Private equity firms have been using creative deal structures to tackle the pressure of elongated holding periods that developed thanks to the soft M&A and initial public offering markets.
In 2023, the total deal value of financial technology M&A transactions was $29.92 billion, down from $37.56 billion in 2022 and $76.15 billion in 2021. The continuous slowdown shows sellers have not been willing to accept lower valuations in the gloomy market. The trend started as interest rate hikes began in 2022 and still lingers.
"I don't see a return to the record number of deals made in 2021, but if interest rates come down and the macro economy remains stable, then a more traditional M&A environment is very possible this year," according to Steve Greene, executive vice president in corporate development and strategy at payment company Fleetcor Technologies Inc.
"Hopefully, we'll have a much clearer picture by the summer," Greene wrote in emailed responses.
Private equity firms are typically involved in about one-quarter of the fintech M&A transactions.
Bounded by fund term constraints, general partners of private equity funds typically sell portfolio companies before the fund reaches the end of its lifespan. Because of sluggish M&A and muted IPO activities, the average holding period for buyouts among North American private equity funds spiked to 7.1 years as of November 2023, the longest since 2000.
The lack of transactions from private equity can slow down deals in the fintech space as financial sponsors tend to take part in about one-quarter of the deals in the sector. In 2023, private equity was involved in 62 fintech deals, or 23.8% of the total, compared to 102 deals, or 23.0% of the total in 2022, and 154, or 26.9% of the total, in 2021, according to S&P Global Market Intelligence data.
Since a full recovery of M&A and IPOs is still unclear, private equity firms have been using creative financing structures to extend their investment horizons, so that they do not have to sell high-performing portfolio companies low, only because the fund's deadline is approaching, deal advisers said. Limited partners have also appeared willing to provide flexibility to their general partners who manage the portfolio, as opposed to pressing for exits right away when the market is at a low ebb.
"I think that sponsors have more flexibility from their [limited partners] than they have had in the past, either to hold assets longer just in the fund that they're in, or to employ something more creative and more structural, like a continuation fund, or a fund-to-fund transfer of some sort," said Chris Pedone, managing director in Houlihan Lokey's fintech group.
Becoming creative in deal structures
As more traditional forms of equity are falling short due to valuation gaps, there are financing solutions available such as structured equity financing and continuation funds for private equity firms to maintain positions in businesses that they do not want to exit just yet, said Roshan Punjabi, senior managing director at Guggenheim Securities who focuses on fintech M&A.
Structured equity can help private equity firms to add debt-like features in an equity financing round, Punjabi explained. The financing can also be structured with warrants to turn it into equity down the line at the right price.
In a continuation fund transaction, the general partner would set up a new investment vehicle and use it to buy one or few select companies from other funds managed by itself. Sponsors nowadays largely use continuation funds for their best investments that they want to hold longer, Pedone noted.
In a deal announced in October 2023, Guggenheim Securities advised private equity firm BV Investment Partners LP in forming a single-asset continuation fund for Rightworks LLC, a software provider for tax and accounting firms. BV initially invested in Rightworks in 2016 via BVIP Fund VIII, a fund that it raised in 2014. The continuation fund effectively let BV take out Rightworks from the prior fund but retain the ownership in the new vehicle. Other existing investors including Lexington Partners LP rolled over into the new fund, according to the press release.
Such deals are made possible by collaborations between industry bankers and private capital teams, Punjabi said. In early 2022, Guggenheim Securities hired Orcun Unlu from Citigroup to build out its private capital advisory capabilities.
"Especially in more volatile markets, people are looking at a traditional M&A sale, a continuation vehicle, and structured equity almost in parallel as they look for liquidity. So it's not quite your normal M&A process like we've seen in recent years," Punjabi said.
Better positioned for next steps
Whatever the deal structure is, private equity firms benefit from improved scale, growth or profitability of their portfolio companies, so that they are in better positions in the ultimate liquidity event. Minority investments in solid businesses are welcomed, especially those having M&A plans, Pedone said.
A step-up in valuations in a new equity financing round could also help existing shareholders to liquidate a certain number of shares, if they do not want to fully exit, he added.
Core banking software company Computer Services Inc., doing business as CSI, is one of the fintechs that recently raised new capital to accelerate inorganic growth. On Jan. 10, CSI announced a strategic investment from TA Associates LP. The new equity financing valued CSI at over $2 billion, with TA Associates taking 30% ownership. Centerbridge Partners LP continues to be the majority investor, while Bridgeport Partners retains its position as a minority investor. The two private equity firms teamed up to take CSI private in 2022 for $1.6 billion.
"We may have extended the timeline a little bit, but certainly, we've extended the opportunity with TA's investment, because I think they are going to allow us to be a little bit more aggressive on M&A," David Culbertson, CSI's President and CEO, said in an interview.
Some strategic fintech buyers view the current timing as favorable because the market is less competitive. They are taking actions now because they would have to pay up after M&A is fully recovered, said Robert Antoniades, general partner and co-founder of venture capital firm Information Venture Partners.
"We're seeing inbound interest from strategic buyers paying what are seemingly fair multiples. I think we're seeing the beginning of a return to strategic M&A. I don't think volumes are going to be crazy. There's still enough uncertainty in the marketplace," Antoniades said.
