Private Equity Faces Liquidity Crunch Amid Record Number of Unsold Businesses

In the last decade, private equity (PE) has experienced explosive growth as an asset class, attracting investors seeking high risk-adjusted returns. However, current market conditions have put pressure on PE firms to return capital to limited partners (LPs). Recent estimates place the value of unsold PE-backed businesses at over $3T.

The global slowdown in M&A activity witnessed in 2023 has impacted the ability of PE firms to offload assets at attractive valuations. Overall, the value of PE-backed companies sold in private or public markets fell 44% year-over-year. The decline was even more pronounced when exiting to other PE firms, with the value of PE to PE transactions falling 47% from 2022.

Another telling sign of PE’s struggle to exit portfolio investments has been the rise in average holding periods. As of Q4 2023, the average holding period among US and Canadian PE firms rose to 7.1 years, up from 5.7 years in 2022. This is a far cry from the typical target 3-5 year holding period.

The pressure to generate liquidity has resulted in the adoption of creative tactics, among them, net asset value (NAV) financing, which allows general partners (GPs) to borrow against the underlying value of their portfolios to generate liquidity. Another strategy which has been growing in popularity has been turning to the secondaries market and continuation funds. In 2023, the amount of money raised in the secondaries market nearly doubled, with industry giants Blackstone and Lexington Partners raising in excess of $40B, on a combined basis.

The scarcity of liquidity in the market has also impacted fundraising efforts. In 2023, fundraising concentration hit its highest level in over a decade, with the world’s top 25 fundraisers securing over 40% of total commitments as investors look to back managers with a track record of generating liquidity.

While M&A activity is expected to rebound in 2024 as a result of easing macroeconomic conditions and lower interest rates, PE firms likely face a multi-year process to generate true liquidity for LPs. It will be interesting to see how this impacts the asset class in the coming quarters and years.