2025 Outlook: Private Equity in the age of perma-volatility

The market remains challenging, with ongoing uncertainty in a growing number of geographies and sectors, as well as persistently high interest rates and costs. Of course challenges beget opportunities, and reflecting on what has been can help to clarify what we may expect in the year ahead.

Three out of four – not bad

We got three out of our four predictions for 2024 right: first, there was indeed some recovery in deal volume during the second half of the year, but it was – and remains – modest. This may well be due to our second prediction, which we got wrong: we expected a good supply of attractive assets to come to the market, which did not materialise to the extent we thought it would. As a result, the price gap persisted, thus limiting deal activity.

Third, as we and many others expected, funding difficulties in our sector intensified. Leverage still is very hard to come by and often comes with onerous terms. Instead, the use of non-standard financial instruments such as continuity funds increased. These can only be a stopgap in our view; the sector has to return to normality at some stage.

We feel we got our fourth and final prediction absolutely right: the growing realisation among Private Equity (PE) firms that improving operational excellence is the most powerful and promising value lever of them all. AURELIUS is marking 20th anniversary this year and was built on this principle, so for us this has always been self-evident.

The age of perma-volatility

Let’s turn to our predictions for 2025, a year which we think will continue to be complex and challenging for PE, but which will also offer exciting opportunities for those who can navigate what has become an age of perma-volatility.

Encapsulating a particularly combustible mix of high interest rates, low productivity, weak economic growth, geopolitical upheaval and increasingly worrying consequences of climate change, this multi-dimensional phenomenon is becoming the new normal. Erstwhile 10-year economic cycles now feel more condensed, upturns more elusive and fleeting. But fortunately, our industry is proving resilient and agile, able to manage this perma-volatility and support portfolio companies to do the same.

Dealflow and sentiment to pick up in 2025

We expect the cautious recovery seen in the second half of 2024 to continue, and probably to accelerate in 2025, fuelled by a narrowing price gap, a slightly less onerous interest rate environment, and a backlog of deals waiting to happen. In fact, the latest AURELIUS Carve-Out Survey, carried out in November 2024 and available on our LinkedIn page, reveals that half of respondents expect a narrowing of the price gap and thus more deals, while data from Real Deals shows that European deal value to end of August 2024 already outstripped FY 2023, with volumes on course to exceed 2023 levels following a surprisingly busy Q3[1].

Sentiment is improving, too, with a recent survey of 200 UK PE firms, undertaken by Deutsche Numis, revealing that 84% plan to each make five to 10 investments in 2025[2], a significant change from last year, when only 12% of firms indicated they were “highly likely” to pursue bolt-on acquisitions for their portfolio companies. Public assets have become a key pipeline focus for 26% of respondents, nearly doubling from 14% in 2023. Activity will be driven by corporates eager to rebalance their portfolios as well as PE firms with significant dry powder. Incidentally, this sentiment is also backed by the findings of our Carve-Out survey, with 80% of respondents optimistic that corporates will put non-core assets up for sale.

However, while deal flow and sentiment are likely to recover, generating returns will require a move back to basics which our industry has not fully embraced yet: hands-on value creation through operational excellence as PE’s other two levers – leverage and multiple arbitrage – remain stubbornly unavailable. It has finally become clear to everyone in our industry, on paper at least, that tomorrow’s successful PE firms will be those who have proven adept at generating alpha rather than relying on beta to succeed. For AURELIUS, this is not ‘tomorrow’; it has been our modus operandi since 2005.

The risks of a bigger state

The persistently weak economic backdrop has dented public finances and forced governments to focus on enhancing their tax income. This has obvious implications also for the tax burden on our industry, with the UK being only one recent example: the hike of carried interest tax by four percentage points from next year will be followed by a reclassification of carry proceeds to trading income, requiring higher tax payments still.

Germany is another example: tax laws are becoming ever more complex and authorities have recently been much more deliberate about using these laws to enhance their tax income from PE firms.

No one likes higher taxes of course, but we think our industry can live with recent changes. What is more threatening to Europe’s attractiveness as a place to invest in, and what we cannot live with in the long term, are frequent, unpredictable and unexpected taxation changes and ambiguous legislation that allows tax authorities to alter their stance at a moment’s notice. Surprises are bad for business and PE firms are no different from any other enterprise in that regard.

Such changes could catalyse relocation decisions across Europe, possibly in favour of the US: we understand that the incoming Trump administration is already considering amendments which may prove friendly for our industry. Governments underestimate the agility and mobility of our industry at their peril. The same applies for individuals: dealmakers are moving to Milan not only for its great pasta.

