Private equity has come a long way from its origins as a niche investment strategy, becoming a major generator of wealth for markets around the world and outpacing public markets in terms of capital raised for over a decade.

Factors like globalization and technological change have contributed to the industry’s evolution over time. Today, PE is considered as an attractive funding source for both distressed ventures and growing enterprises.

Although macroeconomic volatility and concerns over a recession have made for a sluggish 2023, recent data in Q3 shows a promising increase in fundraising as well as a slight uptick in PE-sponsored exits. This indicates that private equity will outlast the current slowdown and remain a viable strategy long term.

A Brief Look at How PE Has Evolved

The term “private equity” has certainly meant different things to different people in the decades following its start in the 1940s. The industry initially emerged as a way of providing capital to fund the post-war reconstruction.

Then in the 1980s, PE experienced a dramatic shift as investors began to prioritize rapid financial gains. PE became more about strategic maneuvering and portfolio growth rather than genuine value generation, a situation which led to increased regulatory pressure in the years that followed.

In more recent years, we’ve seen a trend toward the development of massive PE firms such as Blackstone and KKR with higher budgets and greater market dominance. Their size has enabled them to support larger investments and contribute significantly to localized value creation in markets throughout the world. However, they’ve also been criticized for overshadowing smaller players and influencing markets in ways that limit competition.

Another area of focus in recent years has been the long-standing diversity and inclusion issues within private equity. The industry has historically been male-dominated and largely inaccessible to new players. Fortunately, we’ve seen that pattern begin to shift as women and people of color represent a larger percentage of the top brass in many PE firms. While there’s still a long way to go to level the playing field, the progress we’ve seen firsthand here at Stage has been encouraging and contributed to a diversity of thought in this industry.

Below, we’ve taken a deeper dive into what we see as the leading factors affecting the PE landscape today along with the challenges and opportunities they present both to investors and to businesses.

1) Low Appetite for Risk

Challenges: In the current climate, PE investors are less eager to finance distressed or early-stage companies, gravitating instead to more established businesses and “unicorn” performers. This presents a challenge for startups who may be struggling or who simply aren’t achieving sky-high returns at the moment. As a result, we’re currently seeing a large number of orphaned startups and many more who are headed in that direction. The low appetite for risk globally also presents a challenge to investors, who are left in the difficult position of having to gauge their risk in an uncertain market.

Opportunities: This puts a number of valuable companies in no-man’s land with lower valuations than would be expected even a few years ago. Many PE investors, including our team at Stage, have taken advantage of this gap in the market and responded by investing in early-stage companies where there’s a clear opportunity to add value in the near term. The successes we’ve seen so far underscore the potential for gains of having an adaptive, inclusive investment strategy.

2) Concerns Over Climate-Related Disruption

Challenges: Mounting concerns over climate-related disruption has prompted a shift away from traditional industries with high environmental footprints, such as fossil fuels and heavy manufacturing. Investors may be hesitant to support businesses that don’t align with sustainability goals or lack a clear plan for reducing their carbon footprint. Businesses may also struggle to adapt to the demands of a more environmentally conscious market and potentially face declining valuations.

Opportunities: As the world moves towards a greener future, companies that prioritize sustainability and eco-friendly practices are becoming increasingly attractive. Investors who recognize this trend can direct their capital towards environmentally responsible businesses, and businesses can align their long-term vision with the growing consumer demand for eco-conscious products and services.

3) Globalization and Rising Competition among PEs

Challenges: As more players enter the arena, the investment climate has become increasingly crowded. The result is a growing number of promising startups at risk of being passed over in favor of higher-value alternatives. For investors, the challenge lies in sifting through this class of underfunded companies and finding innovative ways of identifying the diamonds in the rough. It’s a formidable task that takes a great deal of time, resources, and market awareness.

Opportunities: Increased competition does incentivize PE firms to explore a broader range of investments, opening up the potential for new streams of revenue. Firms that embrace this approach can uncover hidden gems among startups and less-established businesses. Competition can also foster a culture of innovation and resiliency within the industry, as firms are pushed to adapt and be more intentional in their investments.

4) Rise of Big PE

Challenges: Large PE firms have the financial firepower to acquire multiple businesses in the same industry, leading to market consolidation and reducing the number of independent players. They also have the advantage of pricing power. With greater resources, they can set competitive pricing strategies that smaller companies might struggle to match. Other advantages include extensive market intelligence, political and regulatory influence, and the ability to attract top talent. This puts smaller firms and companies at a distinct disadvantage.

Opportunities: Startups and growing businesses have the opportunity to benefit from the “runoff,” so to speak, of the gains in big PE. The development of new technologies and models will inevitably extend beyond the walls of these massive firms and stimulate innovation throughout industries. This has the potential to foster a more dynamic investment community that allows for greater idea-sharing and productivity.

Conclusion

The private equity landscape is evolving at a rapid pace, driven by a complex interplay of factors. While the challenges presented by the current low appetite for risk, concerns over climate change, rising competition, and the rise of big PE are significant, they also serve as catalysts for innovation. Investors and businesses are forced to adapt and explore new avenues, creating a more dynamic and resilient ecosystem. As with anything, those who can navigate these challenges and seize the opportunities will continue to thrive, even in uncertain times.