Private equity firms have been playing an increasingly important role in the M&A market. The private equity market tripled in size during the last decade, and a McKinsey report revealed that 2022 was the second most active year in history for private equity-backed deal volume. Additionally, an article published by Harvard observes that private equity’s share of the overall M&A volume is approximately 36%.

There are a number of factors driving the growing role of private equity in M&A. One factor is the availability of capital. Private equity firms have access to large amounts of capital, which allows them to make big deals. According to PWC, private equity firms in the United States have invested approximately $10.7 trillion in capital over the last decade. Private equity firms also have access to more creative financing solutions such as elevated equity contribution, seller’s notes, paid in-kind financing and private credit markets helping them to advance in deals that other parties may not be able to.

Another factor driving private equity’s growing role in M&A is private equity firm expertise. They typically have a deep understanding of M&A, and are able to source and execute deals quickly and efficiently with strong research capabilities and predictable terms. Private equity firms perform substantive industry and competitive research before making an offer to a target entity. They also attempt to understand the ways in which a potential target’s research and development compares and competes with others in the market. This expertise and efficiency combine to allow private equity to be a formidable presence in M&A.

Why are private equity firms attracted to M&A?

1. Speed

M&A can be a quick way to grow a business. By acquiring another company, a private equity firm can instantly add new products, services, and customers to its portfolio, as well as expand into new markets and areas. In the current market, private equity firms are pursuing strategic bolt-on acquisitions to existing platform companies. Sectors that offer protection against risk and some insulation from inflation are particularly attractive to private equity firms. Deals that have strong strategic rationale, significant upside value, and align with global trends such as digitalization, bolstering supply chains, and decarbonization are appealing.

2. Performance

Private equity firms are also attracted to M&A because it can improve the performance of a business. By acquiring a struggling business, a private equity firm can implement changes that improve the business’s profitability and growth potential. Private equity investors are attracted to management teams that are agile and able to effectively facilitate change. Building relationships with key stakeholders within the organization and identifying how an acquisition fits with the private equity firm’s overall portfolio strategy are beneficial because private equity investors have access to more funds, but require the assistance of the key stakeholders to successfully grow the business. This approach presents an opportunity for a portfolio company to grow operations and investors to return value later.

3. Profit

M&A provides a way to generate returns for investors. By buying a company at a low price and then selling it for a higher price, a private equity firm can generate capital gains for its investors. Increasingly, private equity firms are more flexible in terms of amount invested, investment sectors, and capital structure. Private equity firms typically invest with five, seven, and ten year time frames. While many investments are short-term, long-term investments open up opportunities for private equity firm managers to enter deals that involve transformational change to create returns.

The growing role of private equity in M&A is having a major impact on the M&A market. Private equity firms are now major players in the M&A market and they are driving a significant amount of M&A activity. This is likely to continue in the years to come.

For the business being acquired by a private equity firm, there are usually benefits, such as:

• Increased growth: by providing them with capital, expertise, and access to new markets.
• Improved profitability: by implementing operational changes and cost-cutting measures.
• Enhanced shareholder value: by increasing the company's valuation or by taking the company public.

However, there are also some risks associated with private equity-backed M&A:

• Leverage: Private equity firms often use a lot of debt to finance their acquisitions. This can increase the risk of financial distress for the acquired company.
• Culture clash: A different culture than the acquired company can lead to conflict and resistance to change.
• Short-term focus: A short-term investment horizon can lead private equity firms to make decisions that are not in the best long-term interests of the acquired company.

Despite the risks, private equity-backed M&A can be a successful way for companies to grow and improve their performance. By carefully considering the risks and benefits, companies can make informed decisions about whether or not to pursue a private equity-backed M&A transaction.

The Dentons global M&A group includes more than 2,600 lawyers, covers the full spectrum of mergers and acquisitions transactions, which it overlays with strong and deep industry sector capabilities and deep cultural knowledge. Reach out to attorney Leslie Smith for additional resources or support.