PE ends year with a toot, not a bang

You know when you start your turkey trot at a strong, full sprint and by the end, you can barely hit a 12-minute mile? That’s kind of how private equity fundraising panned out this year.

PE funds are set to end the year having raised less capital than they did in 2023—an indication that interest rate cuts haven’t been enough to revive managers’ returns to their investors.

The long-and-short of it is that PE managers just weren’t quite able to push through the pressure of higher-for-longer interest rates, despite the Federal Reserve’s first few cuts this year and cautious optimism from fund managers and their placement agents.

At the end of Q3 2024, total capital raised by PE funds fell 10.8% year-over-year and fund count fell 42.8%, according to PitchBook’s Q3 2024 Global Private Market Fundraising report.

The decline marks a sharp reversal from fairly strong PE fundraising in the first half of the year, with close to $300 billion in new capital raised. In Q2 2024, total capital raised by buyout shops was ahead 14.9% year-over-year.

Macroeconomic realities came down hard on GPs in Q3 2024. Funds struggled to exit their investments at strong valuations, dragging down their distributions to LPs and limiting the amount of capital institutional investors had available to commit to new or subsequent funds.

This vicious cycle has persisted over the past two years across private capital strategies, prompting many LPs to commit their limited freed-up capital to mega-funds in a flight to household fund names. Nearly half of the PE capital raised year-to-date has come from only 16 mega-funds—all over $5 billion in size, according to the report.

These mega-funds tend to tout traditional buyout strategies, which accounted for 86.3% of all PE capital raised YTD. Experienced firms—those with four or more funds under their belts—comprised 87.3% of dollars raised YTD. Both of these figures are decade highs.

Despite a less-than-stellar year, placement agents are optimistic about LP interest in lower middle-market funds in the coming year, which could slightly reverse mega-funds’ dominance in the capital constrained environment.

Rush Harvey, director of the private capital advisory group at investment bank Raymond James, told me he has seen a significant uptick in LPs wanting to take calls and meetings with lower middle market and mid-market PE managers, specifically those with fund targets between $500 million and $1.5 billion.

“I wouldn’t be surprised if, a year or two from now, we see a shift to smaller funds at least being equivalent to the fundraising trends that we’ve seen over the past three to five years,” he said.

LPs, he said, are interested in GPs that are buying companies with $5 to $30 million in EBITDA, largely because the strategy provides a concrete path to exit to a larger buyout shop. Just last week, for example, middle market PE firm Frontenac sold its portfolio company Integris, a provider of IT, cloud and cybersecurity services, to the C$130 billion Ontario Municipal Employees Retirement System. Frontenac built Integris through a series of roll-ups.

Mid-market buyout shops’ fairly straightforward path to liquidity is particularly attractive during a period when the IPO window is slow to open and mega-funds’ path to exit their investments at favorable multiples is on shaky ground.

“The average LP is really interested in the lower middle market,” Harvey added. “Even some $500 million [funds], that can execute and have a clearer path to liquidity by selling to the larger sponsors.”