Reflecting on PE deal activity and trends of 2024 and the forecast for 2025

In this article we analyse some of the key factors that influenced private equity transactions over the last year.

Deal activity has certainly picked up this year, no doubt helped by the uncertainty created by budget predictions for tax increases following the election of a new Labour government in the UK in July, which led to a particularly busy October for deal completions (talk about Christmas coming early)! Steadying of inflation and interest rate cuts have also contributed to the optimism for dealmaking this year, compared to the more cautious approach described in last year’s article A lookback at 2023, from a PE lawyer’s perspective and looking ahead to 2024.

EY reported that private equity deals were up 36% by value and 18% by volume at the end of Q3 compared against the same period in 2023. However, it is recognised that volume and values are well below those of 2021 and 2022, likely caused by the fact that there remains caution around borrowing costs which, whilst plateauing and then falling, are still relatively high and continuing to have a knock-on effect to EV/EBITDA multiples.

Key Themes of 2024:

Continuation fund transactions: a hedge against uncertainty

In terms of activity levels, there had been high hopes for an extremely busy Q3 and Q4, but both exit activity and exit returns have been more modest, with LPs refining their allocation strategies for the upcoming year as they become under pressure to exit due to aging portfolios. Throughout 2024, large platform exits were not forthcoming as predicted and many PE funds hedged their bets during the year by utilising continuation funds and secondaries, allowing them to hold on to assets longer and provide liquidity to investors, whilst remaining poised for a future exit once interest rates recover further and pressures on cashflows in the underlying businesses are alleviated. As predicted, scrutiny of lock-up periods, permitted transfers and drag/tag provisions enabling the possibility of transfers to continuation funds continues to be a focus in the review and drafting of deal documentation.

Valuation expectations: Navigating market uncertainty

Market uncertainty has impacted hold times, with transformation plans that were initially set for 3-4 years being stretched to 5-6 years, highlighting the importance and need for clear value-creation plans. As a result, we continued to see an appetite from PE buyers for deferred consideration and earn-out mechanisms in deal documentation endeavouring to bridge the gap between seller’s valuation expectations and what PE funds are willing to pay, introducing increased complexity into negotiations and drafting.

Sector Focus: Technology, healthcare and a growing interest in energy and infrastructure (E&I) assets

Technology and healthcare sectors continued to attract substantial investments, driven by digital transformation and the need for innovative healthcare solutions, partially with an increasingly aging population.

E&I assets are becoming more popular, as funds try to diversify their portfolios to incorporate assets in this space, as clean renewable energy continues to gain popularity and global net zero targets remain on the political agenda (often supported by government initiatives and tax incentives). These assets often have reliable, stable and predictable returns and are more resilient to economic cycles than other assets. These assets can also benefit from technological advancements (in a similar vein to healthcare investments), providing plenty of opportunity for enhancing value from operational efficiencies and through AI solutions.

Bolt-on transactions and value creation

In the face of ongoing market uncertainty and longer holding periods, bolt-on transactions remained an attractive strategy for value creation in 2024. Funds have continued to consolidate and build on their existing investments ahead of future exits. These acquisitions are also being utilised to acquire companies with innovative technologies or unique capabilities to help enhance portfolio’s offerings in rapidly evolving markets. This is in addition to the continuing drive to create operational efficiencies including via an increasing use and interest in AI-tools that can help achieve this.

ESG: A growing focus

We have seen a continued interest in ESG diligence being undertaken on transactions and increased involvement of lawyers in collecting the underlying data as part of the broader legal diligence process. PE funds are under increasing pressure from stakeholders to demonstrate commitment to sustainable practices, resulting in higher importance being placed on ESG provisions in their investment documentation and increasingly placing these in the heads of terms. This is not surprising, given the opportunities ESG can provide from a growth creation perspective and ESG is becoming a vital part of many exit strategies, as explored further in the article we authored on the subject earlier this year. The continuing evolution of ESG diligence for private equity funds — Financier Worldwide.

So, after a dynamic year in the PE market, what can we expect for 2025?

Predications for 2025

Deal activity: optimism on the horizon

In 2025, with hopefully the most turbulent headwinds behind us, we anticipate that the market will benefit from further lowering of interest rates and more political stability post 2024-election season, driving increased deal volumes and exit values, and a rebound of exit activity, following postponement of such activity in the preceding years and the need to unlock liquidity for investors. Despite the tax changes introduced in the October 2024 Budget in the UK, which our colleague Dan Shilvock discussed in his article in the FT, ‘PE sector can take Budget tax changes on the chin’ - FTAdviser, we can be less pessimistic than we initially anticipated.

This optimism has not gone unnoticed by limited partners (LPs), who are increasingly bullish about prospects for 2025. According to recent insights gathered by SS&C Intralinks from 171 global investors, 78% of LPs surveyed expect an uptick in deal activity over the next year and 63% of LPs plan to increase or maintain their allocations to alternatives over the next 12 months.

Our banking & finance team are noticing a full range of leverage levels on new transactions, with lenders across all debt products and lender profiles showing increasing appetite to lend, and the lowering of interest rates facilitating more competitive terms which will of course be welcomed by borrowers and investors.

Deal terms

Whilst we anticipate that the focus on ESG provisions and flexibility around transfers to continuation vehicles will continue, it is to be questioned whether we will see fewer earn outs and deferred consideration type mechanisms in 2025, with the cost of capital reducing and seller valuation expectations becoming more moderate 5 years after the Covid deal “boom”.

Sector focus and the use of technology

As mentioned above, E&I investment has gained significant momentum in 2024 and we anticipate this trend will continue in 2025, along with investments in healthcare technology, pharmaceuticals and medical devices. Given the digital age, technology will always be a favoured investment sector and increasingly so in the cybersecurity space.

We have touched on AI being a useful tool in generating operational efficiencies to contribute cost savings within portfolios (which is a trend set to continue) but we are also likely to see increased investment in these AI technologies themselves, as LPs are increasingly seeking a unified platform to monitor their entire portfolio. Technology has the potential to play a crucial role in enhancing reporting transparency and efficiency for both general partners and LPs.

Regulatory intervention: Navigating new challenges

Despite the market confidence for 2025, PE funds must remain cautious of the increasing regulatory scrutiny in certain sectors and more stringent antitrust legislation that is coming into play. Significant changes to antitrust legislation include new HSR legislation in the US, effective February 2025, which will make the application and review process more thorough, requiring extensive information and disclosure from PE buyers. Furthermore, in the UK, on 1 January 2025, new filing thresholds will broaden the net of deals potentially subject to CMA scrutiny. This may have a knock-on effect to deliverability, deal timelines and transaction structures, which will need to be well-considered in the deal planning stage, as well as integration thereafter.

Conclusion

Reflecting on 2024, the UK PE market has shown resilience and adaptability, but with cautious optimism, we are looking forward to a very active 2025 against a backdrop of falling interest rates.