Private equity (PE) fund managers will deprioritize new deals and bolt-on acquisitions in the next six months in favor of helping existing portfolio companies, per a BDO survey released on Tuesday.
The shift could benefit portfolio company CFOs having difficulty delivering the financial performance PE owners expected when they bought the business.
With M&A activity depressed, the financial sponsors surveyed picked equity relief (putting equity back into a portfolio company) as the area where they would deploy the most capital in the next six months. (As of March, PE firms in the U.S. had $1.2 trillion of dry powder.)
About 17% of the 405 U.S. PE fund managers surveyed by BDO in March intended to direct capital this way, found the Private Capital Survey by BDO. Another 15% planned to plow capital into distressed businesses.
That is compared with 14% who indicated they would put most of their money into new deals.
The choice of fund managers to put new transactions on the back-burner is an expected result given the drop in M&A activity over the last year due to valuation gaps and uncertain financing conditions, according to BDO’s report accompanying the survey.
In the current climate, some financial sponsors may be able to extract value through asset sales or organic growth improvement in portfolio companies. Still, the majority will “triage their companies hit hardest by the soaring cost of debt and ... operations,” said BDO.
From the responses provided by the 200 U.S. portfolio company CFOs and 50 board members, support from PE owners, financial and otherwise, is sorely needed.
Short of the Goal
More than half (54%) of CFOs and board members of all size companies surveyed (in March 2023) expect it will be difficult to meet the objectives of their PE owners’ investment thesis.
The percentage was even higher (64%) among companies owned by smaller private equity funds (less than $1 billion of assets under management).
Under-resourced portfolio companies are likely feeling the effects of the challenging labor market, cost of capital, and shifting asset prices more acutely. — BDO Private Capital Survey
Ultimate valuation (valuations in the current market), access to people with the appropriate skill sets in critical areas (including finance and leadership), and profitability, in that order, were chosen by CFOs and board members as the top obstacles to meeting financial sponsor goals.
A little more than one quarter (28%) of businesses owned by small PE firms chose access to capital, which presumably equity relief could provide.
“Under-resourced portfolio companies are likely feeling the effects of the challenging labor market, cost of capital, and shifting asset prices more acutely than their counterparts owned by the largest funds,” BDO.
Different Priorities
Given these challenges, CFOs of companies owned by small funds face a critical period operating in a low-growth environment. Will increased engagement from their private equity owners for the rest of the year help?
An important question is can CFOs and financial sponsors align their strategies. Whether CFOs will see eye-to-eye with their financial sponsors on which top-line growth strategies to deploy.
Portfolio company CFOs indicated on the survey that they are primarily focused on increasing capital (42%) and managing operational expenditures (52%). — BDO
According to the survey, fund managers with less than $1 billion in assets expect their portfolio companies to prioritize capital expenditures (41%) and revenue growth (39%).
However, portfolio company CFOs indicated on the survey that they are primarily focused on increasing capital (42%) and managing operational expenditures (52%).
“CFOs owned by smaller funds are more likely to work at smaller companies with smaller balance sheets, which means they feel the impact of higher interest rates and inflation more severely and prioritize operational expenditures critical for keeping their companies afloat,” said BDO.
The mismatched priorities could suggest that "smaller fund managers don’t fully acknowledge the short-term financial distress some of their portfolio companies might be facing," BDO said.
But it might behoove some of these CFOs to listen to experienced PE partners.
Many of the CFOs surveyed are used to operating in an environment with low-interest rates and easier access to refinancing.
About three in five (60%) of CFOs surveyed started working in their current roles less than 10 years ago, which means they started their tenures during or after 2013 — just five years after the financial crisis, when the Fed funds range was still between 0% and 0.25%.