Private Equity Isn’t Selling Right Now, But Maybe You Should

A dam has been built in the middle market M&A world. This is no ordinary beaver dam, but the equivalent to that of the Hoover Dam.

This dam’s construction reflects a convergence of factors within the private equity sector and the broader M&A transaction landscape. Currently, private equity firms are flush with cash reserves, totaling a staggering $1.2 trillion in buyout funds alone. However, despite this abundance of capital, the market is experiencing an absence of investment opportunities. The low supply of acquisition targets is made worse by several factors, including elevated interest rates, debt multiples at a 10-year low, and traditional lenders being tight with credit and underwriting. All of this makes it difficult for private equity to buy new companies. 

Another, less discussed phenomenon is also occurring – which is that it is a difficult time for private equity to sell its existing portfolio companies.  Normally, financial buyers like to hold their investments for three to five years, then sell them, and generate some capital for themselves and their investors. 

If you think back to when many of their existing portfolio companies were purchased, there are some good reasons for why this current environment might be challenging. Many companies purchased prior to COVID (2019) at very high multiples are just now recovering to profitability levels. Valuations have generally remained strong but are not at those historical levels. The result of this is that a sale, even now in 2024 for many portfolio companies, would result in a net loss to investors. No PE firm wants that on its record. 

As a result, the average hold period for portfolio companies stands at approximately 5.8 years, the longest experienced in 15 years. There has been a small trickle of exits from PE groups but the backlog behind the dam of portfolio companies that need to be sold to give limited partners their liquidity is very real.

Now, how does this apply to or affect business owners wondering when the right time to sell is? Well, let us make it simple for you: the time is now.

Do you think that our PE friends have been sitting idly just waiting for rates to come down? No. They have fancy degrees and big salaries to justify. 

They have been working to reduce costs and improve operations in their companies during this period in an attempt to show growth in cash flow, spiff up the story, and prepare for that exit. These companies are going to be lean, mean, and well-packaged when they come to market. 

Now, let’s say you are a business owner that wants to sell, and you don’t have all the high-priced/pre-COVID/IRR-hurdle baggage that private equity is dealing with right now. You have a nice business. You have nice margins. Even if you have a business that does not rise to the level of “perfect to sell at this moment” – it might make sense to overlook some of those issues and go to market anyway.

You have the ability to take advantage of this window where there is abundant capital looking for transactions and we are not yet in a period where you will get lost in the flood of tricked out and spruced-up private equity portfolio businesses coming to market.

The companies safely protected by the dam represent a number of family- and founder-held businesses on the verge of being drowned in a pool of gussied up PE assets. Due to the current lack of supply in the market, these businesses have a unique opportunity to stand out, capitalize on PE’s eagerness to deploy their money, and achieve premium valuations.

However, this is a temporary, unique market we are currently in, because as soon as that dam breaks, laws of supply and demand will begin to take over.  Valuations will naturally decrease, and resources will begin to be stretched.  Smaller businesses and those with less than perfect attributes will be disproportionately impacted by decreases in value.

So Then When Will the Dam Break?

The dam will break when one of two things happens:

1. The Fed begins to cut interest rates
2. Private equity firms crack under external pressure from investors to sell

The timing of the two factors is unknown. You can collect data points on potential rate cuts from all the experts, but the reality is even the Fed doesn’t know when inflation will be considered “tame” enough to begin cutting rates. On the private equity side, all firms are notorious for portraying “herd mentality,” meaning once one leading firm decides it’s time to sell, the rest will follow, causing the dam to break.

As a business owner, you might be thinking, “this is not what I’ve been hearing on the news.” It is important to understand that a good majority of M&A reporting is about private equity transactions and not the lower middle market. Most of that reporting fails to understand the forces of low supply and high demand. It’s an important distinction that we are in a low supply market – not a slow market.  In this case (think back to Econ 101), you want to be the supplier.