After a record-breaking year in 2021, 2022 demonstrated that the years of predictable growth in the private equity industry have, at least temporarily, come to an end. The war in Ukraine, the energy crisis, rising interest rates and global supply chain difficulties have put pressure on businesses and financial investors alike. This resulted in a slight decrease in the number of deals and a slightly reduced average deal value in the private equity industry in Europe in 2022. The average deal execution timeline, from approaching potential investors to the closing of a transaction, was also more prolonged compared to previous years.
Does this mean there is a negative outlook for private equity in Europe for the coming year? Despite the current challenges, most of our private equity clients still share a broadly positive outlook for 2023. Set out below are some of the key factors to be taken into account from a private equity perspective.
Every crisis is an opportunity
The vast majority of our private equity clients anticipate taking an opportunistic approach to deal-making in 2023. The healthcare and life sciences, business services and technology and software industries are expected to remain a core investment focus for many funds. Whilst there is still an abundance of dry powder and attractive targets are sought after, valuations are in many cases likely to stay below the high levels seen in recent years. This valuation gap between sellers and buyers has contributed to the slowdown in activity and extension of deal execution timelines. But as sellers reset their own valuation expectations, this may create opportunities. In the context of auctions and other competitive processes, investors who have previously shied away because of extremely high valuations and tough competition may be tempted to re-consider their approach. A number of investors also expect that there will be more bilateral opportunities as, in uncertain times, sellers may be inclined to focus more on transaction certainty than the race for the highest bid. Other opportunities may be realized as corporate groups divest non-core assets in the more challenging economic environment, increasing the number of available targets. There are also indications that the market for distressed assets may grow in 2023, which could attract investors focusing on special situations.
Increased focus on diligence and negotiations
With tightening returns on investment margins, it is expected that, during the coming year, private equity buyers will continue to assess targets and investment decisions carefully, consistent with the approach taken in 2022. This will result in a continued emphasis on due diligence, be it from a legal, financial, commercial or technical angle. Creative solutions may also be required – particularly where there is still a valuation gap between buy-side and sell-side needs to be bridged. In times of macro-economic uncertainties as a result of high energy costs and supply chain difficulties, it is also likely that there will be greater focus on dynamic purchase price structures, with more direct risk sharing between sellers and buyers (for example through earn-out and deferred compensation elements).
In 2022, rising interest rates, as well as a decreased appetite for risk on the part of certain financing providers, rendered access to debt financing more difficult. In some cases, particularly heavily leveraged deals were abandoned due to the lack of suitable debt financing. This is unlikely to change significantly during 2023. As a result, a number of our private equity clients have told us that they anticipate that securing suitable acquisition financing will continue to be a significant challenge and that the increased cost of acquisition financing may push certain buyers to the deal-making sidelines. In 2022 we saw some clients adjust deal structures by acquiring minority stakes as a solution to the lack of debt financing, retaining the potential to acquire a majority stake via refinancing at a later date – this is a market-wide trend that we expect to continue during the coming year. It is still unclear if and when current international political tensions can be expected to stabilize, helping to reduce the volatility of the global capital markets and rising inflation – both being indirect cost drivers for debt financing.
ESG and digitization
Most private equity funds expect that ESG will play an increasingly important role in 2023 as more and more investors focus on environmental protection, sustainability and social responsibility as important elements of their investment strategies. Attention will need to be paid to ESG-related aspects along the entire private equity value chain, from fund formation to deal execution. ESG may also play an important role in further promoting the industry’s digital transformation. With increasing ESG reporting and monitoring obligations on the one hand, and ever growing numbers of funds and assets under management on the other, the need for better digital solutions supporting fundraising, deal-making and portfolio administration for the private equity industry is palpable. Larger private equity funds are likely to make their own investments into dedicated digital infrastructure, while smaller funds may in-source services from third-party providers.
Historically, private equity has demonstrated its resilience to economic downturns and other challenges. In the same way as our clients, we maintain a positive outlook; the combination of deal experience and the ability of investors to take a flexible approach means they are well placed to overcome and capitalize on the challenges ahead.
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If you are interested in discussing any of the topics in M&A Outlook 2023 in more detail, or have any questions, get in touch to find out how we can work together.
Key legal and regulatory developments driving and shaping M&A
M&A trends in the life sciences and healthcare sector
Due to the multiple ongoing crises we are currently dealing with, stakeholders and key decision makers operate in an environment characterised by volatility, uncertainty, complexity, and ambiguity. If met with resilience these quite difficult times still provide chances and opportunities though.
Navigating distressed M&A
Investors and advisers have been poised for a flood of distressed M&A transactions since the early days of the pandemic.
Bridging the valuation gap in times of uncertainty
Rising interest rates, long-lasting inflation, supply chain uncertainty, regulatory changes, pressure for business transformation, geopolitical instability, economists predicting a global recession – dealmakers are increasingly confronted with extremely challenging conditions that affect their M&A-roadmaps.
M&A trends in Asia: The outlook for 2023
Asia has not been immune from the global macroeconomic headwinds that have built steadily over the course of 2022, and is now also experiencing rising inflation and interest rates and tightening monetary policy, albeit perhaps not to the level seen in the West.
Tech M&A: A return to pre-pandemic levels?
Following a surge in M&A activity in 2021 and the first quarter of 2022, deal making in the Tech sector slowed significantly through the remainder of 2022.
The outlook for banking sector M&A in 2023
There continues to be longstanding speculation in the market about when a next big round of consolidation in the banking sector might occur.
ESG in Canadian M&A and Shareholder Activism: Perspectives for 2023
Despite somewhat shaky economic conditions and geopolitical upheaval on the world stage, M&A activity in Canada was relatively steady in 2022.
M&A in the Middle East builds on active 2022
Proving its resilience and ability to weather political headwinds, the Middle East region saw a particularly active year for M&A during 2022, with several deal-makers citing pre-pandemic levels of activity.
Merger control in Europe: Will the increased scrutiny of deals impact M&A in the year ahead?
2022 saw the rhetoric about “killer acquisitions” made concrete. Both the European Commission (EC) and German Federal Cartel Office (FCO) fought to defend their ability to review acquisitions of entities with limited EU presence, revenue and customers, with the EC’s jurisdiction confirmed by the EU’s General Court (GC), and the FCO losing at first instance.