Back to the old school in alternative assets

For over a decade, alternative assets enjoyed a bull run across a range of asset classes that looked like it might never end. But, as we know, all good things come to an end – cycles (and interest rates) always win. The 2023 slowdown in private equity, M&A and venture capital was overdue. However, its severity, especially in the UK, is proving worse than some feared. 

So, what does 2024 hold for these alternative sectors? 

VC in a spin 

The 2023 collapse in VC funding was especially brutal in sectors like tech (AI aside). Further, in the US in 2023, for example, a mere $67bn was raised by VCs, a 60% drop from 2022. Not only has this caused problems for companies seeking capital, it’s also slowed economies, such as the US and the UK, who have been fueled by the growth that this model of funding provided. 

At the start of 2024, VC funds do sit on a lot of capital, which is encouraging. However, as stated by Ibrahim Ajami, head of ventures at Mubadala, a lot of this will be used to “clean the mess” created over the last decade, so volumes deployed into new businesses going forward could still disappoint. On this topic, an interesting (and concerning) consequence of this crash is a strategy now being employed by VC funds to create PE-style structures to aid portfolios. These have been deployed because the timeline between investment and exit in VC-backed businesses has lengthened. Hence, as Sifted and the FT report, VCs are using continuation funds so that new funds can buy old assets, creating liquidity for portcos or returns for investors. 

This feels like a significant development and is some distance from the classic model of finding and investing early in great companies. If VC is now relying on financial engineering to keep investors happy, that’s bad news for startups and scaleups. Of course, quality VCs continue to do good things, especially in hot sectors, like AI. But the exuberance of the past decade, where many paid over the odds for less-than-great opportunities, continues to bite.  

PE looks promising

The PE story we keep reading is about the wall of capital waiting to be deployed by funds. But the $4 trillion of dry powder isn’t going to be put to work until confidence around the quality of target companies and price levels returns, especially in the mid and small-cap sector.

High rates means that PE can no longer rely on borrowing cheap to fuel returns and cut the cost of capital. But perhaps that’s no bad thing – arguably, PE has been too easy and, in markets, easy never lasts. As in VC, the pressure is mounting as fund investors demand to see returns. Of course, this might mean taking lower offers for portfolio companies, but given 2023’s low deal volume, getting anything sold right now at a satisfactory price would be good news for funds. 

Given the dry powder, and the size of the funds being raised by established players (including, interestingly, in retail PE) there’s a sense that if the market starts to gain momentum, it may not be a bad 2024 for deal makers. Like in VC, PE traditionally succeeded because of quality deal sourcing and operational excellence in portcos. There is cash to be spent and opportunities out there, but PE will likely have to go back to these roots if it wants to return to profitability in 2024. 

M&A could be okay

Whisper it quietly, but there seem to be one or two optimistic noises emanating from global M&A, which could signal the end of the sector’s worst bear market for a decade. 

But it’s impossible to predict the strength and speed of a recovery and it remains uncertain due to ongoing macroeconomic and geopolitical challenges. With M&A so inextricably linked to the confidence that global corporates have in their own and their target’s balance sheets, companies need to see confidence returning to global markets before inorganic growth returns.

Q4 2023 had some sizable transactions. Deals have been done in January. As per the FT, ​​Fantasy M&A is back, as deal makers talk up their prospects. But volumes are suppressed and deals continue to fall through. Inflation has to fall rather than persist, with sellers agreeing a midpoint in price before we return to the cadence of deals that characterised so much of the last decade. And that’ll likely only happen, at the earliest, in the second half of this year. 

The uncertainty of everything 

I read recently how Goldman had earmarked its alternative assets business, including private equity, private credit and infrastructure, as a “priority for growth” in 2024. No surprise, really, given the opportunities that now exist following the slowdown of 2023. 

However, there are no guarantees that these will bear fruit in the coming 12 months. In fact, as we drift through the year, with rates and inflation still high, the Middle East conflict grinding on, and an extremely volatile global political agenda, it’s easy to see how we might reach a point, say, in Q3 when alternative markets still haven’t really got going again. 

Across VC, PE and M&A, this means old-fashioned deal-making is the order of the day. With borrowing expensive and financial engineering out of fashion, deal makers will go back to looking for quality businesses at fair prices. Sounds simple, but it’ll be harder than ever because the whole market will adopt the same strategy. This could drive prices, and a “flight to quality” is better than a slowdown, but, unfortunately, with the incredible amount of uncertainty in the air, I can’t see 2024 bringing too much cheer to alternative deal makers.