Investments in so-called private equity continuation funds are expected to reach a record high in the first quarter of 2023, according to Greg Durst, managing director of the Institutional Limited Partners Association (ILPA), as private equity investors are hesitant to accept lower valuations.

“In Q1 we will see more investments in continuation funds than during any quarter in history,” said Durst, speaking on Thursday at the SuperInvestor conference for private market investors in Amsterdam.

General partner (GP)-led transactions are expected to form the majority of secondary private equity transactions for the first time this year, according to a recent report from PGIM. The share of GP-led transactions – such as continuation funds – has already more than doubled over the past five years, and the trend is expected to accelerate into next year.

Private equity managers can opt for a continuation fund, as PGIM noted, “if the timing for an exit is especially bad due to broad market and economic conditions,” as is the case now. In other words: if they cannot now find another investor ready to pay the price they want.

“It’s important to close the gap in expectations between buyers and sellers,” noted Matthias Fackler of private equity and infrastructure investor EQT, also speaking at the SuperInvestor conference.

Because of the rise in interest rates and other macroeconomic headwinds, investors expect valuations of privately held firms to come down, in line with their public market equivalents.

What goes up, must come down

“Valuations have plateaued, but they haven’t come down yet,” said Ruulke Bagijn, head of global investment solutions at private equity firm Carlyle. “Entry multiples have not declined, with the exception of growth and tech perhaps, but if you look at history you would expect there’s more to come.”

For exits to pick up again, valuations must head lower, speakers at the conference agreed.

“I agree multiples have to come down, and if anything I expect some multiple contraction, especially in tech,” said Gilbert Kamieniecky of Investcorp Technology Partners. “For new deals, we have become more conscious about valuations. For sure, we should not assume any more multiple expansion going forward.”

So will this mean that LPs, pension funds included, will have to accept write-downs on their private equity investments? Not necessarily, according to Fergal Mullen, co-founder and partner at private equity firm Highland Europe.

“Companies still have in mind their absolute valuation of last year. Consequently, it has been a bit quieter on deal flows,” he said. Even though economic activity is slowing across the globe, Mullen believes companies will be able to compensate for lower valuations by increasing profitability so that deal activity can pick up again.

“You can only hit that pause button for so long. I expect that the companies we target will continue to grow, so that they will eventually meet expectations in terms of price.”

Growing your profitability as a recession looms seems easier said than done, but the proof will be in the pudding. “As we enter a recession, investing along strong trends is even more important than before because these will develop regardless of the economic trajectory,” noted EQT’s Fackler.

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