In 2021, private equity (PE) saw a record year for mega-deal activity with deals of $1 billion or more making up 32% of the year’s total activity. This historic investing year comes as the result of dry powder accumulation among PE firms, developments in the interest rate environment, and the emergence of mega-funds.
This visibility and performance have given these PE mega-deals a favorable reputation among LPs, who increasingly turned to larger firms during the more bullish market environment of 2021. Given their standing in the PE landscape, it is vitally important for GPs representing small or mid-size firms to understand the workings of mega-funds, how they came to prominence and how to adapt to the conditions they have established.
What is a mega-fund?
A mega-fund is any investment fund with $5 billion or more. Given their scope, these funds almost always originate from large, well-established firms with long-standing reputations, which may operate multiple mega-funds over time or even concurrently.
Mega-funds operate on the premise that with more LP capital, they can make larger and more impactful deals, ultimately leading to more significant exits. Since they target more substantial investments, they are generally less agile than small and mid-size firms, but they come with the advantage of being a potentially more insulated investment.
With access to greater amounts of capital and larger potential returns, mega-funds also often benefit from a greater degree of momentum, expressed in shorter fundraising periods and a quicker process to return to the market.
What are mega-deals?
Mega-deals are transactions valued at over $5 billion , typically in the form of an M&A deal between two large corporate entities. Though they represent the upper limit of mergers and acquisitions, mega-deals are still motivated by many of the same objectives as smaller M&A deals. For example, a mega-deal may come from a company or fund looking to acquire a specific type of technology or asset without having to develop it themselves. Even on such a large scale, this type of deal could still confer savings to the company, seeing as they can cut R&D costs and receive other indirect benefits.
Other advantages of participating in mega-deals also closely align with those seen in smaller deals, such increasing scale, shoring up administrative or staffing weaknesses and eliminating competitors. Naturally, given the scope of these acquisitions, they have a much higher impact and potential benefit to a business compared to more customary M&A deals. Though smaller companies can still be attractive to these types of buyers, like in the case of trying to expand into a new industry, they aren’t able to match mega-deals in areas like expanding a customer base.
What are mega-exits?
Mega-exits are transactions involving companies valued at $1 billion or more. Like mega-deals, their activity also experienced a record surge in 2021, with a total of 75 listings breaking the mega-exit threshold. US mega-exits emerged from favorable conditions, like the influx of government stimulus funds and increased earnings from companies recovering from pandemic-related setbacks. Fields like IT and healthcare saw incredibly successful IPOs as the result of this exit market, but many believe these to be some of the last major mega-exit successes for the time being.
With market uncertainty setting in after the peaks of 2021, investors are expected to be more hesitant to list their companies, lessening potential mega-exit activity this year. Declining stock prices and rate hikes also present an added complication for those trying to pursue mega-exits, leading not only to a lower mega-exit volume, but also lower valuations.
How do SPACs affect mega-deals and mega-exits?
With special purpose acquisition companies (SPACs) continuing to receive funding in 2022, some expected them to be an active force in the ongoing mega-exit scene. In practice, however, SPACs have underperformed with both a low deal volume and low valuations compared to their results in recent years. Indeed, the median SPAC deal size is half of what it was the year prior, while transactions are at their lowest point since early 2020.
Looking at SPAC investments in 2022, we see mixed results that are largely attributed to not buying the right companies. Within this period of SPAC activity, we can also observe deals that SPACs walked out of retracted, which have given them a negative reputation. Though the continued growth of SPACs would seemingly point to a compatibility with mega-deals, they will need to adjust their approach or continue to miss out on these opportunities.
What are the advantages of PE mega-funds?
Private equity mega-funds benefit from a combination of factors, emerging from both their inherent traits as mega-funds and due to the unique conditions of the 2021 investing climate. One of the major drivers behind the mega-fund boom of last year was the interest rate market. With interest rates at a low point in 2021, PE mega-funds were able to leverage their assets much more effectively and gain access to a greater number of potential deals. This buying potential was further amplified by the record dry powder figures of most mega-funds, which in many cases were channeled into peer-to-peer exits.
With these conditions in place, private equity mega-funds were able to create a knock-on effect from one mega-fund to the next. A successful PE mega-deal acquisition would then be followed by a high return mega-exit—in some cases a sponsor-to-sponsor exit with another firm’s PE mega-fund. These returns would not only cut down on the return to market process but would also incentivize LPs to participate in the firm’s next mega-fund and potentially draw in new investors.
As LPs continued to join and commit more capital with each successive fund, firms in 2021 experienced a cumulative effect on their mega-funds.
Why are LPs drawn to private equity mega-funds?
Though market forces like interest rates, valuations and discount rates were a major contributor to the recent success of mega-funds, LP sentiment and participation was also of great significance. With the economic downturn brought about by the COVID-19 pandemic, many investors looked to mega-funds as a safer investment. Many of the private equity mega-funds available to investors were from firms like Hellman & Friedman, Silver Lake and Bain Capital, with enduring reputations and an established base of investors, increasing visibility and trust among these LPs.
Many LPs also took an interest in mega-funds after examining some of the market windfalls they had experienced throughout the year. For example, knowledge of the dry powder available to most firms prompted many LPs to investigate further, as did knowledge of public market valuations.
This data, which is often used as a precedent and forecast for mega-fund performance in the private market, offered reassurance to PE investors that the private market was due for similar results. Looking at investing developments throughout 2021, we see that public listings are largely responsible for putting into motion the mega-exit environment that private equity would later build on top of.
What GPs can expect from mega-deals in the future
Mega-deals have seemingly pushed out smaller and mid-size private equity firms, but 2022 presents the possibility of yet another shift in the PE ecosystem. Though firms with mega-funds continue to see an influx of deals, many factors like interest rates that benefited them in 2021 have since reversed or have been scaled back. Without these headwinds acting in their favor, mega-funds will become increasingly reliant on successful exits in order to continue to see worthwhile returns.
Mega-funds have not only been affected by regulatory and economic changes, but also a change in LP preferences. After heavily relying on larger firms for the past year, many LPs are now turning to smaller, more nimble firms that may be more receptive to their individual needs. The return to small and mid-size PE firms might also be inspired by the fact that their funds can in many cases be more specialized than the investments made by a mega-fund.
In 2022, mega-fund demand for LP capital is outstretching fundraising efforts, which combined with increased literacy on the efficacy of mega-deals, is beginning to call them into question.
2022 mega-fund projections
The future of mega-funds is still quite variable, but likely to take a more definite shape before the end of 2022. On the one hand, mega-funds continue to build on the momentum they amassed in the past year, with deal stats still flourishing and more and more firms returning to the market as the pandemic recedes in different regions. Conversely, many elements of the perfect storm present in 2021 have greatly diminished, with new obstacles emerging in their place. Regardless of how these firms ultimately position themselves, they will continue to affect the market and have influence over LPs—a factor GPs must always be mindful of.
Even more reading
Curious to read more about the rise in PE mega deals and exist? Our latest analyst The Growing Prominence of US PE Mega-Deals and Exits, note breaks down the critical data GPs need to know behind PE mega-deals.