Looking forward: North America in 2017

US private equity market participants anticipate valuations to decline and deal flow to accelerate in the next 12 months, with a horizon set for possible regulatory and policy changes.

The private equity community is cautiously optimistic for 2017, acknowledging that the environment for investing and fundraising will be mostly similar to 2016.  

Private markets asset manager Hamilton Lane's managing director Brian Gildea explains there is currently a balance between bearish and bullish indicators in the data that the firm collects and analyses for the industry, which includes general partner behaviours on fund sizes and investment pace, and economic indicators such as purchase price multiples.

“Our outlook for the coming year really is neutral,” Gildea tells Private Equity International . “The key message for our investors for 2017 is: relax and stop worrying.”  

Here are five predictions for the new year:

More spin-out firms will be formed 

The private equity space has become increasingly crowded, with more players coming onto the field.  A post-crisis period filled with strong fundraising and plentiful distributions to limited partners thanks to high valuations at exits  has fostered an environment suitable for spin-outs to establish their own funds.

There were several successful debut fund closes by spin-outs in 2016, including The Riverside Company spin-out  Align Capital Partners , The Carlyle Group spin-out  Stellex Capital Partners  and  Insignia Capital Group  founded by former Friedman Fleischer & Lowe professionals. Market participants believe additional new funds from spin-out firms are in store for 2017.

“We will continue to see a flow of new funds being formed as individual general partners try to build their own firms,” Chicago-based Adam Street Partners' managing partner and head of investments Jeff Diehl told PEI . “Seasoned GPs with sector knowledge, expertise and relationships can generate interesting investment opportunities, so investors must just be mindful of the track record of a new team.”

Deal flow will pick up 

After a slowdown in 2016 in US private equity deal volume – PitchBook is projecting it will be  down about 18 percent from 2015  – it is expected to regain some steam in 2017. US fund managers are sitting on some $322 billion of capital to deploy, and interest rates are still at historical lows despite the recent increase by the Federal Reserve.

“Based on what I've heard from clients, I think January 2017 will see a fair amount of activity,” said Bill Stoffel, private equity leader at Ernst & Young. “Whether it holds steady throughout the year or not is to be seen, but there's a fair amount of deals in the hopper that should come to market in 2017.”

He pointed to the energy sector, which “came back from the cliff” and will see several transactions being made – and technology, where later-stage investments are rapidly growing alongside early stage.

Valuations may finally taper 

With interest rates still at historical lows, many predict further upticks on rates for the coming year, which could lead to a decline on premiums paid on purchase prices multiples.

“I wouldn't be surprised with three rate increases in the next 12 months,” CohnReznick private equity and venture capital principal Jeremy Swan said. “Raising rates, which increases the cost of debt, coupled with increasing equity in each deal, has the potential to dampen valuations.”

Potential regulatory and policy changes loom 

With Donald Trump as the new occupant of the White House, there may be significant policy changes in the new year that could impact private equity directly.

The president-elect has proposed taxing carried interest as ordinary income, although it's unclear whether Congress will back him up. “I think carried interest taxes will get debated by the new administration,” Diehl said. “It would likely be discussed as part of a bigger tax reform package and thus could take time, but it's possible we see a modification of tax rates in 2017, including carried interest tax rates.”

Regulatory changes could be in store as well. “Going into 2017, it will be interesting to look at the potential lessening of regulatory enforcement, particularly areas with leverage lending guidelines,” said Kevin Schmidt, a partner and private equity co-head at Debevoise & Plimpton. The Trump administration could also tackle Dodd-Frank.

LPs embrace longer-term funds 

Private equity shops have recently broken out of the traditional 10-year lifecycle for their blind-pool funds, offering  long-term funds . Firms such as The Carlyle Group, Blackstone and CVC Capital Partners have all eyed the long-term structure, which would allow them to pursue opportunities they would otherwise have to pass on .

This will likely continue as LPs become more familiarised with them. “Sponsors are in the market with sector funds having longer terms where the strategy warrants it,” said Rebecca Silberstein, a partner and co-head of private equity at Debevoise. “It is not only a longer-term play, but may offer a different return or liquidity profile with some variation in the economic deal between GPs and LPs.”