Private Equity Facing Challenges Amidst Market Volatility
In recent years, US equity markets have experienced significant growth following the market panic caused by the Covid-19 pandemic. Despite the S&P 500 surging nearly 95% over the past five years, US private equity firms are facing challenges in profitably selling the portfolio companies they have accumulated. According to research by Cherry Bekaert, there are nearly 12,000 portfolio companies, and at the current exit pace of 1,500 companies a year, it would take nearly eight years to clear the existing inventory.
Investors in private equity have seen distributions of capital decline from 30% of net asset value to only about 10% of net asset value, as reported by Bain. Frustrated investors, including prestigious institutions like Yale and Harvard, are turning to the secondary market to sell stakes due to the lack of profitable exits. The excessive exuberance in private markets during the 2020-2022 period, when valuations were booming and interest rates were low, has led to the current challenges faced by private equity firms.
The hangover from this period of high valuations and aggressive deal-making has resulted in a backlog of flawed pre-2020 deals and new deals that were initiated at high valuations. As exits have dried up, deeper problems within the asset class are being revealed. The overallocation to private equity, with allocations outpacing the size of the market, has led to a liquidity crisis.
With private equity fundraising experiencing a sharp drop in 2024 and further slowing in 2025, the industry is starting to reverse course. This slowdown in fundraising leads to fewer exits, lower valuations, and worse returns. The lack of natural buyers for private equity assets, particularly in the microcap range of public markets, further complicates the situation.
Financially, private equity-backed companies are under strain due to heavy reliance on leverage. Debt levels have risen, with debt to ebitda ratios exceeding eight times for many portfolio companies. Default rates for private equity-backed companies are nearing 17%, more than double that of non-private equity firms.
Private equity sponsors are resorting to refinancing and selling companies into continuation funds to hold assets, but this strategy may not be sustainable in the long run. Private equity, once considered a high-performing asset class, has underperformed the S&P 500 over the past few years, according to McKinsey.
The consensus on private equity is shifting, with questions arising about the sustainability of the current model. As the industry grapples with challenges related to market volatility and liquidity issues, the future of private equity remains uncertain. It is essential for investors and firms to adapt to the changing landscape and navigate the complexities of the market to ensure long-term success.