Funding challenges to remain

While banks are cautiously reopening their books and private credit funds seem more willing to deploy capital, the cost of such capital will remain elevated relative to the goldilocks period of the 2010s, even as base rates are falling and spreads are tightening. There is evidence for this in a Deutsche Numis survey for the UK: it shows that two-thirds of respondents still deem the domestic debt market “challenging” or “significantly challenging“, only a slight decrease from 73% a year ago[3].It is worth noting in this context that the speed of interest rate reductions is already slowing and may well come to an end in 2025, as some inflationary pressures persist. This will of course add pressure on the performance of PE firms to generate good returns for their sponsors.

Needless to say, this liquidity squeeze enhances the competitive advantage of firms with skills in operational excellence.

ESG 2.0?

The evolution of environmental, social, and governance (ESG) priorities reflects the difficulties of today’s operating environment, particularly as different LPs place varying levels of importance on the issue. The recent stalemate at COP29 in Baku clearly attests to the ebbing and flowing of serious commitment to the issues when confronted with other crises. Our own Carve-out Survey shows that 70% of respondents feel ESG considerations are waning in relevance.

The underlying issues ESG frameworks aim to address remain urgent however, and it is to be hoped that PE firms adopt a more focused “ESG 2.0” approach in future, targeting fewer, high-impact areas instead of spreading efforts thinly across numerous criteria where quantifiable impact is questionable.

Such a shift could see PE making a tangible difference on key issues, reinforcing its role as a responsible custodian of capital. It is for this reason that AURELIUS is taking this focused approach. Rather than going through a large box-ticking exercise, we intend to make a real difference around a small set of what we regard to be key issues.

AI can boost efficiency, but human overlay remains crucial

AI is showing great promise, but also revealing its limitations in processes where human involvement remains essential for achieving the desired outcomes. Our position on AI has not changed substantially in the last 12 months. We can see that the potential for AI-driven transformation across operations is immense, and we are trialling a range of AI tools in this area.

Moreover, we leverage AI to accelerate data analysis ahead of acquiring new companies, where it supports our deal sourcing by summarising data and analysing market trends more efficiently. This effectively boosts the top of origination funnels and enables faster and more thorough due diligence and decision-making by our investment teams.

Once we own a business, we help it to embrace AI where suitable as part of a digital strategy to create efficiencies and enhance client offering and service. This is supported by our Operations Advisory team, which now has AI expertise integrated within and can identify high-value AI applications to drive cost savings or revenue growth. In fact, half of AURELIUS’ portfolio companies surveyed at a recent event already incorporate AI into their workflows. Examples include Footasylum’s AI-driven customer service enhancements and LSG Sky Chefs’ use of AI for waste reduction and passenger forecasting.

A recent Bain & Company report[4] reveals a similarly selective pattern of AI adoption across our industry: according to respondents, about a fifth of PE firms have successfully operationalised AI across their portfolio companies, about a third are still in testing or development phases, and a third have yet to identify clear use cases.

A vintage year is possible

There is no question in our minds that 2025 will again be full of challenges. But we expect a more active year in terms of transaction activity both on the buy and sell side. We are looking ahead with rational optimism, aware that challenging times are accompanied by opportunities – it’s just about finding them and nurturing them to success. AURELIUS’ operational model lends itself to this opportunistic approach.

For PE overall, 2025 will once again be a year to roll up sleeves, embrace innovation, and generate alpha instead of relying on beta to deliver the high returns LPs have come to expect.

by
Dirk Markus, Founding Partner of AURELIUS

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[1] https://realdeals.eu.com/article/deal-activity-heading-for-a-bumper-year-despite-a-pause-in-august

[2] https://www.reuters.com/world/uk/private-equity-firms-expect-more-uk-deal-activity-2025-survey-says-2024-11-12/#:~:text=LONDON%2C%20Nov%2012%20(Reuters),equity%20firms%20published%20on%20Tuesday

[3] https://www.reuters.com/world/uk/private-equity-firms-expect-more-uk-deal-activity-2025-survey-says-2024-11-12/#:~:text=LONDON%2C%20Nov%2012%20(Reuters),equity%20firms%20published%20on%20Tuesday

[4] https://www.bain.com/insights/creating-value-with-ai-the-race-is-on-in-private-equity-infographic/?utm_medium=email&utm_source=mkto&utm_campaign=AT-PE-2024-12-03&utm_term=creating-value-with-ai-the-race-is-on-in-private-equity-infographic/&mkt_tok=Mzc4LU5ZVS0yMjAAAAGXMaVa8Wn695R1-hX6-H3dizhTqBjXS940hpFTYBoCUS7OKkc25-H7YOss_7z3vt4rFGw1nzwlncbaSJAwR_Ifnfki2mgttpU-yeawL4GM_iqhWQ