Over the past few years, the private equity market has experienced significant fluctuations. The COVID-19 pandemic caused private equity to take a second-quarter hit, but thankfully, recovery was quick. 2021 was a record-breaking year—strong corporate valuations, cheap debt and a strong recovery from the pandemic resulted in a combined deal value of $1.1 trillion. 

In sharp contrast, 2022 was riddled with challenges. By the third quarter of the year, the outlook was decidedly bleak. The war in Ukraine, rising interest rates and inflation resulted in the M&A market cooling. 2021 was always going to be a difficult year to beat, but 2022 brought long-lasting challenges that have sent shockwaves across the globe.

This begs the question: what does 2023 hold for private equity?

Key Themes for 2023

2023 will likely be characterised by cautious opportunism. Private equity firms are keen to deploy vast amounts of dry powder, but many will take a cautious approach to dealmaking. But what else will this year hold for private equity? We’ve outlined what we believe will be the key themes for 2023:

Markdowns create opportunities for cash-rich investors

The current economic climate has created opportunities for cash-rich investors, allowing buyers with access to funds to capitalise on new opportunities while valuations are low. Private equity firms are holding on to record amounts of dry powder—having vast amounts of capital to deploy will allow many firms to make it through the downturn and snap up deal opportunities in the process. 

Deploying capital

This year, private equity firms will focus on deploying capital, likely in the form of more complex transactions such as undermanaged corporate carve-outs or the pursuit of two or more complementary assets at the same time. In addition, Series A and venture capital activity are also likely to increase from January to March in the UK as investors are up against the clock with the Capital Gains Tax deadline. For those with liquidity, 2023 could be the year to seize new investment opportunities. 

Cautious investors seek ‘safe’ deals

Economic uncertainty has led investors to emphasise identifying M&A risk factors early. In 2023, investors will be looking to put their money into businesses with healthy fundamentals with solid propositions and strong technical capabilities. Companies performing amid slow growth and high prices will draw strong interest from cautious investors—differentiated brands will receive plenty of interest, especially if they have strong ESG propositions.

TMT dominance is set to continue

In the first half of 2022, technology, media and telecoms (TMT) transactions dominated in the United States, with more deals completed than any other sector. Despite challenging economic and geopolitical conditions, the appetite for technology deals will likely continue in 2023. 

Asset diversification

Faced with the energy crisis and high inflation, technology companies will continue to pursue active M&A strategies to bolster their positions in the face of the current economic storm. However, it’s not only tech companies looking to bolster their positions. Investors in the Middle East are targeting tech investments in an asset diversification drive. The pandemic put pressure on Gulf Arab countries to diversify their portfolios as they grow increasingly concerned about the sustainability of hydrocarbon revenues. 

Supply chain changes

MMuch-needed changes to supply chains will also help to drive deal activity. Supply chain improvements have been neglected in recent years due to geopolitical and financial crises. As a result, technology, media, and telecom companies are keen to reduce their dependency on ‘unstable’ regions—this mass relocation will require large investments, creating plenty of appetite for deals.

5G expansion

But asset diversification and supply chain changes won’t be the only TMT deal drivers in 2023—rolling out the next generation of 5G and expanding existing coverage will require colossal investment. The expansion of 5G access has led to a decline in overall global speed, and many countries are investing huge sums into improving 5G networks. As a result, investors will be keen to close deals relating to 5G this year.

Consumer deals will remain popular

M&A will remain active in the consumer sector, but the pace of dealmaking will normalise as there is less competition for assets. However, demand for certain consumer products, such as food, beverages and personal care products, will likely remain particularly strong. The consumer brands that will garner the most interest from private equity firms are strong, differentiated brands, especially ones with health and wellness angles and a strong ESG proposition. Undifferentiated consumer brands, on the other hand, will show signs of struggle. For these brands, a renewed focus on value creation is essential to survival.

Social responsibility

Consumers expect brands to invest in social responsibility initiatives. Investors are also increasingly committed to social responsibilities, focusing on assets with fruitful ESG and DE&I initiatives. Consumers are choosing to support brands that focus on all aspects of sustainability, including eco-friendly packaging and ethical sourcing. Companies with a strong ESG proposition free of greenwashing will be quickly snapped up by sustainable investors.

A thriving secondaries market

The private equity secondaries market is set to boom in 2023, with record levels of deal flow expected. This boom will be driven by LPs’ demand for liquidity, a dry exit market and the denominator effect. Secondaries transactions reached record levels in 2022, with a total volume of $57 billion in the first half of the year. 

Investor over-allocation

When public markets began to tumble in Q3 2022, investors were over-allocated to private equity due to the denominator effect—they needed to release capital that was locked in long-term private equity investments. However, traditional exit routes have proved challenging for firms in recent months. The secondaries market acts as a refuge for investors, as it provides them with an alternative liquidity source and gives them the flexibility to amend their portfolios when the state of the private market limits their freedom to plan and manage their portfolios. 

Pricing difficulties

However, secondaries transactions will likely experience pricing difficulties this year. As the economic climate darkened, buyers and sellers experienced problems agreeing on the value of assets. As assets in the market were discounted, many sellers seeking liquidity decided to pause transactions, as they weren’t willing to take the financial hit required to gain the liquidity. Over the course of this year, sellers will start adjusting their expectations on discounts, and transaction volumes will begin to rise. 

ESG will begin to bear fruit

Multiple crises, including the COVID-19 pandemic and the escalating climate crisis, have prompted leaders, businesses and consumers to prioritise sustainability. As a result, ESG has taken the top spot on many firms’ investment agendas.

