2024: Reading the Private Market Tea Leaves

In October, I made a soft prediction in this post that the Venture Capital market was coming back to life.  Specifically, I said, “Absent any major macro changes the first half of 2024 could look a lot like the second half of 2020 ($170M deal value across 15,000 deals). 

This prediction, while focused on Venture Capital, extends to Private Equity transactions, as well.  It was predicated on three major beliefs:

1. Stabilizing Interest Rates – Inflation is reducing to the goal of 2%, so borrowing costs are stabilizing and will likely even be reduced. 

2. Historic Amounts of Dry Powder – It’s higher than ever and GPs need to make investments to maintain strong relationships with their LPs.

3. Time’s Up – Portfolio companies (in venture and PE) have over-stayed their welcome.

Interest Rates:

Open the FT app on any day and you’re likely to see a discussion on interest rates.  The latest news was that stocks fell as hopes fade for early interest rate cuts.  Stocks fell because the market had priced-in rate cuts this Spring and the generally held view is that borrowing costs won’t fall until the Summer.  While this may seem like bad news, what was implied is that rates aren’t going up!  Stable rates and the prospect of future cuts are welcome news to investors who have been watching rates increase since March 2022.  Since many buy-outs are financed at least partially with debt the prospect of stable (or decreasing) borrowing costs will increase the profitability (and the potential for success) of a broader range of investments.  Clear foundation for investment -- check!

Dry Powder:

Dry powder represents the amount of committed capital from LPs that hasn’t been deployed by investors.  BlackRock reports, in its 2024 outlook, that there is over $2.5T in dry powder allocated to Private Equity. 

Naturally, LPs committed this capital seeking a return.  While they’re undoubtedly happy it hasn’t been invested frivolously, they ultimately want to see it put to work to receive the returns anticipated from PE/VC.  Otherwise, they’ll want to reclaim the funds and invest elsewhere. 

Pressure from LPs onto GPs means that PE/VC firms will be in buying mode looking for strong investments to allocate their capital.  Increased market demand – check!

Time’s Up:

If we assume that GPs want to placate their LPs, the alternative to returning unallocated capital is to realize gains on prior investments.  In other words, sell their portfolio companies.  The typical holding period for a PE and VC firm varies by investment style, but is 3-5 years and 6-8 years, respectively.  The decreased valuations witnessed the past 2 years meant that less companies were coming to market for fear of a bad exit.  Today, many funds still contain companies that were originally invested between 2016-2018.  These companies have exceeded their hold periods.  GPs will increasingly be looking to exit and realize their gains, even if it means slightly smaller gains than they would have liked.  GPs could get creative and attempt to roll some of their assets into a continuation fund like Lightspeed is reportedly exploring, but I doubt this will be the norm.

At the other end of the spectrum are start-ups and scale-ups.  Many of these companies went into the downturn awash with cash, but unprofitable.  Significant lay-offs across the tech sector enabled these companies to preserve cash, but unless they achieve profitability their runways are finite.  Given the lack of deals over the past 24-months, many are likely in desperate need of a cash injection.  As time has passed, the reality of their situation has sunk in, and Boards/Founders will accept mediocre valuations on worse terms.  If unable to court Venture funding to keep the IPO dream alive, expect Private Equity to swoop in to purchase majority stakes or the worst case alternative -- an increase in bankruptcy filings...      

More companies coming to market – check!

Conclusion:

We’re walking into a year where there are increased appetites to sell (or receive funding), increased appetites to buy/invest, and a market environment underpinned by stable/decreasing interest rates. 

LP pressure on GPs will result in PE-owned companies coming to market, so they can realize their investment gains.  Often, PE-owned companies are sold from one PE firm to another, which will create opportunities for other PE-firms to deploy their dry powder.  Combine this with venture-backed companies who require a cash injection and 2024 is ripe to be a big year for transactions.