Private Equity Predictions: Tackling 2024’s Opportunities and Challenges

[00:00:00] Sean Mooney: Welcome to the Karma School of Business podcast about the private equity industry, business best practices, and real time trends. I'm Sean Mooney, BluWave's founder and CEO. In this episode, we have a great discussion about what happened in 2023 in the world of private equity, why it happened, and what our predictions are about what will happen in 2024.

[00:00:34] Enjoy.

[00:00:42] Today we're going to be talking about what the best business builders in the world were up to in 2023, what we predicted was going to happen and what we're predicting will happen in 2024. So, to frame things up, I've been way too regularly saying, quote unquote, this too shall pass. Really since March 2020, most of the time since then it's felt a little bit like I've been living and we've been living in this good news, bad news washing machine.

[00:01:14] And as we all know, things seem hardest right before they get better. Economic cycles are nerve wracking, they fatigue us, they drain optimism. Then right when things seem bleak, things start getting better. When I look at BluWave's data, which reflects what the best business builders in the world have been and are doing right now, And combine that with macroeconomic data, I believe that we've reached the bottom and we'll be entering the next six to eight year growth cycle.

[00:01:49] A friend of mine recently asked, as we were talking about this and I was sharing kind of the perspectives that I, that I had, uh, discerned from our data. And he asked me if I was going to change my personal investment portfolio's posture towards growth. And my answer was that in many ways I already had.

[00:02:07] And one of the things that we first started doing, particularly in the second half of last year, Is we started heavily hiring blue and so we increased our headcount by more than 40 percent last year i think it's most people are many anyways we're cutting we started hiring and we did this because of the confidence that we gained from watching an aggregate the best business builders in the world take action.

[00:02:32] And running towards a storm and now running past the other side of it towards kind of rosier times ahead. And so history, you know, has time and time again informed us that periods like now are the best times to be intelligently assertive. Our data corroborates this. It's showing us patterns that the macroeconomic world is getting better and the best business builders in the world are starting to hit their throttle down with the idea that things are getting better versus worse and should enter into a new growth phase in the months and years ahead.

[00:03:10] So before we jump into 2024, let's talk about what we saw in 2023 and how this is going to inform our predictions going forward. So strike that second. So value creation, value creation was front and center in 2023, percent of the projects that blew is supported across hundreds of BluWave and their thousands of portfolio companies.

[00:03:37] Related to value creation and definitionally, this is the phase after private equity firms have invested in their companies gears towards making their companies bigger, better, safer, stronger, faster, and more valuable. The reason that we saw value creation continue to get bigger and bigger and bigger all times highs last year is a couple fold one is econ one to one.

[00:04:01] Every year, there are more and more BluWave with more and more dollars under management. They're competing for a similar supply of deals looking for capital companies looking for capital. And when you have that dynamic with more demand, static supply, purchase prices go up, and if you don't do anything, returns go down.

[00:04:19] Private equity firms are resilient and tenacious and gritty, and they're not going to just let returns go down. So they've been doing more and more and more value creation. The second reason for maybe less due diligence versus value creation is that the deal market continues to be relatively soft.

[00:04:37] So there's just fewer opportunities to do diligence vis a vis value creation. As you'll see in some of the future predictions, we think that'll start easing in the, in the periods ahead thematically as we peel the onion further back in 2023. We saw particularly strong and accelerating activity in a few areas within value creation.

[00:05:00] So let's think about and talk about those a little bit. One, we saw sales and marketing in the value creation phase surge 20 percent year over year during the second half of 2023 versus the second half of 2022.

[00:05:14] This shows that P industry is hitting the gas towards growth. Second, we saw technology data and analytics projects, including AI grow 10 percent year over year during the second half of last year. These are in general, very meaningful, large dollar projects that take confidence to invest in.