While countries in all seven continents are paying more attention to ESG, Europe continues to lead the movement. In December 2019, the European Commission announced the creation of the European Green Deal, a roadmap intended to make Europe the world’s first climate-neutral continent. The deal will result in vast investment in several areas, including energy, agriculture, transport, finance and regional development, and research and innovation. To achieve the goals set by the European Green Deal, the European Commission has pledged to mobilise approximately $1 trillion in sustainable investments over the next decade.

From infancy to maturity

Europe’s sustainability drive is steering investor and consumer expectations alongside regulatory requirements. As a result, ESG is no longer a “nice to have”; a strong ESG proposition is critical to gaining market share, raising capital and engaging high-value employees. There is almost limitless potential for ESG to spur deal activity for years to come as it moves from infancy to maturity. 

Investor attitudes towards ESG are shifting. For example, one study conducted in 2021 found that 72 per cent of respondents always screen target assets for ESG risks and opportunities pre-acquisition, and 56 per cent have refused to enter GP agreements or turned down investments on ESG grounds. It’s clear that the majority of private equity firms recognise the responsibility they have in helping to solve some of the world’s major challenges.

Firms recognise that they must allocate more resources in this area to maintain positive relationships with customers and other key stakeholders. For those lagging behind on ESG, M&A acts as a fast-track method for them to secure their futures by improving their records.

But ESG isn’t on the upswing because firms need to improve their records. A consensus is forming that ESG is a key value creation driver, as there is evidence to suggest that companies do well when they adhere to ESG standards. A strong ESG proposition can lead to higher returns, reduces risk, supports growth and expansion, reduces costs and legal or regulatory interventions, and increases investment. For many private equity firms, 2023 will be a crucial year for creating new value to drive growth, and ESG will play a vital role. 

ESG’s first big test

In Q3 of 2022, ESG faced its first big test. Now that money-making isn’t as easy as it once was, will investors stick to their ESG investments? ESG equity funds faced challenges on two fronts. First, tech stocks, which ESG funds tend to be overweight on, suffered significant losses last year. Second, oil and gas stocks, which many ESG stocks are underweight on due to environmental concerns, performed well due to the rally in energy prices. 

In mid-2022, opinions on ESG investing in a bear market were mixed. One survey found that almost 30 per cent of financial advisors planned to increase their use or recommendation of ESG funds over the next year, up from 24 per cent in 2021. However, 15 per cent planned to decrease their usage. 2023 will further test investors’ commitment to ESG investments.  

Your 2023 M&A Toolkit

To take advantage of opportunities while limiting risk, investors need robust, forensically accurate insights into assets of interest. Onefourzero provides the tools to provide speed and depth, allowing investors to learn more about an asset or sector.

Diligence

Onefourzero delivers data-driven M&A reports for investors to help make decisions that affect commercial growth, digital strategy, marketing investment, operational effectiveness and international expansion. To learn more about a sector or an asset, you can commission the following work:

Snapshot report

Our snapshot report gives a fast but robust overview of a sector or asset, delivered within three days. The snapshot report is useful pre-approach, giving your firm a glimpse into your market of interest. The snapshot report provides much-needed comfort around a target asset or identifies areas for a deeper dive.

A sneak peek of onefourzero’s snapshot report

Early-stage diligence report

Before instigating a formal diligence process, you may decide that you need to learn more about a target asset’s commercial performance. That’s where an early-stage diligence report comes in. Please note that the report can be serviced entirely without access to the company. An early-stage diligence report provides a valuable outside-in review of target asset’s commercial performance compared to the sector overall, as well as specific competitors.

Alternatively, if you require a deeper dive into a target asset:

Technology and IT due diligence

Onefourzero’s technology and IT diligence process involves in-depth management interviews and careful review of all documentation. Once our team of expert consultants have explored the target asset’s cybersecurity, risk and compliance management and IT infrastructure and architecture, we will produce a clear red flag and opportunity rating. 

You can learn more about onefourzero’s technology and IT due diligence approach here.

Full commercial due diligence

Private equity firms seeking a full assessment of a target asset would benefit from full commercial due diligence on the buy or sell side. The full commercial diligence process combines company access, data room content and vital outside-in data from over 1,500 sources to deliver a comprehensive assessment of several business areas. 

Value Creation

As the economic climate worsens, many firms will be looking to focus on value creation. A key value creation driver today is technology—a data and tech-led value creation strategy is a non-negotiable requirement for all businesses.

Consulting with investors, portfolio companies and individual brands, onefourzero delivers strategies to create tangible commercial value for clients. Our value creation services span digital transformation, IT and technical consulting, data maturity audits and commercial headroom modelling. 

You can find out more about our extensive value creation services here.

Threesixty

Leveraging analytics is vital for businesses across sectors. That’s why we created our proprietary one-stop, self-service data solution, threesixty. The tool allows firms to access a wide selection of data, including:

• Market size, growth and share
• Marketing efficiencies and positioning
• Engagement and user experience
• Commercial performance and benchmarking
• Customer cohorts and sentiment
• Sales, pricing and conversion 

There are several dashboard packages available to suit all organisations. Packages are also customisable, as you can include add-on enhancements, such as engagement and user behaviour mapping, access to the originations engine and other options. 

You can learn more about our one-stop, self-service solution here.

Final Thoughts

2023 may be fraught with difficulties for investors, but there is light at the end of the tunnel. Inflation in the UK is expected to fall back from the middle of this year. Inflation in the Eurozone will likely follow a similar trend. 

But we’re not out of the woods yet. More than ever, private equity firms are keen to invest in businesses with a healthy balance sheet and a strong ESG proposition, as they are more likely to weather the current economic storm. Investing in assets that will provide returns has never been more critical, and the stakes couldn’t be higher. For example, private equity returns are a major threat to pension plans’ ability to pay retirees in 2023. Situations such as these demonstrate that the argument for using data to make better investment decisions grows ever more convincing.