HHL study: Private equity firms postpone exits – valuations and liquidity face pressure

• One in four PE firms (25 percent) reports deteriorating liquidity in its portfolio companies
• 80 percent see banks lending much more restrictively, with 40 percent even describing lending as “significantly restrictive”
• More than half (55 percent) can only pay dividends from portfolio companies to a limited extent or not at all

“The economic crisis in Germany has not spared private equity firms based in Germany,” says Prof. Dr. Bernhard Schwetzler, head of the Center for Corporate Transactions and Private Equity (CCTPE) at HHL Leipzig, who led the scientific side of this study. "In many cases, private equity funds have invested in German SMEs that are now struggling with the new market situation. Low interest rates, successful fundraising, and the resulting investment crisis around five years ago led to higher risks being taken on some investments. The changes in the real economy and financial markets have now brought these risks to the fore."

65 percent of respondents stated that the current market situation is putting pressure on the valuations of their portfolio companies; five percent consider the current valuation discount to be “significant.” When asked about the drivers for the lower valuations, half (50 percent) cited higher interest rates, followed by a decline in liquidity in portfolio companies from the funds' perspective (35 percent). Operational optimization (35 percent) and cost reduction (20 percent) are the most frequently cited measures with which PE firms are responding to the extended holding periods. At the same time, there has been a noticeable deterioration in liquidity in some of the portfolios.

Liquidity situation deteriorates at one in four PE firms

In their own portfolios, one in four PE firms (25 percent) report that the liquidity situation of their portfolio companies has deteriorated. The most important reason for this is lower sales, according to 55 percent of respondents. Thirty-five percent cite increased operating costs, and 10 percent cite higher financing costs. One-fifth (20 percent) stated that they had recently violated financing covenants.

The most important measures for reducing liquidity bottlenecks: 75 percent are optimizing working capital, 70 percent are further reducing costs, and 55 percent are injecting additional capital.

“Although only a minority have liquidity problems, these are often particularly serious,” says Dr. Martin Schneider, Senior Managing Director, private equity expert and co-author of the study at FTI-Andersch, FTI Consulting's consulting unit specializing in restructuring, business transformation and transactions. "Market conditions are also affecting portfolio companies, and declining sales are a key problem. This means that some companies are currently unsellable for funds. It is now necessary to carefully examine which companies can be sensibly restructured—and which ones cannot be realistically valued in the medium to long term. In that case, a painful end may be better than endless pain. Every fund affected will now be looking closely at this."

Refinancing is becoming more expensive

The liquidity situation described above is leading to new refinancing requirements for portfolio companies. 64 percent of respondents cite liquidity as the main reason for refinancing within the past 24 months, followed by financing requirements for strategic restructuring (57 percent) and regularly planned refinancing (50 percent). A total of 70 percent of respondents have carried out refinancing during this period.

80 percent of respondents report that banks are acting noticeably more restrictively in specific sectors; 40 percent describe this approach as “significantly more restrictive.” In terms of conditions, 35 percent had to accept higher risk premiums, while a quarter cited higher covenants and additional collateral.

“Since the end of the Covid crisis, we have been observing that financing conditions are becoming more difficult, even though interest rates have recently fallen again,” says Martin Schneider. "In industries such as automotive, mechanical engineering, and retail in particular, the checks are much more demanding and the terms and conditions are worse. And we are seeing more and more often that refinancing is not happening at all, pushing companies to the brink of existence. To avoid getting into such a situation, it is crucial to have a very clear and strategic liquidity management strategy. After all, if you still have money in your account, it's much easier to get more."

Dividend capacity declines

The weaker liquidity situation is also affecting the ability to pay dividends. Fifty-five percent report that dividend payments by their portfolio companies are limited or severely limited (ten percent). Forty percent cite a deterioration in cash flow as the most important reason. Around one-third (30 percent) are withholding dividends in order to retain liquidity for investments.

One in four companies also considers the environment for dividends to be significantly worse in the medium term. 40 percent expect a temporary restriction and anticipate a recovery in the coming years.

"Many funds are invested in German SMEs. There are currently no signs of a rapid recovery for Germany. Individual companies can take advantage of the situation, but overall, structural challenges remain. Cautious assessments are therefore more sensible than exaggerated optimism at this point," says Martin Schneider.

About the study

The study was conducted in collaboration between the management consultancy FTI-Andersch and the Center for Corporate Transactions and Private Equity (CCTPE) at HHL Leipzig Graduate School of Management. It is based on an anonymous survey of private equity firms focusing on Germany regarding the current situation of their portfolio companies, in particular holding periods, valuation effects, liquidity situation, refinancing, and distributability.

The responses of a total of 20 PE firms based in the DACH region regarding the current situation of their portfolio companies were evaluated. The study's population consists of PE companies with active portfolios that invest primarily in medium-sized companies. The survey was conducted anonymously and with standardized questions in accordance with academic standards. The study is led by Dr. Martin Schneider (Senior Managing Director) of FTI-Andersch and Prof. Dr. Bernhard Schwetzler, Chair of Financial Management and Banking at HHL Leipzig.

About FTI-Andersch

FTI-Andersch is a management consultancy that supports its clients in the development and implementation of sustainable future, performance, and restructuring concepts. FTI-Andersch actively supports companies that are facing strategic, operational, or financial challenges and change processes—or that want to align their business model, organization, and processes for the future at an early stage. Its clients include, in particular, medium-sized companies and corporations that operate internationally. FTI-Andersch is part of the FTI Consulting Group (NYSE: FCN) with more than 8,100 employees.