M&A value, I want to say up 40, 41%, financial sponsor transaction down 9% year-on-year.

So what's going on? Why are they so nervous of what's been happening in terms of the software scene? Everyone thinks that AI is just going to come and completely destroy the software space overnight.

I don't think it's going to have the one-time, overnight, big wall kind of impact that I think a lot of people think it might.

What's the catalyst that needs to happen, do you think, to re-stimulate deal activity in private equity space? Deals find a way. Private equity is going to find a way.

I guess we'll dive straight in. What's the big deal this week? Last week, we talked about the M&A update in the first half of the year.

I want to do the same in private equity because I think, quite interestingly, you'd expect the two to really follow each other closely.

If global M&A volume is up, then private equity M&A volume should be up as well, and it's not. And I want to spend a bit of time digging into some of the reasons why that's the case.

Absolutely. Yeah, last week's episode, we talked all about the M&A boom.

We talked about the drivers. We talked about the risks.

But hang on a second, Graham. Private equity, not the same thing happening over there. Talk to us about it. What's going on? Okay, so compared to public M&A, where we had M&A value, I want to say up 40, 41%, financial M&A or financial sponsor transactions down 9% year-on-year. So what's going on? One, if you think overall thematically what's been happening in global M&A volumes, we talked last week, there's a ton of uncertainty right now. We're in a high-interest rate environment.

There's a lot of geopolitical uncertainty, uncertainty from software and AI exposure. All this stuff that's making everyone just say, "I don't know what's going on." In public M&A, we talked about a lot of people we think are buying companies as a defensive posture, right? Uncertainty is driving M&A volume because people are trying to protect themselves.

I guess if you compare the motivations of a strategic buyer to a financial buyer, in a period of high uncertainty, if you're a financial buyer, you're a lot more resistant to take this defensive punt.

I think just say, "You know what? First, I need to sit on the sidelines and just wait and see what plays out. Because if I go and make a big investment in, say, an AI business to support a software business I already own, I don't know how this is all going to play out.

So my first kind of order of operations is to say, 'You know what, I'm going to sit tight and kind of see what happens.'" I don't think that's the only thing that's causing the slowdown, though. So you have overall this uncertainty, and you also have some real reasons why private equity is just a lot more constrained than it used to be.

I mean, obviously, one thing we talked about before, we still have a lot of dry powder, right? Yeah.

So private equity is still going to have to go out and buy businesses.

But at the same time, the other thing private equity needs to do, which they haven't done as much of, or certainly not at the pace that they used to, is repay capital back to investors.

And ultimately, the only way that private equity is going to continue to continue raising funds, continue to buy more businesses, is if they return that capital back to LPs and then raise more money. I think there's some good reasons why that has all started to slow down a little bit, and we'll spend a few minutes covering some of those.

Okay. So you say, although there is a lot of dry powder, they're finding it harder to exit their current investments, and they're also not raising as much new funds. So that's kind of one angle in terms of maybe less appetite for deals from that perspective. But in terms of the market environment, the interest rates, the valuations, the stuff we talked about in last week's episodes around M&A, why does it have so much more of an impact on appetite for deals for private equity versus corporates? Well, just think about how private equity is financing a lot of these acquisitions.

I mean, we're undertaking leveraged buyouts. We're using a lot of leverage.

You go back to that private equity episode we did, what, a month or two months ago, we were kind of looking at the value drivers in a typical LBO deal. Ultimately, one of the ways that you're increasing your equity return is through the use of leverage in a private equity transaction.

If that leverage is getting more expensive, and most private equity debt is some kind of floating rate instrument, so in a rising interest rate environment, your overall interest bill is going up.

If you're paying more interest expense, then your equity return goes down. Your overall- Yeah ... we call it cost of ownership, is going up.

It's actually kind of funny. I mean, obviously, we're looking at another Bain report as well as part of the backing data for some of this episode.

And you can tell a consultant put this together, I think, because I think they call it a deal cost index or something like that.

Oh, yeah.

And basically saying, deal cost is an all-time high.

And what they really mean is purchase price multiples are high right now, right? We've talked about US public equities are at a much more premium valuation, say, compared to Europe. We've got the overall global M&A volume driving up purchase price multiples.

So companies are still expensive right now.

Yeah.

So you've got both a high entry multiple combined with a high cost of debt, and those two things together means it's just not as easy to make your return as it used to be.

Okay. So we've got that. And then But then you also mentioned software as well, which again, that's kind of almost stimulated the corporate M&A scene because, as you said, they've been kind of moving quite defensively to buy other businesses, try and protect their positioning in the market.

But that's not the case with private equity.

Why are they so nervous of what's been happening in terms of the software scene? Well, people have taken at least a perceived hit around software exposure, because we've talked before about how private equity has outsized software exposure compared to most other investment classes, right? And for historically good reason, right? Cash generative businesses, good revenue visibility.

You've generally got a pretty good ability to put price increases through year on year.

Good customer retention. All the things that make both a good equity and a debt investment kind of has led to this outsized software exposure. You've also got, obviously, the outsized software exposure in the private credit space.

