In Mergers & Acquisition, Private Equity is Replacing Banks

Published: Jan 14, 2023  |  

Managing Director with Alvarez & Marsal

Today, Private Equity (PE) firms are flexing their agility muscles, dodging and weaving their way past major economic uncertainties to find opportunities. 

Inflation, the Ukraine conflict, supply chain disruptions and rising interest rates have injected uncertainty into PE-led mergers and acquisition (M&A) activity and undermined deal valuation multiples to such a degree that many deals are postponed or dying on the vine. That follows a year when PE accounted for 25 percent of all deals, a record share. The sector is sitting on $2 trillion in dry powder—latent cash waiting to be spent—just as deal activity begins to slow.

So, where’s that money going, if not into traditional M&A deals?

There’s a secret that’s beginning to emerge: PE investors are becoming the new “banks” for financing deals, including distressed companies. What do I mean?

PE investors are two times as likely as banks to lend new capital to companies on the verge of restructuring. If this trend continues, it represents a dynamic shift from public funding and traditional bank loans to private capital markets.

The trend is expanding fast. Global private debt grew tenfold in the ten years leading up to 2020, reaching $4.12 billion, according to S&P Global.

And it’s changing the dynamics of the PE/restructuring push-me, pull-me back-and-forth in the marketplace. Historically, patterns in a recessionary environment demonstrated that restructurings rise while PE M&A activity declines and vice versa. It’s been that way for 30 years.

This time, it will be different.

An injection of cash into a stressed company keeps the entity afloat but also allows the PE firm to align interests with an eye on unlocking higher returns later. Debt financing and equity infusions puts more of that dry powder to work.

With that potential in sight, PE firms are willing to risk more debt financing than banks, which are limited in how much risky debt they can hold. Private equity credit funds are easier to deal with because they’re not subject to the regulations that banks are, so they’re filling the void. If banks don’t want to lend, these funds can—and it’s competitive, since everyone in the sector is “all in.”

We really don’t need banks anymore.

Private Equity and Companies in Need of Restructuring

In the past, when companies were in danger of not being able to pay their debts as they came due, banks often stepped in, providing the necessary liquidity but ultimately restructuring and selling the company.

Enter PE funds. They’re more willing than banks to work out a plan with distressed companies and provide necessary financing. Creditors are also more willing to work with PE firms, and the companies are more than happy to find another way out of the mess.

In short, banks can’t tolerate the risk, but private credit funds can.

Expect more of these rescue financing missions in the future as M&A opportunities decline in the short-term.

PE Funding Leads to Avenues for Greater Performance Improvement

PE funds are known for creating value, either through operational improvement or acquisitions. And they’re accustomed to doing so during the typical four- to seven-year investment horizon before selling the company off at the end of the process.

Now, even in restructurings, PE funds are conducting performance improvement.

They have an incentive to not just “right the ship” but to produce a better company. Distressed or non-distressed companies alike can benefit from a corporate transformation, including incorporating a digital strategy to improve the business and to monetize products or areas of the company that previously had not been.

Flexibility, Nimbleness and New Frontiers

PE funds are finding creative ways to invest their hefty stores of dry powder, and it goes way beyond traditional dealmaking.

Unencumbered by banking regulations, they can provide debt financing, inject capital, and make equity plays. Many are no longer lone rangers, dueling it out with competitors, but often team up with them and investment banks to pull off sizable transactions.

And they’re giving distressed companies a new lifeline, while providing an opportunity for fund managers to build value and unlock higher returns.

Some industries are more attractive to the new PE playbook than others—in future columns, we’ll look at some surprising opportunities in M&A in key sectors. Stay tuned.

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