punctured stock market and rising interest rates have made many PE managers take a deep breath. “In the short term… it’s likely to get choppy,” Bain predicted in its report.

Overall, most PE leaders are smartly measuring their activity levels, while sitting on mounds of dry powder that eventually needs to be used. “We do believe M&A will continue to be a strategy going forward,” says Besprozvany about tuck-in acquisitions for his firm’s portfolio companies. “But we’re very thoughtful of how many deals we can do and at what pace.”

Others are also watching and waiting. “I’ve already pulled back the reins middle of last year in anticipation of cautiousness of the consumer world,” Moross noted. He gives a “muted outlook” for 2023 overall, but believes 2023 will also provide investment opportunities for HighPost.

Bodnar of Prescriptive Capital also remains positive. “Senior living is going through some headwinds right now,” he says. “That sector is still recovering from the Covid crisis and getting back to a more stabilized occupancy. But we look at this as an opportunity to sort through the operators who have staying power.” Bodnar says the key is simply to be patient and find the right deals, at the right time. “We don’t have a pre-set amount that we’ve raised that needs to be deployed. So we’re in a fortunate position to be patient,” he adds.

CAI remains full steam ahead. In October the firm announced it had raised over $1 billion, through the closing of its $825 million inaugural fund and its affiliated co-investment program of over $200 million. The firm expects to make eight investments in the fund, Green noted. So far, CAI has done three deals, including funding the construction of 22 hydroelectric projects in the Eastern United States.

In its midyear report, Bain stated that “Successfully negotiating the current environment will require controlling what you can as an investor. It will be essential to help management wring out revenue gains, preserve (and even expand) margins, and manage cash on the balance sheet.”