2017 Analyst Note: How US PE firms can maintain investing during the next recession
June 01, 2017
For those private equity investors and limited partners that believe an economic downturn may come sooner rather than later, we analyze deal flow, debt/EBITDA ratios, and capital deployment during the last recession as well as the key differences between then and now. Further, we propose a three-point plan with expectations for lower valuations and longer hold times, increased nonbank lending, and a higher number of sub-$100 million deals.
As discussions surrounding a US recession increase, it is important for LPs and fund managers to examine the macro landscape. This is even more crucial for 2015 vintages and beyond as they will still hold large amounts of capital to be deployed. To be clear, we do not predict if or when a down cycle will begin. However, given increasing fear of such an event, the current 84-month long expansion, and an understanding that our economic system rides on a series of ups and downs, we know a retraction is bound to happen at some point.
US lenders struggled to fund leveraged buyout activity during the last recession resulting in an 81% decrease in deal value between 2007 and 2009 and a median debt/equity ratio that dropped below 50% for the first time. In the event of an economic downturn, we do not anticipate a limited credit market to be a key driver hampering . Instead, we believe a growing number of nonbank lenders will continue funding activity should commercial bank lending significantly tighten.
Currently, PE managers are sitting on more than $550 billion in dry powder. In addition, we’ve seen a roughly 379% increase in sovereign wealth fund capital vying for existing targets since 2008. With this amount of capital ready to execute transactions, we believe a significant problem the PE industry faces moving forward is the potential for this vast amount of money chasing a limited number of quality targets to drive industry IRRs well below LP expectations.
Changes in the PE landscape over the last 10 years provides opportunity for quick-moving PE investors and trouble for the rest. Developing nonbank lending networks, sourcing deals in less saturated markets, and planning for longer hold times with lower exit multiples will help PE investors deliver strong returns throughout a recession.