Private equity entry valuations decreased to 10.8x EV/EBITDA in 2023, presenting an opportunity for investors. (UBS)

From trick-shots to new dreams for brand growth. Dude Perfect, the buddies from college who added their first trick-shot to YouTube in 2009 and became top influencers, announced plans to further expand their vision with the help of a "9-figure" private equity investment. This move comes at a time when private equity (PE) managers are navigating a complex landscape marked by high interest rates and a cautious approach to deal-making. Despite these challenges, the latter half of 2024 looks promising for PE, with expectations of a 13% recovery in US PE deals, according to EY-Parthenon Deal Barometer.

For investors, the addition of private equity to portfolios could enhance long-term returns, diversify sources of return, and stabilize portfolio performance. Private equity, which involves investing in private companies, has grown in popularity as more companies choose to stay private longer rather than access the public markets. This shift has led to a three-to-one ratio of private-equity-backed companies to publicly listed firms. Private equity investments offer diversification across asset class, sector, vintage, and geography, and are managed by General Partners (GPs) who raise capital from Limited Partners (LPs).

General Partners, responsible for fund management, have unlimited liability and receive a management fee and a share of profits. They actively work with portfolio companies to boost their success. LPs, on the other hand, provide capital without engaging with company management, have limited liability, and expect returns on their investments. They commit capital that is called upon over time by GPs.

Investors typically see returns when GPs sell portfolio companies, and capital is distributed back to LPs. Private market investments require long-term commitments, with investment periods often exceeding 10 years. Direct investments in private companies by individuals are possible but demand greater expertise and significant capital.

The PE market in 2023 saw private equity managers primarily focusing on operational improvements within their portfolio companies amid rising interest rates and macroeconomic uncertainty. This cautious approach led to a 30% drop-in US PE deal activity compared to 2022.

For 2024, we believe the current environment of high interest rates and expensive debt has forced managers to adjust to a new deal-making environment. Managers are prioritizing operational growth over financial engineering and multiple arbitrage, focusing on revenue and EBITDA growth, and positioning their portfolio companies to be in the best shape for exit when the window opens up again.

Private equity entry valuations decreased to 10.8x EV/EBITDA in 2023, presenting an opportunity for investors. Additionally, the private equity market is not oversaturated with cash chasing deals despite record levels of dry powder of $2.6 trillion in cash or liquid securities set aside to purchase new deals at the end of 2023. According to S&P Global Market Intelligence, this level of dry powder is below the historical average relative to assets under management.

The UBS Chief Investment Office recommends investors focus on private equity funds that have a strong operational performance record, as well as exposure to value-oriented buyouts, secondaries, or secular trends (including software, health, and climate-related solutions). Additionally, CIO’s recommendations include private strategies that align with powerful long-term trends like digitalization and decarbonization (private infrastructure and thematic private equity funds).

Despite the inherent risks of alternatives, such as illiquidity, lock-ups, and high fees, they offer unique investment opportunities not available in public markets. Successful private equity managers will likely be those who can secure attractive valuations, excel in operational value creation, and leverage the secondaries market for liquidity solutions.

To read more, please refer to our report: Private markets (Quarterly private markets update).

Contributors: Jennifer Liu, Daniel Scansaroli, and Jennifer Stahmer