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Private equity firms eye 2023 with a mix of caution and optimism

Jan 10, 2023

Before 2022, most private equity (PE) managers only experienced 80s-level inflation through textbooks. Now, they have their own war stories to tell.

In 2022, the U.S. hit record-high inflation and the Federal Reserve aggressively hiked up interest rates several times. Borrowing became expensive and fund performance and company valuations took the hit. Supply chains operated in fits and starts, and containers sat waiting in ports. And the war between Russia and the Ukraine outlasted everyone’s expectations.

Despite the laundry list of hurdles, there were still some reasons for hope and optimism.

To level set, 2021 was a record year of activity. Fundraising and buyouts were slower in 2022, but they were still above pre-pandemic levels. And PE funds are now holding on to a lot of dry powder, so they’re ready for acquisition opportunities.

While there’s no way to be certain, there are indications that we’ve hit peak inflation and it will go down from here. The Inflation Reduction Act, passed in August 2022, also had positive implications for PE firms. It included key tax and revenue-raising provisions, plus $370 billion in spending and tax incentives that could bolster investment across several industries.

Private equity trends:

Uncertainty will still be a key theme in the months (maybe years) ahead, but PE firms can take strategic action to build resilience. Here are five priorities for private equity in 2023:

1. Evaluate and plan for people assets

Baby boomers are expected to liquidate over $14 trillion in small business valuations. Many owners are leaving the workforce after closing, leaving behind huge leadership gaps. Post-transaction, PE firms are struggling to fill C-suite roles, as well as accounting, finance and operations positions.

As part of due diligence, evaluate the team you’re buying and the job market. Understand the risk any departures might cause and the expense to replace quality talent in a tight labor market. Company leaders often say that people are their most valuable asset. That never feels more accurate than when those leaders leave.

The C-suite isn’t the only place with empty seats. There are only 73 workers available for every 100 open jobs, according to the U.S. Chamber of Commerce. To protect investments, PE firms need to build pipelines of skilled workers who can get orders out the door. They may need to partner with schools or vocational programs to recruit the next generation of skilled laborers.

2. Leverage data and automation

There’s more data available now than in any other period in history (e.g., customer data, supply chain data, lending data, etc.). It’s accessible — if you have the right tools, governance processes and data skills. Make sure that you’ve got consistent, good, quality data to inform due diligence. PE firms also need tools to model scenarios so that they can respond correctly to changing conditions.

Within your portfolio, look for labor-saving or labor-replacing technologies to ease the skills gap and lower costs. To retain key people, you’ll need to alleviate some of the workload. Automation can ease some workforce constraints.

3. Budget wisely

History means nothing right now when it comes to portfolio company budgeting. We’re in brand-new territory, without a baseline or sense of normalcy to cling to. Keystones such as revenue and ordering history aren’t applicable because of the pandemic. To do well in 2023, PE firms must budget realistically — even conservatively.

Data from the past two years isn’t applicable, but some of the business practices are. Flex your agility muscles. Be nimble. Know the right questions to ask. Explore what-ifs.

4. Get ready to buy

Valuations are low and interest rates are high — but PE firms have capital to put to work. Deals can and will be made if the right teams are in place. PE firms should prepare for strategic buying opportunities, with or without bank financing.

5. Recession-proof asset allocations

PE firms can build resilience by reevaluating their industry and investment mixes when considering new fundraising. They need recession-proof businesses in their portfolios to create some cushion if recessionary conditions continue. B2B firms and business services with recurring revenue are worth looking at. Technology and residential services (including repair and restoration) may be worth exploring too.

Wipfli can help

Looking to jump on some of 2023’s top trends for private equity? Wipfli can help. From due diligence and data analytics to succession planning and talent optimization, we help private equity firms navigate an ever-changing business landscape.

Learn more about how we can help.

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Michael L. Vaccarella
Partner, National Leader Private Equity & Transaction Advisory Services
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Mark B. Martinelli, CPA
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Kevin S. Owens, CPA
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