Having witnessed its strongest quarter in two years, private equity (PE) is on the rebound. Strong global financial markets and strategic pivots towards technology-driven investments have all created the perfect conditions for a PE comeback following a tough few years.
But the new calm raises a critical question: Are the key drivers behind this recovery actually sustainable?
PE deals have reached their highest level in two years
Stronger global financial markets have provided a fertile environment for PE firms to identify and capitalize on robust investment opportunities, driving a significant surge in deal-making activity.
Despite persistent services inflation and geopolitical tensions, global growth is predicted to maintain steady momentum. This improved economic outlook has emboldened firms to pursue acquisitions aggressively, reflected in the recent surge in deal value. PE activity skyrocketed in Q2 2024 with 122 deals valued at US $196bn, almost doubling from Q1, reaching the highest level since 2022.
Investor confidence has been equally instrumental in private equity’s recovery, with limited partners (LPs) continuing to allocate capital to PE funds amidst improving market conditions. Rede’s liquidity index score of 58 in H1 2024 boosted confidence in distributions, while 73% of general partners expect PE activity to increase throughout the year.
GenAI: PE’s strongest lifeline
Market conditions alone don’t tell the full story. PE firms are strategically pivoting toward technology-driven investments, with a particular focus on artificial intelligence (AI) and generative AI (GenAI) as central strategies to stimulate value creation, enhance top-line growth and optimize capital usage in portfolio companies (portcos).
In 2023, PE-backed investments in GenAI companies more than doubled, to the tune of $2.18bn. Early 2024 saw a continuation of this trend, with $250 million going into GenAI investments in mid-February, which alone exceeded the previous year’s first-quarter totals .
Investing in GenAI captures the broader zeitgeist of today’s AI revolution. As AI continues to dominate headlines and reshape industries, PE firms have an opportunity to capitalize on the enthusiasm and potential of this technology.
For example, AI is becoming integral to sectors like healthcare, finance and consumer products, where the need for automation and accurate data analytics is crucial. Tech companies in this space are thus positioned for exponential growth, perfectly aligning with PE’s strategy of identifying high-growth, future-proof investments that can weather economic uncertainties.
By backing AI-focused companies, PE firms are not only riding the wave of technological transformation; they’re also contributing to the sector’s recovery by channeling capital into one of the most promising areas of innovation.
Are we witnessing another cycle of boom and bust?
While optimistic market forecasts and tech-driven investments signal recovery, there are signs that not all is well beneath the surface. Despite the uptick in activity, we’re still in the midst of an anemic deal climate. Capital calls are increasing while distributions remain sluggish at just 8.7% of valuation in Q1 2024, and August’s global market rout was a stark reminder that the economy is far from fully recovered.
For all their potential, AI investments are also whipping up a few crosswinds. 60% of senior PE leaders are concerned about the responsible use of AI, with many fearing data security vulnerabilities, regulatory challenges and the rise of “AI washing,” as companies become more willing to exaggerate their AI capabilities to attract investment.
With everyone reaching for the same prize, investors are also keeping a close eye on the fast-rising valuations within GenAI, which can make it difficult to secure lucrative exits or achieve expected returns.
These challenges beg the question: Are we witnessing the early signs of another boom-and-bust cycle? Some investors think so, telling dealmakers to put their own assets on the chopping block – but there are silver linings on the horizon.
Multiple tailwinds building in PE’s favor
While the surge in GenAI investments is stirring concerns, it should also serve as a testament to PE’s ability to innovate and adapt in times of hardship. The groundbreaking opportunities within GenAI are far too significant to be overshadowed by, for example, short-term valuation risks – it’s precisely these high-growth opportunities that position PE firms to capture the next wave of market-defining innovations.
AI is also being increasingly used by PE firms to enhance operational performance within their portcos. 85% expect AI to transform business operations, using it to streamline logistics and reduce costs; to personalize customer experiences and anticipate market shifts; to enhance due diligence, identify potential risks and drive more strategic investment decisions – and that’s just the tip of the iceberg.
More good news comes in the form of falling interest rates. Anticipation is growing that the Federal Reserve will reduce interest rates as early as September. This should be very positive for PE firms because it means reduced borrowing costs, cheaper financing deals and potentially higher returns.
Additionally, declining rates will positively impact portcos by lowering their debt servicing costs, ultimately improving their profitability and attractiveness for exits. This change could provide significant tailwinds to PE firms, helping to sustain the industry’s recovery amid ongoing economic uncertainties.
The road ahead
Despite challenges, the PE space has shown exceptional resilience and adaptability. Is the stage set for a sustained recovery? I say yes – but with one caveat.
PE firms must embrace AI in all its forms. Backing companies who are at the forefront of the AI revolution is the best chance of survival. Adding these companies to the portfolio simultaneously allows firms to tap into their expertise and technologies, and then extend these innovations across their entire portfolio.
We’re seeing a lot of promise with the first initiative, but sadly there is a lack of commitment when it comes to bringing AI into the heart of operations. While 66% of PE firms consider them essential, only 7% have adopted AI tools. Plugging this gap will be essential to building a resilient portfolio that can withstand market fluctuations and ensure sustained recovery in an increasingly competitive landscape.
