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In 2023, attorneys saw venture capital exits at their lowest levels since the pandemic and 2008 market crash.
According to the Bain & Company Global M&A Report 2024, in 2023, the total M&A market dropped 15%, to $3.2 trillion, the lowest level in a decade. Also, private equity exits — the process of selling investments through various strategies — were down 44% in value and 22% in volume.
“M&A practitioners told us that the valuation gap was the biggest obstacle to dealmaking, and there were other headwinds in 2023 as well, including high interest rates, macroeconomic uncertainty, rising regulatory scrutiny, and new political pressures,” the report states.
J. Jeffrey Brown, senior counsel in Faegre Drinker Biddle & Reath LLP’s Indianapolis office, agreed that the market and venture capital exits are determined by interest rates.
“The only thing that’s going to lead to a strong exit market is going to be lower interest rates and a better (initial public offering) environment,” Brown said.
“… I don’t think that’s any different in Indiana than anywhere else,” he added. “I think if the company is really successful, there are going to be buyers from all over the country who want to buy it, and if it’s a fire sale, there’s going to be the same market for it in Indiana or out outside of Indiana. So I don’t think that geography affects exits nearly as much as I do think it affects the initial investing environment.”
New normal
Despite the record low of 2023, Barnes & Thornburg LLP partner Joshua Hollingsworth is cautiously optimistic about the future of venture capital exits.
“Looking forward to 2024, I think the forecast is a little bit cloudy,” Hollingsworth said. “I think there’s a consensus that it probably can’t be worse than it was in 2023. Hopefully, it’s getting a little bit better. I think from an exit standpoint, there’s probably a feeling that we have some pull forward, or I guess a backlog of deals that maybe didn’t get done last year that will be pulling forward.”
Still, Hollingsworth also opined that 2024 may not be a total rebound for exits. Rather, he said, they’ll likely find a “new normal” in venture capital activity.
Brown said it’s difficult to make a prediction about what may occur, but generally, what needs to happen to improve venture capital exits is a better environment.
Looking at a chart, he said, “You’d see that the Fed raised interest rates from around zero to about 5.25% over the course of about, you know, 18 months, and if they backtrack that by 75 basis points to 1%, which is like three or four quarter points, reductions in rates over the next 12 months” would create the right market environment.
“I think something like that, or even really when you start seeing the first two of them, then I think that’s going to signal to people that they’re heading in that direction and things are going to get a lot better,” Brown continued. “I think it would get a lot better for venture capital, for private equity, for the markets, in general. But there needs to be a better interest rate environment, a little lower inflation and a better IPO market. That’s what it’s going to take.”
Intensifying competition
The stock market was up in 2023, Brown said, but that alone doesn’t translate to a better venture capital environment.
“You can’t look at the stock market as a as a predictor of where the venture capital market’s going to go. Other than that, hopefully it frees up the IPO market a little bit and makes it easier for venture capital companies to exit through an IPO,” he said. “In some ways, a very good public market is almost in competition with the venture capital markets because it just means that private equity has to do that much better to compete with the public markets.”
The Bain & Company report predicts that in 2024, competition will intensify. It also predicts more scale deals for consolidation before seeing a return to scope-oriented capability investing to drive growth.
“Higher interest rates have introduced a whole new generation of M&A analysts to the concept of cost of capital and the value of $1 of earnings in the future. This has led some acquirers to make a short-term shift to scale deals where the cash flows are nearer and more certain,” according to the report. “For others, it has shut off the M&A tap for the time being. But we know that the market ultimately rewards growth.”
Brown added that Indiana has strong private companies that are venture funded and are growing at a stage that, when the market does free up, will see exits.
“I think we’ll see some really good successful exits from Indiana companies, and we just need to have the right market environment for that to happen,” he said.
Regulatory pressure
Another factor is increased regulatory pressure not just on venture capital, but on all M&A activity, according to Hollingsworth.
“I think the regulatory environment is pretty well set up for a single acquisition, but it is not as robust for a series of acquisitions,” Hollingsworth said.
He explained that some areas and companies are doing 30 to 40 acquisitions in a year. Some of those may be smaller, he said, “but in the aggregate, I think it represents what the regulators believe is an anti-trust problem.”
According to Bain & Company, in 2022 and 2023, at least $361 billion in announced deals were challenged by regulators around the globe. Most of those closed, the report says, often with remedies.
“Today’s U.S. Department of Justice and Federal Trade Commission prefer litigation, and the legal outcome often is a court-ordered remedy,” the report explains.
One example cited by Bain & Company is the FTC’s challenge to Amgen’s $27.8 billion purchase of Horizon Therapeutics, which was resolved via a consent order after being delayed for months.
“Rising scrutiny and lengthening review timelines have caused a handful of companies to withdraw their deals,” the report states.
The report suggests that the answer to adapting to potentially tricky deals is “conviction on the strategic rationale for the deal and a watertight value creation story.”
“A transformative portfolio strategy might necessitate proactive divestitures to clear the path for big-ticket dealmaking down the road,” it states.•
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