Five Trends Defining Private Equity in 2023

Original content produced by BDO United Kingdom


Our BDO 2023 Private Equity survey has recently been launched which highlights a number of key challenges facing PE companies at present. With valuations at sky-high levels and concerns about financing uncertain, fund managers and operating partners cite risk exposure uncovered during due diligence as the number-one challenge to closing deals in the current environment.

Locally in Northern Ireland, we are seeing high levels of appetite from Private Equity investors. Today’s announcement (25/10/23) from the New York State Common Retirement Fund and Private Equity fund, 57 Stars of $50m of additional investment to support growth in the market is positive news for the region. It is clear that companies in Northern Ireland are becoming more attune to the opportunities that Private Equity brings, with a number of recent high-profile cases resulting in significant growth for those that have secured investment.


BDO’s Private Capital Survey and our global PE expert network cast light on the trends that define 2023 and beyond for PE firms and their portfolio companies.

The BDO 2023 Private Capital Survey, produced by BDO USA, encompasses insights from over 650 U.S. PE stakeholders. The survey includes private equity fund managers, portfolio company CFOs, and board members. Its findings highlight trends, opportunities and challenges defining the market landscape for PE firms and portfolio companies. 

Expert insights from BDO private equity professionals around the world add a panoramic view to the survey’s findings, taking the global pulse of private equity and pivotal trends. 

Top challenges for PE funds 

Q1 2023 was the slowest quarter for PE M&A activity since 2020. The fact underscores that economic developments, such as increased cost of capital and persistent inflation, continue to impact PEs and their capital deployment.

Source: BDO 2023 Private Capital Survey

The challenges PE fund managers and operating partners identified include risk exposure, lack of bandwidth, market consolidation, buyer and seller valuation gaps, increased competition, lack of quality deals, supply chain disruption, economic uncertainty, and lack of internal resources.

ESG and sustainability are increasingly crucial for PE deals. One reason is that limited partners (LPs) and PEs have seen ESG-focused companies outperform their competitors. In other words, ESG and sustainability can be vital value creation tools. 

Over 80% of surveyed fund managers and operating partners have turned down at least one deal due to ESG concerns. It suggests that ESG risks may be an indicator of broader business risks. 

ESG criteria

Source: BDO 2023 Private Capital Survey

The landscape around ESG and sustainability continues to evolve, including new regulations and reporting requirements for PEs and portfolio companies. For example, companies in some regions may be advised or required to seek independent assurance on their ESG reports. 

PEs and companies are also seeking to further develop trackable targets to document positive impact and avoid accusations of greenwashing.

However, a core issue may be a shortage of in-house experts capable of conducting thorough analysis and reporting. 

Australia / Asia point of view:

"In the current climate, transparent financials and a path to profitability are key. Put bluntly, investors have little appetite for aspirational companies. There is a focus on cash flow management, and industries that tend to generate predictable, stable income are viewed as increasingly attractive.

PEs remain interested in industry spaces that are experiencing a downturn. One example is technology, whose solutions continue to drive efficiency across industries. The emergence of generative AI may contribute to its rapid rebound. 

Lack of in-house expertise and talent puts pressure on PEs and portfolio companies. 

One example is ESG, which is increasingly essential to LPs and has a proven track record of helping companies outperform their peers. However, ESG reporting, assurance, benchmarking, and governance are often novel undertakings. 

The same dynamic applies to other areas for C-level executives. The role of the CFO, for example, covers a broad portfolio of tasks and responsibilities. Additionally, few CFOs have experience dealing with the economic climate they now face, increasing the need for assistance from PEs and other business collaborators." – Sebastian Stevens, National Leader, Private Equity, Partner, Corporate Finance, BDO Australia.

Nearly half of CFOs and fund managers report being understaffed, particularly in crucial leadership and finance roles.

This issue comes to light during a crucial period for fund managers, portfolio company CFOs, and boards pursuing resilient growth plans amidst a volatile business landscape. 

understaffing

Source: BDO 2023 Private Capital Survey

It is worth adding that fund managers view talent management as the most critical value creation lever. However, the high costs of attracting and retaining talent imply that these staffing challenges will not vanish swiftly. 

As a result, companies and PEs are exploring ways to outsource functions or departments, including hiring interim C-suite leaders.

Faced with a challenging economy, many private equity companies prioritise supporting portfolio companies over pursuing new deals. 

