Key takeaways
- PE exits appear poised to accelerate as interest rates and economic growth align.
- More recent vintages are lagging well behind historical exit trends.
- As the PE market has matured, innovative solutions have been developed to facilitate market making.
The coil of activity has been compressed by higher rates for the past two years after a deployment boom in 2021, and capital is begging to be released.
In our view, growing piles of dry powder is deployed as macro drivers conducive to deal activity begin to align. As rates decline, transactions become immediately more viable given lower borrowing costs. The sensitivity to even marginal reductions in interest rates is recognizable, as shown by the uptick in M&A activity in the second quarter as spreads tightened. We expect deal activity will also be supported by continued stability in domestic growth and bipartisan industrial policy facilitating capital investment in U.S.-based manufacturing and high-growth technology.
Moreover, if these factors align to invite dry powder off the sidelines, we believe the middle market stands to be a large beneficiary. Roughly 80% of current U.S. dry powder resides with large cap GPs—the most rate-sensitive buyers—who are commonly the exit route for middle market GPs. Although middle market PE showed lower beta to the exit slowdown in 2022 and 2023, we would expect an uptick in activity from large cap sponsors to accelerate exits in this segment. Due to the dearth of deployment in recent years, large cap dry powder has also aged in place, in many cases nearing the end of funds’ investment periods. Time is ticking for these dollars to be put in motion, tilting the scales of pricing power toward those selling up market.
The annual rate of exits by investment year have tracked well below history for recent vintages, as the decay rate—or the annual rate of exits for a given investment year—plummeted when rates rose. In assessing potential activity, we see that if annual decay rates were to normalize in 2025 to the historical average, then investments made from 2015–2023 alone would be expected to produce roughly 1,500 exits—nearing the 1,566 produced in 2021, the highest on record. Were this cohort to fully “catch up” (make up for past years of under-exits) by year-end 2025, then an additional 1,170 exits could be expected from this cohort.
Even if 2025 does not provide a full catch-up, which we do not expect, exit volumes will be forced higher in the coming years as funds approach the end of their life. Bear in mind, the recent challenges to deal-making simply delayed many exits, pressing sponsors to now be structurally induced sellers, regardless of asset-specific views. Even though we expect much of this deal flow to be high quality, this would be a significant amount of volume for the market to process, especially if the sometimes open/sometimes closed IPO window remains fickle.
We expect innovative solutions to play an increasingly prominent role in this environment. This includes the growth of a secondary market and adoption of evergreen funds as an attractive vehicle for a range of investors. These innovations have broadened the base of investors entering PE as well as the vehicles through which exposure is obtained.
