Navigating an uncertain future: The 2024 election and its ripple effect on private equity funding

The upcoming 2024 U.S. presidential election has cast a long shadow over the financial landscape, leaving investors and industry stakeholders alike considering the potential ramifications on the private equity and venture capital markets. As the nation braces for a pivotal shift in leadership, a palpable sense of anticipation hangs in the air, fueled by the market’s insatiable thirst for stability and certainty.

The ‘dry powder’ conundrum

One of the most striking narratives to emerge from the private equity sector is the staggering accumulation of “dry powder” — the industry’s term for uncommitted capital reserves. At the heart of this phenomenon lies a key issue: While private equity and venture capital firms have amassed record-breaking sums of investible capital, their propensity to deploy these funds into new ventures has waned considerably.

According to the latest figures from S&P Global Market Intelligence and Preqin, global private equity and venture capital funds held a staggering $2.62 trillion in dry powder as of July 10, 2024. This colossal war chest represents an unprecedented surge, with funds adding a remarkable $49.44 billion to their coffers in the first half of the year alone — a figure that dwarfs the $27.97 billion accrued over the previous 12-month period.

Capital concentration

Delving deeper into the data reveals an intriguing concentration dynamic. A mere 25 private equity and venture capital firms collectively hold a commanding 21% of the global dry powder reserves, amounting to a staggering $556.19 billion. This uneven distribution underscores the challenges faced by emerging fund managers in attracting capital, as investors gravitate towards established players with proven track records.

This imbalance can be attributed to the tumultuous dealmaking environment of recent years. As exits from existing portfolio companies slowed and profits dwindled, investors became increasingly cautious, opting to reinvest their limited resources into long-standing partnerships rather than venturing into uncharted territory.

Deployment outlook

While the accumulation of dry powder paints a picture of abundance, the underlying reality is far more nuanced. Private equity deal activity, which had been languishing for two years, is finally showing signs of revival. The $189.05 billion in announced deal value between January 1, 2024, and May 31, 2024, represented a 9% improvement over the same five-month period in 2023, offering a glimmer of hope for the industry.

However, the road to recovery remains fraught with obstacles. The persistent discord between buyers and sellers over valuations is a significant hurdle. Lingering concerns over inflation, interest rates and economic uncertainty have made it increasingly challenging for market participants, particularly on the private equity side, to secure favorable financing terms.

Navigating interest rates

One of the pivotal factors shaping the private equity landscape is the intricate interplay between interest rates and valuations. As interest rates soared in 2022, triggered by escalating inflation, the ripple effects reverberated through the venture capital and private equity spheres.

The precipitous decline in venture capital activity can be due to the allure of risk-free returns offered by rising savings rates. With the prospect of earning a guaranteed 4.5% to 5% return on bank deposits, investors have become increasingly reluctant to commit capital to speculative ventures with uncertain outcomes.

The impact on the private equity front has been equally profound. The escalating cost of capital, with interest rates reaching dizzying heights of 8% to 12%, has rendered leveraged buyouts prohibitively expensive. This perfect storm of factors has effectively paralyzed deal flow, as market participants grapple with the uncertainty surrounding the trajectory of interest rates.

The Silicon Valley Bank hangover

Compounding the challenges posed by the interest rate issue has been the fallout from the collapse of Silicon Valley Bank and related bank closures. This seismic event sent shockwaves through the venture debt market, leaving a lingering sense of trepidation among lenders.

The ripple effects extended to the private equity realm, where fundraising efforts fell short of expectations, albeit to a lesser degree, as firms pivoted to rely on their existing cash reserves.

The valuation problem

As the dust settles from the tumultuous events of the past few years, the private equity and venture capital industries find themselves grappling with valuation concerns. On one hand, the prospect of declining interest rates holds the promise of fueling higher valuations across various asset classes, including real estate and business enterprises.

However, this scenario presents a double-edged sword for private equity firms. While lower borrowing costs may enhance the allure of leveraged buyouts, the corresponding surge in valuations could potentially erode the very advantages they seek to capitalize on.

Potential tax code changes

As the election nears, the specter of potential tax policy shifts looms over the private equity and venture capital realms. The expiration of the Trump-era tax cuts in September 2025 has fueled speculation and uncertainty, with investors and business owners alike bracing for the potential fallout.

Under a Democratic administration, industry insiders anticipate a surge in sellers rushing to offload their businesses before the anticipated tax hikes take effect. Small or middle market businesses may try to go to market pretty quickly in the event of a Democratic win, presenting potential opportunities for savvy investors.

Conversely, with a Republican victory, the previous Trump tax cuts may be not only extended but also supplemented with additional incentives, such as an expansion of the Section 179 deduction for machinery and equipment purchases.

Searching for certainty

Amidst the currents of uncertainty, one factor emerges as a beacon of hope for the private equity and venture capital industries: the promise of stability. Regardless of the election outcome, the mere act of resolving the political impasse is expected to unleash a torrent of pent-up investment activity.

Private equity firms and investors, in general, seek some sense of certainty, and volatility often keeps money from being placed. The accumulation of dry powder over the past few years is a testament to this sentiment, with funds exercising caution in the face of an ever-shifting economic and regulatory landscape.

While the pursuit of stability remains a guiding principle, the ability to embrace change and seize emerging opportunities will be paramount. By fostering a culture of adaptability and maintaining a keen eye on market trends, these industries can navigate the uncharted waters of the post-election era, unlocking new avenues for growth and capitalizing on the ever-evolving investment landscape.

How Wipfli can help

In unprecedented times, a roadmap for resiliency is essential for economic survival. The private equity and venture capital sectors are at a crossroads, with challenges and opportunities all linked to November’s outcome.

If your firm is considering its options as it looks toward the post-election landscape, Wipfli can help you navigate the changes to come. Contact one of our dedicated professionals today and let us assist in charting a course for your future growth in an uncertain environment.