A lot of private credit managers have been under pressure, not able to make all these redemption requests and whatnot.

So you've got just overall scrutiny on both the private equity funds and the credit funds that back them through this software exposure.

That's meant, let's think about how it plays out on, say, the credit side. If your providers of credit are facing a lot of pressure from their investors, their LPs, what does that mean for you, the borrower? Most likely, your borrowing cost is going to increase.

Your capital is going to get more scarce. It's going to get more expensive.

It's going to make it even more difficult for you to make that same return on any given deal. Now, interestingly, I don't think I've seen any real software default yet still. So as far as I'm aware, we're still in this, I think the term they use in this Bain report is SaaSpocalypse.

Everyone thinks that AI is just going to come and completely destroy the software space overnight.

I think one of the things I was saying a while ago is, I think there's a good reason to believe that AI is going to have a big impact on this space. I don't think it's going to have the one-time, overnight, big wall kind of impact that I think a lot of people think it might.

And by the way, I think if that were the case, I think we would've seen something already.

Yeah.

And I'm not saying, by the way, that I don't think we're going to have any software pressure or any software defaults, but it feels like that particular aspect might have been blown out of proportion a little bit.

Yeah.

But there's still all these GPs are still facing LP pressure around all these themes.

And again, it's just making it more difficult for them to raise money.

Yeah. And then so coming back to the exit point, though.

So challenges around exits, I know we've talked before about particularly the IPO market, much more challenging for private equity at the moment.

The report does talk about the holding period.

Traditionally, we talked about private equity aiming to hold for a period of five years, two and a half times your money over five years. That's a nice sweet 20% IRR- Yeah ... which is what a lot of funds will target with their deals.

The average holding period's now gone up to seven years, which does erode, in the absence of anything else changing, erodes that IRR.

So what- Yeah. Well, assuming you're still exiting at the same valuation, but yeah, 100%.

Exactly. So that's a challenge for them, isn't it? If they're actually sitting on these investments for much longer than they want to.

Yeah, and I think the other thing that I think some LPs are thinking, and that it seems to be coming out in this report, and certainly from every private equity and private credit business I know that's kind of been selling assets, I think this generally holds true.

Which is in this environment where you have, especially financial sponsors, financial buyers who are feeling a bit nervous and not willing to pay up for any asset. I think what we've been seeing is, generally speaking, we've had people sell... You can still sell really high-quality assets, right? We've seen people sell high-quality credit assets.

We're seeing people sell high-quality equity assets as well. So you can still sell the good stuff, basically.

So I think what's happening, which is worrying some LPs, and I think quite rightly, is if you have financial sponsors that are going to market with their best assets and trying to prove a track record to say, "Hey, I can still sell like I used to be able to." What that's meant is the rest of their portfolio, kind of the rump of assets, is probably not as high quality as what has been sold so far.

Mm-hmm.

So I think a lot of investors are saying, "Hey, I don't have necessarily as much faith in the marks maybe that I used to. I'm not as willing to help you raise a new fund because especially I still haven't received that money back." And then, so we've been in this market where we've seen a lot of people, instead of selling assets, are putting assets into continuation vehicles just to kind of keep their exposure.

That works, but you also face some LP pressure for that too, because then you have questions around, hey, what valuation or what mark does it go from one fund to the other in? Also, that still requires funding. That's an LP- Yeah ... potentially not getting their capital back.

So I think we're just in this sort of weird cycle where we've got private equity just hasn't been able to sell assets like they used to be able to.

That's had an impact on their ability to raise new funds, and it just feels like the overall private equity machine is just not operating as fast as it used to. Now, I do think, like all things, this will be a cycle in the market. I don't think we'll be in this position forever.

We talked before about deals find a way.

Private equity- Yeah ...

is going to find a way. It just feels like we might be in this kind of slowdown for a little bit now.

Whoa, Graham. You're getting me a bit depressed here.

It sounds like private equity's in a real funk at the moment.

So what's the catalyst that needs to happen, do you think, to re-stimulate deal activity in the private equity space? Good question. I think we need a bit more time on, say, this software scare trade to see how it pans out.

I suspect a lot of LPs are sitting tight and waiting to see what happens here. Are we going to have a big wave of software defaults? Are we going to see EBITDA decrease 30% in the next couple of years? I don't know yet. And I think if you're private equity right now, you're just doing the one thing you can, which is, "I've got this portfolio of assets. I'm just going to run those assets as well as I possibly can," especially on the basis that we know the one thing you can seem to do right now is sell a high-quality asset.

So if you've got this portfolio of companies, you're going to do whatever you can to improve asset quality and hopefully get them to a point where you can actually list them for sale.

Okay, interesting. So that was a really insightful discussion there. Learned a little bit more about the state of the private equity market at the moment and maybe some hope for the future in the coming months if news flow on software particular isn't as bad as feared.

So I hope those of you that have tuned in to listen, you've really enjoyed our deep dive into the state of the private equity market at the moment.

That's all we've got time for today. Thanks from me and over to Graham.

Thanks, Debs, and thanks to everyone, and we'll see you all next week. Take care.