[00:05:37] Think about this as fundamental system selection and like. Also, they're putting in data analytics, visualization structures that are enabling them to see the future better. And so this once again says, how do we navigate the new, how do we navigate the future better and faster? The third thing thematically that happened last year is we saw human capital and, uh, we saw human capital activity increase 8 percent during the second half of last year.

[00:06:09] And so what this means is PE continues to hire at record levels. What we found particularly interesting is not only was this your prototypical C suite hiring, but we're seeing massive surges in mid level hiring demand from private equity firms and also wanting to be connected with those related resources.

[00:06:28] And so that's an area that we haven't really seen a lot before prior to this last year in 2023 was meaningful direct activity by the BluWave to hire and augment and improve and enhance and bring new skills to the mid levels of their organizations. As we look at this data and particularly these top trends.

[00:06:45] This has revealed to us that PE has been shifting from defense to offense. They're doing growth projects. They're doing big data analytics projects. They're hiring people. What is also interesting about this is that the mix of the topics is shifting from Maybe more supply chain, cost improvement, turnaround type resources towards these growth projects, tech projects that require confidence in dollars, hiring growth oriented people all the way down the middle of the organization.

[00:07:16] So the private equity firms are investing and hitting the gas. At least that's what our data is showing. At the same time, when we looked at macroeconomic data within all of the noise and the churn, we see a number of things on inflation has dropped by more than 50 percent from a year prior, it continues to drop.

[00:07:37] We've seen five quarters of positive GDP growth, the strongest of which was, the most recently reported quarter. We're seeing continued resilient consumer sentiment and the Fed also announced that they're introducing more stimulus in 2024. Together this gives us a pretty good idea that. Private equity industry is throttling down if you'd like to learn more about the details of 2023, please see the episode notes and you can request a copy of our 2023 PE insights report, which will go through all of this and much more in significantly greater detail.

[00:08:15] Before we turn the page to two thousand twenty four i'd like to talk just a little bit about what we predicted what happened in two thousand twenty three headline is we predicted pretty well it's not that we're no strict by any means we just have this privilege of supporting a large number of the best business builders in the world private equity investors.

[00:08:37] When we aggregate what a large population of these business builders are doing and take a look at how it changes over time and the underlying trend lines behind them, it enables us to not only understand what and why things happened in the past, but also make a relatively educated prediction about what's going to happen in the future.

[00:08:56] And so let's talk about what those predictions were the 1st prediction that we made in 2022 about 2023 was about the economy.

[00:09:07] We predicted that the Fed would create a shallow recession to prevent a situation like the 1980s from happening again. I think we were largely correct, but somewhat off on this. The economy has been amazingly resilient. The Federal Reserve did take strong action to taper inflation. What we saw, though, is the entire economy did not enter into a recession.

[00:09:29] Many parts of it are in a recession and were in a recession and have been in a recession. So think about manufacturing, think about large parts of the tech ecosystem, think about certain areas in healthcare services and consumer products. Those areas by and large have been in recession, but other areas of the economy, like business service have been showing quite meaningful growth, where amazingness of our economy, which allows us to sell products and services to each other has really held us up. So that is one prediction. I'm glad we were only partially correct on the next prediction that we made in 2000, 2000, the next prediction that we made in 2022, about 2023 was the bursting of the VC bubble. And you think about it now it's, it's pretty, I think it seems like a somewhat obvious prediction, but back then in 2022, not many people were talking about this.

[00:10:21] And so what we were seeing was the venture capital industry. Investing in lots of companies with relatively little due diligence. Many more dollars chasing the available supply of companies looking for dollars. And so what inevitably we thought was going to occur is that this bubble is going to burst and that there was going to be a return to maybe the earlier days of discipline in the VC world.

[00:10:48] And of course, what did we see? We saw the, the VC bubble bursting in 2023, we're already seeing some reform around AI. We think there's going to be some huge winners in this space. But a lot more losers. And so just keep on, but so just keep an eye out for this. We do think, though, as well as you'd look forward out of this new discipline, coming out of these crops of new BC back companies are going to be some of the world's most amazing companies that we've ever seen, just like we saw in 2001, 2002 and 2008, 2009, this new discipline, I think, is going to create the next big winners in the world of technology and innovation.

