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Overheard at DealMax: Exit backlog anxiety grows

Illustration of an exit sign with dollar bills on it

Illustration: Sarah Grillo/Axios

Dividend recaps, add-ons and continuation vehicles continue to characterize private equity dealmaking in health care, DealMax attendees said.

Why it matters: As private equity's exit backlog grows, so does anxiety about returning capital to limited partners.

The big picture: Q1 didn't usher in the M&A wave PE might have hoped for, with 136 deals announced — just four more than Q4 2023.

What they're saying: "Now that we are at 12 to 18 months with little exits, I think it is a bridge too far for LPs," says Bob Dunn, managing director at consultant GF Data.

  • "Fundraising is a lag indicator, exits is a forward. When it comes to continuation funds, it doesn't solve the exit dilemma but gives another option," says Charlie Gifford, senior partner at New Heritage Capital.
  • "I do think that the continuation vehicle is the path of least resistance," Gifford adds.
  • Minority stake deals and fund-over-fund transfers are increasingly becoming popular, says Justin Abelow, managing director of Houlihan Lokey's financial sponsors group.

Yes, but: Valuations, which have been a major sticking point, continue to come down as the number of above-average performing companies participating in the market decreases.

  • In Q3 2022, "we reached the highest incidence of above-average performance transactions in the market, at 71%, and the lowest margin on that, at about 8%," Dunn says.
  • In Q1 of this year, the incidence is down to 38% of above-average companies participating in the market.
  • "I am starting to see more books and higher-quality deals," Gryphon Investors managing director Vince Carey tells Axios.

Zoom in: The lower middle market is active and "the riches are in the niches," says one director of business development at a lower middle market firm.

  • Niche private equity funds delivered an average IRR of 38% and a MOIC of 2.2x net of fees over the past 10 years. During the same period, diversified funds of all sizes in North America averaged an 18% IRR and 1.7x MOIC.

State of play: This week, a handful of PE-backed strategics announced add-ons, while some sponsors took a first bite of the apple.

What we're watching: "We don't need A-plus [assets] coming to market," says Abelow. "Those have been coming out and getting done at the same valuations."

  • "I want to see the A- and B+, B- (assets) etc. hit the market. Those could represent better opportunities, thus giving the market a chance to normalize."
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