Private Equity Predictions: Tackling 2024's Opportunities and Challenges

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. 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 Blue Haze 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 a bottom and we'll be entering the next six to eight-year growth cycle.

A friend of mine recently asked, as we were talking about this and I was sharing the perspectives that I had 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. And one of the things that we first started doing, particularly in the second half of last year, is we started heavily hiring at, And so we increased our headcount by more than 40% last year. I think, as most people, or many anyways, were cutting, we started hiring. And we did this because of the confidence that we gained from watching, in aggregate, the best business builders in the world take action and running towards a storm and now running past the other side of it, towards rosier times ahead.

And so history 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 macro economic 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. 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. Value creation was front and center in 2023..

77% of the projects that blew is supported across hundreds of P firms and their thousands of portfolio companies 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 101..

Every year, there are more and more P firms with more and more dollars under management. They're competing for a similar supply of deals looking for capital or 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. 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. 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 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.

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% year over year during the second half of 2023 versus the second half of 2022.. This shows that PE industry is hitting the gas towards growth. Second, we saw technology, data and analytics projects, including AI, grow 10% 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.

Think about this as fundamental system selection in life. 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 future better and faster? The third thing thematically that happened last year is we saw human capital activity increase 8% during the second half of last year. 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. 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 PE firms 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, 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. 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. One, inflation has dropped by more than 50% from a year prior. It continues to drop. 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 the 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 in much more, in significantly greater detail. Before we turn the page to 2024, I'd like to talk just a little bit about what we predicted would happen in 2023..

The headline is we predicted pretty well. It's not that we're Nostradamus by any means. We just have this rare privilege of supporting a large number of the best business builders in the world, private equity investors. 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.

Let's talk about what those predictions were. The first prediction that we made in 2022, about 2023, was about the economy. 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. Many parts of it are in a recession and were in a recession and have been in a recession. 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. Other areas of the economy, like business service, have been showing quite meaningful growth, where the amazingness of our economy, which allows us to sell products and services to each other, has really held us up. That is one prediction. I'm glad we were only partially correct on.

The next prediction that we made in 2022, about 2023, was the bursting of the VC bubble. You think about it now, I think it seems like a somewhat obvious prediction, but back then, in 2022, not many people were talking about this. What we were seeing was the venture capital industry investing in lots of companies with relatively little due diligence, many more chasing the available supply of companies looking for dollars. What inevitably we thought was going to occur is that this bubble was going to burst and that there was going to be a return to maybe the earlier days of discipline in the VC world. Of course, what did we see?

We saw 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. 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 VC-backed 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. The next one 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, three, four days on, and maybe one, two days off. Largely, what we've seen is that virtually every PE firm that we work with and know of is in at least a hybrid, if not a five-day schedule. 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, when we were compartmentalized into digital boxes, we've always been an in-person world. We've gone back into that. It's just too much at stake, and there's too many competitive advantages. We've seen, I think, most of the world coming back, and now large swaths of the tech world is also coming back as well. The next thing that we predicted was branding and PE.

We thought that branding was going to become more important in private equity in 2023 and beyond. The reason for that is there are so many dollars chasing a similar supply of companies out there. If it's just dollars that you have, you're not going to be able to compete. If you have a competitive advantage, but no one knows what it is, you're not going to be able to compete. It just makes too much sense for brand formation in private equity.

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 in very interesting and creative ways. We see email marketing.

We are seeing people increasingly asking us to be guests on our Karma School of Business podcast. We're seeing people embrace these top private equity innovator awards that we have. 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. The 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 going to become very commonplace across every business, in part because we saw what was coming next. In the fourth quarter of 2022, we started talking about this thing called ChatGPT and MidJourney and Dolly and how they were going to change the world, bringing untold efficiencies. In 2023, that's not such a big prediction. In 2022, not a lot of people are talking about it. We've seen huge amounts of adoption, as everyone who reads the headlines knows, of these tools.

By adoption, I think in 2023, what we saw was a lot of curiosity, trying to figure things out. 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. We need to lay the foundations. That's one of the really smart things about private equity is. they're very deliberate, very analytical, very driven by scientific method.

They'll take one step at a time to get to where they're going multiple steps down this journey. What we saw was lots of interest in AI, but what happened was lots of activity around data quality, data analytics, and other precursor activities that were going to enable the future intelligent adoption of AI tools as a tactic that are part of their larger strategies. 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 BlueWave. BlueWave is the go-to expert of those with expertise. BlueWave connects proactive business builders, including hundreds of the world's leading private equity firms and thousands of leading companies, to the very best. BlueWave credentialed professional service providers, independent consultants, and interim executives for their critical, variable, on-point, and on-time business needs. Now back to the episode.