[00:11:27] The next 1 that we predicted was a return to in person work. We thought that the business world, particularly private equity was going to return to a hybrid structure 3, 4 days on and maybe 1, 2 days off. In largely what we've seen is that virtually every firm that we work with and know of is in at least a hybrid, if not a 5 day schedule.

[00:11:50] Again, there's just too many competitive advantages. There's just too many competitive advantages for being in person. We've been a tribal species for thousands of years, and up until a couple after 2020, where we were brought in the digital when we were compartmentalized into digital boxes. We've always been an in person world and we've gone back into that.

[00:12:12] It's just too much at stake and there's too many competitive ventures not being. And so we've seen, I think most of the world coming back and now large swaths of VC are doing their, and now large swaths of kind of the tech world is also coming back as well. The next thing that we predicted was branding and PE.

[00:12:29] We thought that branding was can become more important in private equity in 2023 and beyond. The reason for that is there are so many dollars chasing. Similar supply of companies out there and if it's if it's just dollars that you have, you're not gonna be able to compete and if you have a competitive advantage, but no one knows what it is, you're not gonna be able to eat and so it just makes too much sense for brand formation and private equity.

[00:12:54] We've seen a ton of activity last year on this. We see people proactively submitting for awards. We see updating of websites. We see engagement on channels like LinkedIn and very interesting and creative ways. We see email marketing. We are seeing people increasingly asking us to be guests on our karma podcast.

[00:13:16] We're seeing people embrace these top private equity innovator awards that we have and regularly calling us trying to be included in this to the extent they're worthy, et cetera. So there's a lot going on in this firm. I only think it's going to get bigger and bigger and better and better as the years progress.

[00:13:31] Next thing that we predicted was a rise of analytics and AI in everyday business. We're predicting that everyday tools like Snowflake, tableau Power BI were gonna become very commonplace across every business. In part, because we saw what was coming next in the 4th quarter of 2022, we started talking about this thing called chat GPT and mid journey and Dolly and how they were going to change the world, bringing untold efficiencies 2022

[00:14:03] 2023. That's not such a big prediction 2022. Not a lot of people are talking about. And so we've seen huge amounts of adoption as everyone who resides lines knows of these tools. And by adoption, it's really, you know, I think in 2023, what we saw is a lot of curiosity, trying to figure things out.

[00:14:22] We had tons and tons and tons of tech projects last year that started with, we wanted to do AI. What was really interesting is. Where they ended up was in the right place. I said, AI is going to develop. It's going to be a future tactic as part of our strategies. More on that in a second. And, but we need to lay the, the, the foundations.

[00:14:42] And that's one of the really smart things about private equity is they're very deliberate, very analytical, very driven by scientific method, and they'll, they'll take one step at a time to get to where they're going multiple steps down this journey. And so what we saw was lots of interest in AI, but what happened was lots of activity around data quality.

[00:15:01] Data analytics and other precursor activities that we're going to enable the future intelligent adoption of AI tools as a tactic that are part of their larger strategies. So that's the 2023 predictions. I think we did a pretty good job. On the predictions let's see how we do in 2024. This episode is brought to you today by BluWave.

[00:15:28] BluWave is the go to expert of those with expertise. BluWave connects proactive business builders, including hundreds of the world's leading private equity firms and thousands of leading companies to the very best BluWave credentialed professional service providers, independent consultants, and interim executives for their critical variable on point and on time business needs.

[00:15:48] Now back to the episode. BluWave. So in 2024, there are a number of things that we believe will happen based upon what we're seeing across our larger data sets and other commercially available data sets.

[00:16:03] First is just like we've been talking about in foreshadowing during this entire episode, the economy is getting ready to enter his next growth cycle. And we think this is going to be a traditional 6 to 8 year growth cycle, not a 15 year fed fueled mega cycle where we were going all gas, no breaks.

