2022 Private Equity Outlook as of First Quarter
As we moved into 2022, who could have predicted some of the head winds we are currently facing with inflation, interest rates, war in Ukraine and COVID. PE firms are facing a much different operating environment at the end of the first quarter of 2022.
An imminent rise in interest rates, the impact of inflationary pressures, more hawkish monetary policies, and continued supply chain pressures will be currents that flow throughout the remainder of the year. For many funds, inflation has already proven to be more persistent than they’d first thought.
For the portfolio, impacts will, of course, vary by sector; however, many of the industries where PE is most heavily invested – technology and health care, for example — should be able to maintain margins based on pricing power.
For new acquisitions, the impacts are more nuanced. PE firms have been operating in an environment of historically low-interest rates for the bulk of the last 20 years. While a lower cost of capital has been a clear tailwind for new deals, they’ve also attracted competition, not only from other PE firms but also from corporate acquirers, family offices and others, with the ultimate impact of driving up valuations. According to Dealogic, In 2011, the average leveraged buyout (LBO) was acquired at a multiple of 8.8 times EBITDA (earnings before interest, taxes, depreciation, and amortization). In 2021, the average LBO closed at a multiple of more than 11 times EBITDA. Many companies, especially those in the tech space, have traded significantly higher. Thus, while a period of higher rates would indeed increase financing costs, the negative impact should be offset — at least to a degree — by a drop in entry prices. Right now, the vast majority of PE firms are underwriting some measure of multiple contraction into new acquisitions, based on an assumption that valuations will regress to historical averages.
Perhaps less certain is the impact on future fundraising. While a short period of higher rates is unlikely to change LPs’ allocations much, longer term, rising interest rates could prompt a rebalancing in investors’ portfolios. However, PE’s track record in delivering attractive risk-adjusted returns over the last 20 years should make a compelling case for continued investment.
Craig Arends is a principal at CLA and is the managing principal of CLA's private equity practice. Craig brings a concentration of experience in providing accounting and transaction structuring advice for leveraged recapitalizations, purchase accounting and SEC reporting, assessing quality of earnings, and GAAP accounting. He has far-reaching experience with critiquing financial models and reviewing target companies' financial performance to identify cost reductions and/or operating efficiencies Craig has more than 30 years of experience in public accounting serving public companies, private equity groups, and companies, including a term as principal in charge of a Big Four Capital Markets Group in Moscow, Russia. He has led financial accounting due diligence projects for private equity investor groups and venture capital funds, primarily in the technology, communications, and manufacturing industries, as well as assisting with Foreign Corrupt Practice Act matters ranging from investigation of payments made, validation of compliance with corporate policies, and review of proposed transactions to ensure compliance. When not working, Craig enjoys watching any sports, but his most favorite are baseball, football and soccer.
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