As the calendar turns to 2024, many private equity firms are hoping the headwinds of higher interest rates and ongoing geopolitical and economic uncertainty that slowed deal activity in the first half of 2023 will fade into the rearview mirror. In fact, the Q3 EY Private Equity Pulse survey revealed that two out of three private equity investors expect deal activity to increase over the next six months. Regardless of when deal activity picks up, we expect private equity firms to prioritize several areas in 2024. Here are five trends to watch:
1) Artificial intelligence
This disruptive force is at the top of every leader’s list. The latest EY CEO Outlook Pulse, a survey of 1,200 CEOs around the world, revealed that 7 out of ten 10 said they recognized that their companies must move forward with artificial intelligence (AI) to avoid falling behind the competition. Private equity firms share this urgency as they focus on developing effective and efficient uses for AI and GenAI.
In 2024, private equity firms will expand their use of artificial intelligence. We anticipate that AI implementation will quickly shift from automating back-office functions to automating enterprise-scale platforms. Firms will expand use of the technology for due diligence, LP requests and reporting, setting the stage for large-scale transformation that will affect the entire enterprise, supported by the technological maturity that private equity firms have been working toward over the last decade.
GenAI will also be deployed as a value driver in the portfolio, accelerating traditional levers like cost takeout, top-line transformation and revenue growth. For example, for consumer packaged-goods companies, proprietary data leveraged by AI can drive anywhere from 10% to 45% of sales growth. One leading PE firm is already looking to build an in-house tool that could leverage GenAI to augment the investment process – something we will see more of in 2024.
2) Infrastructure
The bipartisan Infrastructure Investment and Jobs Act provides for $1.2 trillion in federal spending over the next five years. Coupled with the 2022 Inflation Reduction Act, PE firms have had significant incentives to invest in areas from clean energy to broadband, significantly reframing the future of infrastructure in the US and accelerating decarbonization efforts across myriad sectors.
In 2024, infrastructure, particularly energy infrastructure, will continue expanding as an asset class for PE investment, allowing for more diversified products and funds that match investor expectations. Energy was one of the few bright spots for VC activity in 2023 as companies leveraged IRA provisions to invest in clean energy startups and other companies that focused on renewable energy resources. Continued support of energy is expected, particularly as greater demand for renewable energy sources drives investment in materials and climate tech.
3) Value creation
Strategic and operational improvements will continue to be the largest sources of PE returns. With opportunities for exits currently slower than historical averages, firms will zero in on efforts to create value in portfolio companies on the operations side. The focus will be on finding the sweet spot between cost-cutting and fueling future growth to prepare for anticipated improvements in the exit market.
Private equity’s four- to six-year holding period is the transformation window to pursue value, creating opportunities across sales, marketing, operations and finance. Using rapid diagnostics and narrowing down to opportunities that will drive EBITDA will provide clarity around top-line, bottom-line and capital efficiencies. This means that firms will need to understand the true cost drivers of the business and take appropriate action. Third-party spend, pricing and promotions, and tax savings will be prime areas of focus in 2024.
4) Working capital
EY research suggests that most portfolio companies continue to have enormous opportunities to improve in many areas of working capital, especially as optimizing operational value during extended hold periods takes on increasing importance. In the recent PE pulse survey, 80% of the PE professionals surveyed indicated that they were paying more attention than usual to helping companies improve their visibility into cash and liquidity needs.
To manage working capital more effectively, many PE-owned businesses have followed typical cash improvement methods, such as extending supplier terms, running down old stock or factoring some of the debtor book. Right sizing an IT organization and “lease vs. buy” technology options are two additional examples.
While these tactics can help, more firms are also considering adopting holistic tools that enable firms to optimize working capital and cut costs without reducing their capacity to drive top-line growth. Tools and processes that help organizations sharpen cash forecasting – knowing what’s needed where and when and include cash pooling and repatriation measures – can help optimize the use of existing cash within the business. This also provides increased optionality for management teams and sponsors.
5) Retail market expansion
Private equity firms will continue to experiment and develop expanded opportunities via the retail channel. Retail investors have the same attraction to PE as professional investors: asset class resilience, asset allocation diversification and exceptional performance vs. public markets.
To that end, more than 150 private equity firms have already invested in registered investment advisor (RIA) portfolio companies; nearly 30% of them offer crossover opportunities with at least five other wealth service portfolio companies. For many firms, retail inflows represent their fastest-growing source of new funds, leading them to develop new targeting methods for these investors. Moreover, an ever-increasing number of third-party platforms are providing new distribution channels.
In addition, with their existing M&A and investment models, most private equity firms are well positioned to offer wealth management services to retail investors. Some may even consider offering white-glove service as part of a holistic wealth management strategy, creating a true first-mover advantage.
Private equity has grown rapidly over the past 10 years and the current slowdown in deal activity, albeit brief, offers firms an excellent opportunity to leverage new technology – highlighted by AI and GenAI – and to deploy other operational efficiencies that will drive value creation and transformation in their portfolio companies. The firms that take this step will be poised to fully take advantage of new opportunities when deal activity and the IPO market rebounds.
