"In investing, what is comfortable is rarely profitable."
— Robert Arnott.
The year 2023 wasn't comfortable for angels, private equity investors, and VCs. A growing capital crunch resounded through private markets as VC fundraising fell to the lowest in eight years, and late-stage funding demand outpaced supply by over 260%. Valuations and deals fell. Investor portfolios shrunk in value. The descent that began in 2022 continued, and exit windows remained shut.
But with rate cuts on the horizon, inflation easing, and research-heavy sectors like life sciences and AI potentially holding significant value, now is a time of anticipation. As the economy, corporate profits, and the public market show modest recovery signs, it's fair to ask when the trickledown to the private equity landscape will happen. We'll answer that question in our outlook for private markets in 2024 and review the year gone by.
Hunger Games: Private Markets Review of 2023
The storm clouds of high interest rates and economic uncertainty meant survival and growth were hard in 2023. A flood of startups will compete for funds after having the toughest of years, says ACA Chair Ronald Weismann. The numbers tell the story of a wild year:
- Nearly 20% of rounds were down rounds
- Delay of 3 years between Series B and C rounds
- Global venture investment in Q3 2023 was 65% less than Q4 2021's record $213 Billion
- VC startup funding was down 35% year-on-year
- Almost half of capital raised in Q1, Q2, and Q3 2023 was by funds larger than $5 Billion
Yet, in the broader private equity landscape, strategies based on long-term horizons proved resilient as investors adjusted to the uncertainty.
Over the past several years, angels have continued to invest consistently. The situation played into the hands of those who, like 2022, had opportunities to seek more investor-friendly deal terms and lower valuations.
Stormy Seas and Reforms
Despite the lack of exit strategies, uncertainty, market volatility, and the Fed's squeeze, private capital has braved the turbulence surprisingly well. It will be interesting to see how the increasing chunk of dry powder is deployed once rate cuts are announced. There's more good news, as PitchBook summarizes in its report:
The ecosystem remains well capitalized, and additional sources of liquidity from federal programs like the Inflation Reduction Act and the CHIPS and Science Act are becoming available.
The year gone by was also significant for the sweeping reforms dictated by the US Securities and Exchange Commission's (SEC) Private Funds Rules –– which, when enforced, will impact all private funds. The rules promise to protect investors from conflicts of interest and lack of transparency but with more disclosures and audits on the horizon! Finally, fundraising figures for 2023 will likely be slightly ahead of the previous year, with large funds taking the lion's share.
Private Markets Outlook 2024
GDP and consumer spending are set to slow in the coming year. Inflation has proved to be a stubborn fish to hook, and its trajectory will define the macro environment. The Fed's rate hike reversal, announced in December 2023, gave investors a parting gift. Yet, what will follow this year is anyone's guess. A number of CFOs of portfolio companies, along with their board members, faced difficulties in achieving their investment goals in 2023. The trend could very well continue this year.
Despite public markets showing momentum and modest recovery signs, the trickledown will not influence private capital sooner than three to six months. As Ron Weissman put it, investors must "prepare for pain" till at least mid-2024; a good quarter of IPOs can create positive incentives in the ecosystem. The coming year will also place a renewed focus on due diligence, made infamous by the failure of high-level diligence in FTX's debacle in 2023. According to the Private Capital Investment Survey by Affinity, "..private capital investors have become more thorough with their due diligence after lessons learned from the dealmaking frenzy".
Silver Linings for Private Capital
More opportunities will appear as the backlog of solid IPO-bound companies grows, new exit strategies are developed, and macro indicators turn favorable.
As per Affinity's survey, investors predict an increase in deals in 2024, with something akin to an air of optimism sweeping through sections of the private capital market. Large-scale infrastructure projects in sectors like climate tech will hold more investment opportunities, and technological breakthroughs like AI and biotech will stimulate interest. The survey says new relationships and brand trust will also drive deals in the coming year. VCs will proactively strengthen their networks so they don't miss out on high-quality deals.
The M&A outlook for 2024 borders on the hopeful. Clarity on rate cuts and pent-up demand could foster merger and acquisition growth. Opportunities also present themselves in secondary markets. Some are also anticipating a recovery in tech. US-based tech-focused PE funds, PitchBook reported, could outshine their diversified PE fund counterparts in terms of investment performance this year. While some believe the exit window can be pried open in the coming months, others say meaningful liquidity may not be a market reality till 2025. The past few years have been turbulent for private investors. But with a pivot on rates, softening inflation, investor-friendly conditions, and emerging opportunities, the silver linings aren't yet out of sight.
The blog contains excerpts from Ron Weismann's keynote at the Best of Keiretsu Forum Investment Showcase.
Sources:
https://pitchbook.com/news/reports/2024-us-private-equity-outlook
https://www.blackrock.com/institutions/en-us/insights/private-markets-outlook
https://www.cnbc.com/2023/12/28/startup-bubble-fueled-by-fed-cheap-money-policy-finally-burst-in-2023.html
https://nvca.org/wp-content/uploads/2023/10/Q3_2023_PitchBook-NVCA_Venture_Monitor.pdf
https://www.businessinsider.in/tech/news/the-great-startup-cash-crunch-is-underway-and-its-forcing-late-stage-companies-to-face-their-demise/articleshow/104988873.cms
https://www.spglobal.com/marketintelligence/en/news-insights/blog/the-big-picture-2024-ma-industry-outlook
https://www.lexology.com/library/detail.aspx?g=2986a7dc-57a6-4983-9711-43128059016a#:~:text=All%20SEC%2Dregistered%20private%20fund%20advisers%20must%20procure%20for%20each,Adviser%2DLed%20Secondaries%20Rule.