Fund managers and company CFOs are focused on value creation strategies as they pursue top-line growth.










Source: BDO 2023 Private Capital Survey

CFOs, many of whom started working in their current roles less than ten years ago, must revise their value creation strategies for a different economic reality than they have previously experienced.

At any size, alignment between fund managers and portfolio company executives is critical to achieving goals, including top-line growth. BDO USA’s survey indicates that operational expenditures can be a sticking point, with PEs and portfolio companies having differing views on financial distress, market position, and which financial levers to prioritise. 

Canada / Americas point of view

“In a shifting macroeconomic landscape, concerns around quality deal flow in PEs are likely more rooted in broader economic realities than target quality. While some funds have initially prioritised caution and re-aligning their investment thesis, capital deployment remains robust, adapting to the contours of uncertainty. For example, Canada has seen its mid-market—the heartbeat of its economy— demonstrate deal vibrancy. Some transactions focus on bolt-on acquisitions and adding new talent or geographic reach. However, we also see deals in areas like managed IT, indicating sustained interest even in sectors challenged by ongoing economic headwinds.

The market shifts have led to many PEs broadening capital deployment approaches, including moves from minority to majority investments and co-investments.

Focus on value creation is intricately tied to managing through an inflationary environment. This translates to a heightened emphasis on thorough due diligence, ROI, cash flow management, and result predictability. PEs are innovating, leveraging in-house or third-party analytics tools to make informed decisions, emphasising transactional diligence, and employing anti-inflationary strategies like technology adoption, ensuring a consistent focus on portfolio enhancement and sustainable growth.” - Sunil Sharma, National Leader, Financial Due Diligence, Head of Private Equity, BDO Canada.

PE and companies may also not see eye-to-eye on valuations. However, PEs report that risk exposure is their most significant current challenge. 

risk exposure

Source: BDO 2023 Private Capital Survey

As detailed in the survey report, smaller funds face a tougher fundraising environment than their larger peers. The smallest funds (defined as AUM less than $250 million) suffered the most: only 1,500 reached their recent fundraising targets—the lowest level since 2015. 

Ample capital resources and longer tracker records mean larger funds are better equipped to deliver equity relief to their portfolio companies and feel less pressure to pursue M&A activity.

Great Britain / EMEA point of view: 

“Private equity, particularly in the mid-market, is embracing a renewed emphasis on value creation. An abundance of funds is counter-balanced by more uncertain economic times and increased capital costs, leading PE firms to innovate in their deal-making strategies. One example is certain funds investing heavily in the early stages of deal prospecting but retreating swiftly if prospects aren't promising.

Rising capital costs prompt PEs to divert resources to existing portfolio companies. Although inflation might dent growth and returns, past experiences like the credit crunch suggest continuous deal-making can yield lucrative exits.

PE firms are revisiting their investment strategies to stay ahead of the game with a mantra of you either outperform or follow suit. A developing buyers' market holds great promise for the right investment thesis that accounts for developing risks. 

PE's whole raison d’etre is to dial out risk, a process initiated during due diligence and deal sourcing. For portfolio companies, focus areas include aligning with PEs on what levers to operate to build resilience and growth. These include business top line margins, genuine profit margins and the often-forgotten value creation through reducing business risks." – Jamie Austin, Corporate Finance Partner, National Head of Private Equity and Co-head of Life Sciences Corporate Finance, BDO UK.

Exit and sales options have changed in 2022 and 2023 as worsening inflation, interest rate hikes, and struggling equity markets led to a re-evaluation of exit strategies.

IPOs have slowed, partly due to fewer SPACs coming to market. Exit strategy preferences have shifted toward strategic buyers and financial sponsors. 

exit path for fund managers

Source: BDO 2023 Private Capital Survey

Despite challenging economic conditions, carveouts gained popularity, jumping from last place in 2022 to second place in 2023. This rise can be attributed to fund managers' attempts to maintain asset value amidst more extended holding periods while ensuring returns to their LPs and ready themselves to capitalise when the markets rebound. 

Market conditions may also increase the prevalence of distressed, high-potential assets for new deals. These present unique due diligence challenges and risks beyond liquidity issues but could hold considerable upsides. 

As with the other trends described in this article, the economic conditions mean that there is even more reason to focus efforts on value creation ahead of a deal or exit process to get optimal outcomes. This applies to private equity companies, portfolio companies and companies considering PE-backing. 

Download the full report