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Dealing in a downturn: A “reality check” for private equity

The Côte d'Azur is not quite the same in January as in late September. But I am nonetheless very happy to have been invited by the always excellent #IPEM team to attend and join a panel on Co-investments.

While an interesting panel, moderated by Katherine Kucherenko from #APG and with some very experienced panelists; Carole Barnay from #Ardian, David Smith from #CapitalDynamics, Mateusz Milewski from #PZU, nothing on CI in this post. For that, please see my prior posts starting with ‘Co-investing is for the 1% - The motivations for co-investing’.

Instead, here are my main takeaways and thoughts from a whirlwind two-day conference.

Well-attended at short notice

Although the “main” conference will be held in Paris in September, IPEM Cannes was back, at very short notice, by popular demand.

A different destination for most of the PE crowd, and as the CEO Antoine Colson noted, a nice “mini-break” for those in the industry who are normally Paris based. Cannes offers a somewhat more relaxed setting, even in the winter season, than the usual destinations.

With upward of 3,000 delegates, it was very well attended. And, even if a bit more French than the September version, also well attended by international GPs, LPs, and service providers.

A “reality check” for private equity

Heading into 2023, I could not think of a more apt title. Barring a few bumps, it will likely be a very different economic environment from what we have experienced most of the past decade and it is high time to take stock.

private equity downturn

'Reality check' permeated many of the panel discussions and key-note speeches, which to large focused on the expected changes and how LPs and GPs should adapt and react to this in the coming years.

Nonetheless, beneath all the usual bullish exuberance that is inherent in PE, I also got a sense that people are a bit more worried than they have been for many years. However, no one really wants to be the first to really say this out loud and burst the illusion.

Here I cannot but quote Charles ‘Chuck’ Prince, ex-CEO of Citigroup.

As long as the music is playing, you’ve got to get up and dance

Allianz thinks of War Economics

This was a quite sobering opening by the Chief Economist of Allianz, Ludovic Subran, who spoke about three overall points

  • Great Intervention

  • Great Fragmentation

  • Great Widening

I can’t do Mr. Subran’s speech full justice here; you can read more about his thinking here.

But briefly, what he was talking about was that policy makers have intervened heavily for many years now and will have to pull back. This has been very expensive, too much money has been spent, and taxes will have to increase. Further, support through, Covid, inflation, and recession has predominantly benefitted ‘Capital’ and not ‘Labour’, which will affect social cohesion as inequalities widen. And finally, that policy makers do not know how to effectively respond to this.

While it will hopefully less dramatic than the eye-catching titles, certainly all points that are well worth considering.

The top European PE concern in 2023 is rising interest rates

This, according to the 5th IPEM Pan-European PE Survey was closely followed by

  • Rising Inflation, and

  • Slowdown in growth

mentioned by 64%, 61% and 57% respectively. You can find the full survey here.

War in the Ukraine, mentioned by 49%, was fourth. At least to me, this was a surprise, because, while tragic in so many ways, the War in Ukraine I would expect to have limited impact on its own, beyond what is already captured by the above concerns.

Time to triage the portfolio

While I share the main concerns in the prior section, I was surprised that no one, seemingly, was concerned about what they had been doing in the past many years.

On the back of an almost 15-year unbroken QE fueled bull run, I worry how many investments have been made and how many managers have been funded that should not have been. Implausible as it may sound, these investments and commitments are in someone’s portfolios – hopefully someone else’s.

The question for me is, how these investments will fare now that the era of free money is over. Consequently, if not already done six, or even better 12, months ago, it is high time for both LPs and GPs to triage the portfolio.

I would focus on

For GPs

  • Investments that may have ‘slipped’ through the investments process, but which would not be done now

  • Investments made at aggressive multiples, especially those with inflated EBITDA multiples

For LPs

  • Mediocre GPs that may just have benefitted from a benign environment, i.e., a beta play

  • Any continuation vehicles, not only quality of the fund or the companies but also the terms and conditions of these

  • Any co-investments who may not have the right motivations and / or capabilities as well as all the newer

The secondary environment may not seem to be seller friendly now. But it may be better to sell weaker positions that you don’t believe in now and lock in returns, rather than risk further value erosion as reality sets in.

Other points I noted

  • Fundraising is getting tougher for the large and the small alike – not much surprise there. Many institutional investors have been hit by a denominator effect and fewer distributions and new capital, at least for now is scarcer. Many non-institutional are more risk-off and in a ‘wait and see’ mode

  • VC funding for the mid and later stages have contracted significantly – the non-traditional or tourist investors seem to have left the party, which, Chuck Prince notwithstanding, may be wise

  • VC exits, due to the IPO window closing, has dropped off a cliff

  • Some investors are pulling back from CI, which is benefitting the houses with dedicated platforms

All is not lost, don’t despair

Despite the above, I retain a positive outlook for private equity. The reasons being, and here I am echoing three very good points made by Mr. Colson in his opening speech, that PE and specifically the GPs

  1. Invest for the long-term, so 'bumps' matter less

  2. Are entrepreneurial by nature, flexible and will adapt

  3. Have conviction in what they do

For LPs, beyond triaging their portfolios, this implies they can keep investing. But also, that they need to double down on due diligence and selection combined with thoughtful portfolio construction.

What does my crystal ball say?

This was an excellent question posed by Ms. Kucherenko at the end of my panel. And while the first thing that comes to mind is “Duck and cover”, this, as most PE investors know, is not a viable strategy in private markets.

I believe that there going forward will be much more uncertainty. And, considering my three above points, this will benefit GPs, who can take advantage of their ability to move at speed, creativity, flexibility, and an improved deal making environment with better pricing

It will be easier and harder to find quality. As noted above, too many things have been funded, which probably should not have been. With this being over, it becomes easier to identify true quality. But at the same time also harder, as we must assess what true quality is versus what was simply beta disguised as alpha.

Finally, going back to Chuck Prince, we may have to keep dancing, but that does not mean we cannot change the music and our dance partner.

So, I would start looking and at Distressed and Special Situation Funds, who after 15 years on the sideline stand to benefit as the economic cycle ‘normalises’. And of course, at Secondaries, who will benefit as portfolios are triaged.


Stay illiquid


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