[00:16:22] This is going to be the more prototypical six to eight year up and down that we saw during certainly all of my adult history, you know, since the late nineties in economic cycles. So look for, you know, within all the noise that we are going to move from this kind of soft landing to, we're doing a touch landing and taking off again.

[00:16:45] It's not going to be dramatic, but it's going to be. Entering into just a normal economic cycle, you know, fingers crossed, right? The next prediction that we're making is that sponsors are going to start selling anyone in the world. The investment world has noted that we dearth of activity in exits, particularly by private equity sponsors.

[00:17:13] We think next year that this logjam will start to break and it's going to break in part because private equity sponsors are going to start selling more. We believe this particularly because we're looking at the data portfolios are starting to get old and distributions are starting to get small or have been small.

[00:17:33] So if we look at the median age of private equity portfolios. It's at a nine year high right now, and this data is comes from Pitchbook, by the way, and as we look at the distributions back to LPs, it's at a 13 year low. So limited partners are absolutely pressuring their general partners, the private equity firms, to provide more liquidity.

[00:17:59] And they're persuading the GPs, the general partners, the private equity firms to start selling their assets, even if it's below full potential in earlier days, after COVID started, the LPs were doing what's called the denominator effect.

[00:18:13] Where they were outside where their allocations were kind of out of sync with each other, and they couldn't allocate certain assets to others right now. They're dealing with liquidity effect. If they're saying we need money, if we're going to be able to commit to your next fund, and so what we're going to see is BluWave trying to sell top tier companies are still going to sell a premium valuations, but ultimately BluWave and really anyone looking to access the M& A markets.

[00:18:37] Transcribed Are going to have to start adjusting pricing expectations back towards more traditional pre 2022 peak valuations. The other thing that's supporting this prediction is that M& A investment bankers are also 100 percent going to start lobbying for this trend. The investment banks have been laying off in droves, they need to support their revenue model, and so they're going to do everything they can to get the M& A markets going again.

[00:19:01] At the end of the day, there's just too much at stake with too many stakeholders and too much money for the M& A markets not to restart again next year. So look for that. The next prediction that we're making is now is the time to buy and hit the gas. The private equity deals and investments that are made in 2023 and the first half of 2024 are going to yield the best returns over the next six to eight year deal cycle.

[00:19:30] This happens time and time again. Every study you look at, private equity firms do best when times are worse. They do particularly best when we're at the bottom of the cycle. And so start tracking this vintage. It's going to be a really good one. Next one, as I alluded earlier, deal makers realize that A. I.

[00:19:47] Is a tactic, not a strategy. So just like with the Internet circa 1995. The AI boom is going to evolve with businesses understanding and leveraging technology as a value creating tactical tool that can lower costs, increase the speed of process and improve decision making understanding that it's not some ill defined pie in the sky.

[00:20:10] It's understanding. It's not some. Ill defined pie in the sky business strategy in itself. It's a tactic. And so to give you some context, in 1995, this web browser called Netscape came out and it transformed the internet into something that everyone could use. In 1995, 1996, 1997. Yeah, probably in 1995, then we started things go crazy about the internet and you had internet investment banking groups and you had you can get an MBA in the internet and all this kind of craziness and then eventually people realize like now the internet. No the internet is a delivery mechanism it makes the movement of information and products and services and connection of things better and faster and it's a great way of making the business world more agile strategy itself.

[00:21:06] We're going to start seeing the same thing happen with A. I. in 2024. Our last prediction is something like follow the money, but we're calling it follow the data. Data is the fuel of every business and will be increasingly so.

[00:21:24] In the days, months, years ahead. So our prediction is that the data scientist will be the hottest new hire in private equity firms. As modern data sets continue to expand and involve and competition and P grows BluWave are going to look more and more to BluWave are going to look to more fully make use of these large data sets that are available.