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. First is, just like we've been talking about and foreshadowing during this entire episode, the economy is getting ready to enter its next growth cycle. We think this is going to be a traditional six- to eight-year growth cycle, not a 15-year Fed-fueled mega cycle where we were going all gas, no brakes. 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 since the late 90s in economic cycles.

Look for, within all the noise, that we are going to move from this soft landing to we're doing a touch landing and taking off again. It's not going to be dramatic, but it's going to be entering into just a normal economic cycle. Fingers crossed, right? The next prediction that we're making is that PE sponsors are going to start selling. Anyone in the M&A world, the investment world, has noted that we have seen a dearth of activity in M&A exits, particularly by private equity sponsors.

We think that this logjam will start to break, and it's going to break in part because private equity sponsors are going to start selling. We believe this particularly because, looking at the data, portfolios are starting to get old, and distributions are starting to get small or have been small. If we look at the median age of private equity portfolios, it's at a nine-year high right now. This data comes from Pitchbook, by the way. As we look at the distributions back to LPs, it's at a 13-year low.

Limited partners are absolutely pressuring their general partners, private equity firms, to provide more liquidity, 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. Earlier days, after COVID started, the LPs were dealing with what's called the denominator effect, where their allocations were out of sync with each other, and they couldn't allocate certain assets to others. Right now, they're dealing with liquidity effect. They're saying, we need money if we're going to be able to commit to your next fund. What we're going to see is PE firms starting to sell.

Top tier companies are still going to sell at premium valuations, but ultimately, PE firms and really anyone looking to access the M&A markets 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% 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. 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. 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, dealmakers realize that AI 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. 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, things go crazy about the internet.

You had internet investment banking groups, and you could get an MBA in the internet, and all this craziness. Then eventually, people realized, 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. It's not a strategy in itself. We're going to start seeing the same thing happen with AI 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 in the days, months, years ahead. 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 evolve and competition in PE grows, PE firms are going to look to more fully make use of these large data sets that are available. They're going to be using statistics, and they're going to apply more powerful tools like Python, SQL, and ML AI 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. In part because they have to. This is the new world we're moving from. Maybe when I was entering PE in the 90s, it's a world of algebra.

We're moving to a world of calculus. This is going to be really exciting to watch. I'm curious to see how it unfolds, but I'm confident that data scientists are going to be a large part of the future of private equity.

Lastly, let's talk about what could go wrong and what to watch. Here are our wildcards. First, geopolitics. There's substantial turmoil in Eastern Europe, Middle East, Asia. The US has a major upcoming election cycle.

All of this is incredibly hard to handicap. 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 military conflicts that could substantially impact the economic outlook for the US and the world. Related to this, the other wildcard to watch is oil and gas. Oil and gas prices have moderated substantially, but we're still keeping our eye on a confluence of challenges with OPEC plus in the geopolitical landscape.

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've got to watch the US consumer. Thus far, the US consumer has proven to be amazingly resilient, notwithstanding high interest rates and a whole host of other measures. If the US consumer continues to mount unsustainable amounts of debt and or meaningfully flip into saving mode, it could delay economic strengthening and or cause the Fed to switch into even more accommodating policies and intents. Next up is commercial real estate.

Post-COVID high 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. 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. 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 as a wild card in our Q3 2023 report. In that report, we surmised that the Fed may make creative changes to its official inflation target to enable it to start stimulating before many expect it. Just as some background, it's important to note that the US and much of the Western world arbitrarily adopted its inflation target after a New Zealand central banker put a 2% objective in place in their country in 1989.. Everyone rolled it out. No one's really been able to give a good reason for it, but 2% has been our target since 1989 and it is today.

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, we surmised that the Fed would effectively somehow change its target to enable it to have its cake and eat its two. What did we see during the fourth quarter of 2023? The Fed indicated that it remained committed to its 2% target, but was punning on getting there until 2026.. In the meantime, it was going to start lowering rates in 2024.. I don't know that that's a wild card to watch.

It's more of one proven true. Let's see how it plays out going into this next year. That's all we have for today. Hopefully, this gives you a good lens into what happened within the best business builders in the world in 2023, why it happened, and, more importantly, how you can use that to do better and make your companies bigger, safer, stronger, faster, and more valuable in 2024.. If you'd like to learn more about anything that we discussed today, you can request a copy of our 2023 PE Insights Report, which will give you much more detail about all the things we discussed today.

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Onward.