Rising Interest Rates that Reshapes Private Equity Deals

After several years of safe sailing and cheap borrowing, the global market has recently adjusted for private equity to a new and challenging landscape which includes high interest rates and higher standards of credit control and regulations.

This shift in the trend has forced private equity firms to restructure their investment strategies, rethink how they add value and how they can exit deals when necessary. Due to these trends, the market has become quieter than before. This creates a more strategic dealmaking environment which ultimately reshapes how law firms advise their clients across the transaction cycle of private equity.

Private equity firms typically rely on leveraging, through borrowing money, to finance their acquisitions and to amplify their returns in those deals. However, since 2022, due to rising global interest rates, the cost of debt has drastically increased. The new hikes make highly leveraged buyouts less attractive which reduces the overall deal volume of the market. According to recent market reports and articles, global private equity deals have significantly decreased compared to the booming years of pre-2022.

Although the market activity and deal numbers have decreased, market analysts observe an increase in the creativity in the deals made.

The emerging trend is the rise of minority investments and partnership styled deals where private equity firms will tend to take smaller stakes rather than full control of the target companies. This new approach is aimed at reducing borrowing whilst still giving investors the exposure to growth sectors such as in technology, healthcare, and renewable energy.

Also, there has been an increase in add-on acquisition deals where private equity firms will buy smaller businesses to expand their existing portfolio of companies. These investment strategies show how private equity firms are adapting their investment strategies to sustain growth whilst still maintaining their lead in the industry in the face of the more expensive borrowing climate.

Additionally, a new evolution in the fundraising environment is that institutional investors, like pension funds, have become more selective of where they commit their capital which increases pressure on private equity firms to demonstrate their strong ESG (Environmental, Social and Governance) credentials and sustainable business models before completing any deals. Therefore, firms have been increasingly involved in conducting ESG due diligence and sustainability related financial agreements to reassure the institutional investors whilst reflecting how the broader social trends have influenced the evolution of dealmaking.

For most law firms that specialise in private equity, these developments could now create new challenges and complexities to be addressed. Structuring minority investments demands very careful negotiations about exit provisions, information sharing and governance rights. Lawyers also need to be careful to advise on regulatory compliance especially due to the tightening of foreign investment reviews and antitrust regulations.

In conclusion, the evolution of private equity in the high-interest rate market today reflects how the sector is defined less by megadeals but more by precision, targeted investments, cross-border diversification and sector specialisation.