[00:21:48] They're going to be using statistics and they're going to apply more powerful tools like Python, SQL, and MLAI techniques. We've already seen a lot of private equity firms taking action in this regard and gaining a considerable first mover advantage in acquiring these skilled professionals. We believe the rest of the industry will follow.

[00:22:12] In part, because they have to, this is the new world. We're moving from maybe when I was entering P in the nineties, it's a world of algebra. We're moving to a world of calculus. And so this is going to be really exciting to watch. I'm curious to see how unfolds, but I'm confident that data sciences are going to be a large part of the future of private equity.

[00:22:32] Lastly, let's talk about what could go wrong and what to watch for all these predictions in 2024. So here are our wildcards. First, geopolitics. There's substantial turmoil in Eastern Europe, Middle East, Asia. The U. S. has a major upcoming election cycle. All of this is incredibly hard to handicap.

[00:22:53] It's really hard to predict if risks related to any of these aren't contained, we could be dealing with potential. Enhanced trade wars, supply chain disruptions, and or broad And our broad military conflicts that could substantially impact the economic outlook for the U. S. and the world related to this.

[00:23:15] The other oil related to this. The other wild card that we're saying we need to want related to this. The other wild card to watch as oil and gas oil and gas prices have moderated substantially, but we're still keeping our eye on a confluence of challenges with open plus in the geopolitical landscape.

[00:23:35] If any of those cause a spike in oil that sustains, it could quickly bring inflation Back to the front page headlines. Next up, we gotta watch the US consumer.

[00:23:46] Thus far, the US consumer has proven to be amazingly resilient. Notwithstanding high interest rates and a whole host of other measures, if the U. S. consumer continues to mount unsustainable amounts of debt and or meaningfully flip into saving modes, or meaningfully flip into saving mode, it could delay economic strengthening.

[00:24:05] And or cause the Fed to switch into even more accommodating policies and intents. Next up is commercial real estate. Post COVID hybrid work and still remaining virtual work has dramatically impacted how the business world uses office space. At the same time, A sea of debt is coming due in the commercial real estate world, and interest rates are dramatically higher.

[00:24:32] So the combination of high rates, lower utilization, and declining lease rates could prove really detrimental to the commercial real estate sector. The way that we're looking at this is really for possible contagion in the commercial banking sector, which is heavily exposed to commercial real estate investors.

[00:24:50] And so we're keeping out a look for possible contagion in the commercial banking sector, particularly as it relates to their propensity to lend across the economy and money supply issues. The last one that we're going to call out is related to a bit of a flex that we called out.

[00:25:10] It is a wild card in our Q3, 2023 report in that report we surmise that the Fed may make creative changes to its official inflation target to enable it to start stimulating before many expected. And, you know, just as some background, it's important to note that the U. S. and much of the Western world almost arbitrarily adopted its inflation target after a New Zealand central banker put a 2 percent objective in place in their country in 1989.

[00:25:42] So everyone rolled it out. No one's really been able to give a good reason for it, but 2 percent has been our target since 1989, and it is today. And so we were predicting that the Fed. Given all the confluences of events going on, not the least of which is a major US election cycle where both parties want to be reelected.

[00:26:01] We surmised that the Fed would effectively somehow change its target to enable it to have its cake and eat its two. And so what did we see during the fourth quarter of 2023? The Fed indicated that it remained committed to its 2 percent target. But was punning on getting there until 2026.

[00:26:22] And in the meantime, was going to start lowering rates in 2024. And so I didn't know that that's a wild card to watch. It's more of one proven true. And let's see how it plays out going into this next year.

Private equity insights for and with top business builders, including investors, operators, executives and industry thought leaders. The Karma School of Business Podcast goes behind the scenes of PE, talking about business best practices and real-time industry trends. You'll learn from leading professionals and visionary business executives who will help you take action and enhance your life, whether you’re at a PE firm, a portco or a private or public company.

BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs.