Top 5 Private Equity Predictions in 2023

Sean Mooney:
Welcome to the Karma School of Business podcast. This episode is brought to you today by BluWave.

I'm Sean Mooney, BluWave's founder and CEO. BluWave is the go-to expert of those with expertise. BluWave connects proactive business builders including more than 500 of the world's leading private equity firms to the very best service providers for their critical variable on-point and on-time business needs. In today's episode, we're going to discuss our top five predictions for 2023. Enjoy.

Thanks for joining us. Today, we're doing the always risky endeavor of making predictions for 2023. We have some pretty good ones that should resonate. Let's jump straight in.

The first topic of discussion is the economy. My prediction falls somewhere between Goldman Sachs, which rates the recession risk at 35% and the rest of this rate is pegging the chances at 65%. I think we'll be in a shallow recession through 2023. In many ways, we're already in one in many parts of the economy. I'm choosing to call the current economy, by the way, a transitionary economy because no one can argue with me on that.

First half of the year, in 2023, I believe layoffs are going to surge. They already are in the tech world, and you're going to see a lot more of it there. PE will start with right size as well. It's going to be more minimal. They've already come into this pretty lean and mean. They learned a lot of lessons during COVID, and they've stayed agile because they've been thinking a recession's going to happen for at least the last 12 months.

You're going to see working capital levels be brought in across the economy. Businesses will start stretching payables. They'll start pulling in inventory levels. They'll start pulling in receivables. This is going to cause whipsaw events across whole segments of the economy as people are battling it out to keep as liquid as possible, which is going to have unintended multiple layer impacts on all sorts of businesses. Inflation's going to continue next year, but I believe it's going to temper as the year progresses. I think Chairman Powell is rightfully going to bring in inflation almost at all costs. I think inflation will settle down in the low 3s.

My sense is that the government will also set the new standard at the low 3s. They can't get it to the old standard. Let's just name some new standard and that'll be what it is. I think that's just going to be the cost of bringing this thing in control and also some de-globalization impact that's going to occur. PE companies, as a whole, are going to outperform their peers. They almost always do it as you look at the data within historical recessions. They've been taking action as if a recession is already underway for almost a year. They're going to be making lots of add-on acquisitions in part because there's not going to be as many platforms available to acquire, in large reason, because there's not going to be companies performing and are ready to go to market. There're going to be lots of companies that have to sell.

The PE industry will be white knight buyers from any of them. They're going to be operating in an agile and forward-looking way looking for opportunities while others see risk. Add-on acquisitions is absolutely going to be part of that strategy. For the first time in more than a decade, I think we're going to actually see real bankruptcies. The Bernanke-Yellen error of the Fed giving passes to the banks are going to come to an end under Powell, in large part, because banks are solving it enough this time around to actually write off assets.

If you go back to 2008, 2009 during the Great Recession, the reality was the banks weren't solving enough to call in loans. They had to write off loans. They would've gone under-established thresholds and caused even more trouble. So, Bernanke and the Fed adopted this policy called Amend and Extend. And so, what that means is they're not going to call on loans. They were just going to let them do amendments and then extend and kick the can down the field. And frankly, it was the right thing to do.

This time around, the banks aren't going to get that pass, and in some ways it's a good thing. The bankruptcy code in the United States has been in some ways a great reset for our economy because it allows us to cull the herd, burn the crops, regrow anew. We haven't done that in decades really. And so, as much as pain as that's going to cause, it's not necessarily a bad thing for the long-term health and growth of an economy.

The other thing that you're going to see is that special situation funds have raised lots of capital, and they've been sitting on the sidelines for years. They're going to swoop in to provide capital to these businesses that are going to be needing to hit the reset button and start growing anew. They're going to be very busy. The good folks at Houlihan Lokey Financial Restructuring Group are going to be really busy. That's going to be a part of the economy that I think are going to be quite active as we look to regrow the forest in our economy.

I think you're going to see that the PE-backed world's going to start coming out of the recession ahead of everyone with their environment strengthening during the second half of 2023. You're going to see the rest of the world playing catch-up and joining them in early 2024.

The next big prediction for 2023 is that the venture capital bubble is going to burst. FTX is going to be the canary in the coalmine for the VC industry. Looking at the data, according to PitchBook, the private equity industry only invested in 26 of the 2,655 crypto- or blockchain-backed companies. That's about 1%. The rest was largely VC in some wealthy individuals. When we look at VC at large, thinking about the standards of diligence used by VC and crypto and FTX and the like, I think some real challenges are going to lie ahead.

877 billion of VC is was invested from 2017 to 2021. Nearly a trillion dollars. More than one third of that amount was put to work during the peak of the peak market in 2021. There are huge amounts of investments sitting and inflated marks on balance sheets of capital allocators like pension funds, endowments, et cetera. I don't think the companies invested in by VC are necessarily bad companies.

The problem is that they're structurally burning cash at a time when no company can afford to. Companies don't necessarily go out of business because they're bad companies. They go out of business because they run out of cash. This generation of venture capital was invested in based on an understanding that endless supplies of money was available with little diligence in almost perpetuity. That spigot has been turned off, but the cash burning continues. VC is hitting the brakes as fast as they can with new investments falling quickly and layoff surging. My sense is it's going to be too little too late to look for a major bubble to burst in 2023.

My third prediction for 2023 is that in-person work will make a big return. Productivity in the US has plunged by its sharpest rate since 1947. This plunge took place everywhere, but the manufacturing sector, which happens to be largely in-person. There's been a lot of dancing around the why. Let's call a spade a spade. In large part, it's virtual work. After initial gain in productivity from virtual work, this type of work has regressed to the mean. I know this isn't a popular opinion but just looking at it objectively, I think the root cause is pretty clear.

Here's a personal in-anecdotal experience. When we at BluWave were fully virtual during the height of COVID, I rarely got those quick "do you mind if I ask you a question?" moments. The barrier to entry to hitting that team's button is so much greater than most people think. When we returned to in-person work in our office, first I saw an immediate improvement in productivity and a strengthening of our culture. Next, I immediately started getting these, "Do you mind if I ask you a question? Just a couple minutes?" about five times a day. And so, I started thinking about if you put the math around it, let's multiply these five questions times five days a week times four weeks, a month times 12 months. That's 1200 teaching our collaboration moments that otherwise had been lost.

If you're in a fast-growing company or one that requires agility, collaboration, mentorship, et cetera, in-person work is just critical. We've been a tribal species for nearly 200,000 years. COVID broke us into small digital boxes, and it's proving to be suboptimal. During an economic downturn, companies need to get serious and be as agile as possible. Those that can process real-time information, reinform strategies, and tactically tilt the quickest are going to be the victors.

My sense is the companies that go in person have been in person at least mostly will have an edge over those that aren't. There are already early adopters that have come back to in-person work. In 2023, more are going to follow because the stakes are so high, and they're losing ground to their more agile competitors. To be clear, I don't think the answer has to be all in-person or all-virtual. Usually, like most things in life, the answer is somewhere in between. At BluWave, we're in a hybrid mode with in-person work Monday through Thursday and virtual on Fridays. It seems to be the best mix for us. For others, the answer will depend on each individual business' needs.

The number four prediction for 2023 is that brands will become ever more important in private equity. This one's a bit provocative in parts, perhaps like the in-person work take, but I think it's something that's also important. With the PE industry now decades old and with arguably more than 5,000 PE firms in the US and Canada alone, the PE industry is maturing. The capital that PE has used to be scarce and differentiated in itself. Now, capital alone is becoming commoditized, so leading PE firms are building all sorts of unique capabilities to differentiate themselves and their outcomes.

Candidly, one of the things the private equity industry has lagged on is brand formation. The first word in private equity is private after all. When I think of the business of private equity becoming a business, one of the top opportunities lies in brand formation. What is good for portfolio companies is almost always good for PE management companies. We're already seeing brand formation happening at spots, particularly at the larger cup PE firms that are multi-line asset allocators and more mechanized as a business. The most forward-thinking PE firms will start jumping on the brand training in a big way and will differentially benefit from it when they do. Look for more and more chief marketing officers on the PE website team pages in the days ahead.

My last prediction for 2023 relates to the rise of AI and analytics in mainstream business. Prior to founding BluWave, I spent a lot of time focusing on information, data and analytics, private equity investment opportunities. Prior to 2016, most of the so-called data and analytics world was in reality dashboarding and jargon. Only the likes of Google and Facebook with multi-million, if not billion-dollar budgets, could do interesting things. Every year since founding BluWave, I'd speak with our leading edge AI and machine learning groups in our network and ask if the cutting-edge tools were available for mere mortals yet.

Every year, the answer was nope. Last year the answer was yes. With that answer, we hit the gas at BluWave, building proprietary AI engines that could leverage our, in many ways, one-of-a-kind data to help turn our research and operations team into superhumans for our clients. To get a sense for how far this world has come, I encourage you to check out ChatGPT in DALL E engine from OpenAI. If you go to their website, they have an art generator that's really cool and this chat engine that's amazing. There's also an art generator from a company called Midjourney that's really pretty fascinating. These tools are amazing and demonstrate the power that is coming to fellow mere mortals.

Every PE firm and operating company leader should and will have a strategy around data and analytics. That includes consideration for data maintenance and data visualization at a minimum and very quickly getting to usage of enhanced analytics, machine learning, and AI. At the very least, every company should be using tools like Snowflake and Tableau or Power BI. The next major emergent role in PE is going to be data scientist.

That's all we have for today. For more information, go to bluwave.net/podcast. B-L-U-W-A-V-E. Please continue to look for us anywhere you find your favorite podcast, including Apple, Google, and Spotify. We truly appreciate your support. If you like what you hear, please subscribe, review, and share. In the meantime, let us know if there's anything we can do to support your success onward.

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.