• Continuation funds, minority sales and refinancings dominate means to return capital to LPs
• Stabilised macro environment could open floodgates on full M&A
• Deployment pace and adjustments to return expectations raise eyebrows

Throughout the recent exit impasse, private equity (PE) firms have been acutely aware that they need to return capital to their investors. However, a renewed drive for limited partner (LP) liquidity was at the forefront of this year’s IPEM conference in Cannes, and this is driving a potential rebound in full M&A alongside more creative realisations.

“The priority for all GPs is to return as much money as possible to LPs and they’re going to be innovative in that sense,” said Thomas Vatier, a partner with Quilvest Capital Partners, during a panel about exits. Continuation funds, minority stake sales, LP-led secondaries, and dividend re-caps are set to become even more widely used tools in the liquidity toolbox, a sentiment echoed by many at the conference.

Permira, among other sponsors, has already been adept at using these new tools, having shifted Evelyn Partners into a fresh continuation vehicle, and it has recently been talking with private credit funds for a GBP 400m dividend re-cap.

Distributions have always been the core of the private equity business model but this has been broken with exits down 30% in EMEA in 2023, according to Mergermarket data. “We’ve seen fairly consistent exits for the last couple of years and decent returns. But the big question is still around DPI [distribution to paid-in capital] – this is putting managers under pressure,” said an LP operating in the small and mid-cap market.

The most important statistic in terms of distributions is the DPI on the fund two vintages earlier than the one currently being raised (N -2), according to Sunaina Sinha, the global head of capital advisory at Raymond James, in a panel on exits. That figure has to be greater than one to satisfy LPs, she said.

Return to form
“Despite the vendors’ high expectations in terms of valuation, LPs are pressing for exits,” said Nicolas Beaugrand, managing director with consultancy AlixPartners, adding that any assets that could come up for sale, will come up for sale.

AlixPartners’ conference-wide survey found that 36% of respondents have a positive outlook for exiting in 2024 compared to 22% last year.

Europe’s most likely upcoming sponsor exits, according to Mergermarket’s Likely-to-Exit* model include Advent’s Industria Chimica Emiliana, CBPE’s Perspective Financial Group, and Ardian’s Audiotonix, which all score above 65.

Dealflow is also expected to benefit from a more stabilised macro environment since, although interest rates remain high, sponsors and lenders can now model deal financing and thus returns.

This is expected to benefit the mid-market more, where less leverage is the norm. Large-cap deals, however, are still very impacted by limited financing due to high-interest rates so they will not come back right now, at least there will not be the same level of activity we had two years ago, said François Hellot, head of corporate transactions for CEMEA at Ashurst, on the sidelines of the conference.

Return expectations themselves are also a deal-driving source, as LPs demanding liquidity means that they might have to accept their managers in turn accepting lower prices in sale processes, as most in the industry are recognising that the bid-ask spread is narrowing.

“LP return expectations should adjust down a bit, but there will be a difference between small, mid and large [strategies],” said one private capital adviser, adding that the expectations are lower in the large-cap space, but that the small and mid-cap space, while still seeing multiple headwinds, should not see returns move too much.

“I don’t see a world where they [large-cap funds] could pitch that they are doing the same returns as they used to,” said the same private capital adviser.

One French lawyer speaking on the sidelines said that some large-cap funds are adjusting down to 12%-13% internal rates of return (IRR), while the mid-cap is coming down to around 17%. However, all sponsors spoken to by this news service said resolutely that they weren’t adjusting their return expectations below the benchmark 20% IRR and 2x money multiple.

Some in the industry are, however, resolute that IRR is nonsense regardless. Andrew Sillitoe, co-CEO at Apax Partners described  IRR as a “spreadsheet fiction” during a fireside chat about creative deal sourcing, adding that the correlation between predicted and actual IRR is almost zero, with the firm maintaining a focus on entry multiples.

That all leaves the question of different fund vintages. Funds being invested right now are still expected to deliver outsized returns thanks to lower prices, while those being divested right now are expected to be less successful for the same reason. Meanwhile, funds that were deployed quickly at the top of 2021/22, a year now more consistently seen as an outlier than the norm, could struggle to deliver their expected returns.

“The most important thing is deployment pace,” said Gilbert Kamieniecky, Investcorp’s Head of Private Equity in Europe on a panel. “Some deployed too quick too fast. My N -2 fund is fine because it was eight years ago. The pace of deployment needs to be 20-25% a year instead of 40%.”

*Mergermarket’s LTE predictive analytics assign a score to sponsor-backed companies to help track and predict when an exit could occur through M&A, an IPO, a direct listing or a deSPAC transaction.

To see more features discussing EMEA deal trends, please click here.