Nov 26, 2018

What an economic slowdown could mean for private markets

Dan Primack, author of Pro Rata

Photo: Richard Levine/Corbis via Getty Images

It is too early to know if we're in the midst of a public equities correction, or if the bears have finally arrived. Either way, private markets tend to follow the public lead.

Why it matters: For private equity that likely means a decrease in traditional fundraising, but also new deal-making opportunities and newfound interest in special situations and distressed debt funds.

  • Buyout firms have spent much of the bull market in "harvesting" mode, and have plenty of dry powder to do new deals as prices fall and strategic buyers conserve cash. So long as we don't have a replay of the 2008/2009 credit crunch, don't be surprised to see an increase in PE deals, at least as a percentage of overall M&A.
  • There could be at least a mild "denominator effect" for fundraising, as falling public equity values result in a decrease in real dollars available for new private equity funds. For example, imagine an institutional investor with a $10 billion portfolio back in January, and a 10% allocation to alternatives. In other words, $1 billion available. Now, however, if that same portfolio is slashed to just $8 billion, the alternatives allocation is $200 million smaller.
  • One caveat, per Kelly DePonte of Probitas Partners, is that "a number of LPs have added flexibility to their allocations so they are set within a range, and not a single hard number."

For venture capital, it means that many firms will go "back to basics" and face a lot of very hard choices when it comes to existing portfolio companies. Also, don't be surprised to see corporate VC pullbacks.

  • Venture capital always responds to bull markets with bigger funds and bigger deals. And befitting the longest bull run in American history, this time we've seen the biggest funds and the biggest deals. But there still isn't too much evidence that venture capital really scales — at least not on an IRR basis — and veteran firms will make a lot of noise about picking up their old knitting. Just like there was in 2002 and 2009.
  • This also would mean smaller fund sizes, largely offsetting denominator effects.
  • There could be a reckoning for startups whose growth has been almost entirely fueled by venture dollars. Either because they can't get large new rounds or because they'll come at discounts that erode employee morale. Particularly if the IPO window significantly narrows. Welcome to the expansion-stage dessert.

Yes, but: I must reiterate that no one knows what's around the corner, and even consensus projections of slowed economic growth are just that — projections. It's impossible to guarantee the end to something that has been unprecedented.

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