Private equity deals will slow down, as global economy stalls amid coronavirus pandemic
“As we enter the most significant market drawdown and economic shock since the global financial crisis, private equity and venture capital will undoubtedly be challenged,” according to a recent report from PitchBook.“The asset classes are equipped to alleviate pressures.”
Here are some of the highlights of PitchBook’s report, titled Impact of COVID-19 and Market Turbulence on Private Markets:
Private Equity Implications
Genuine economic deterioration is a primary risk to private capital markets – PE tends to behave as a GDP-linked business. As consumer spending and business investment is set to decline, we expect to see a slowdown in PE transaction volume that follows the expected economic contraction.
Tighter credit markets will force adjusted transaction capital structures; create private debt and special situations opportunities – With tighter lending, PE firms will be forced to enter transactions with more conservative capital structures that include a larger equity proportion. But, PE is well positioned to adapt with over $2.4 trillion in dry powder.
Return profiles will likely face pressure – As economic activity subsides, we still expect to see an enhanced risk premium in the types of leverage and debt solutions used by PE, which will drive yields higher despite the Federal Reserve’s actions to depress overall rates. As earnings fall and the cost of capital rises, asset prices will decline across the board, hurting exit multiples.
Private Market Landscape
Performance – Each market cycle is different; however, distribution rates show performance is largely baked in for vintages 2012 and earlier for PE, and 2010 and earlier for VC. Funds with the most recent vintages are the ones most susceptible to long-term underperformance, if a macroeconomic downturn were to ensue.
Fundraising – LPs are currently underallocated to the private markets, reducing the risk of the “denominator effect.” As a result, while there may be a pullback in fundraising, we do not anticipate a dramatic downturn and expect both PE and VC asset classes to be resilient.
Deal sourcing – For both PE and VC, dry powder levels are at record levels on an absolute basis, but more reasonable when compared to recent investment activity (which is also at record levels). This capital is likely to be deployed, albeit more slowly and perhaps more prudently than in the last few years.