Private equity market in 2023

Thomas Mucha, Geopolitical Strategist
Michael Carmen, CFA, Co-Head, Private Investments
2023-01-26T12:00:00-05:00  | S2:E1  | 23:49

The views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For professional/institutional investors only. Your capital may be at risk.

Episode notes

In the first episode of WellSaid Season 2, Co-Head of Private Investing Michael Carmen joins host Thomas Mucha to share his constructive outlook for today's rapidly evolving private market landscape. In addition, they discuss the role of ESG in privates, how Wellington collaborates with entrepreneurs, and much more.

2:00 - Private equity outlook for 2023

4:30 - Potential recession 

5:40 - A new deal and valuation regime

8:10 - How the macro environment impacts privates

9:50 - ESG in private markets

10:55 - Working with VC founders

14:25 - Personal observations


COLD OPEN (CARMEN): We’ve talked about this as the five stages of grief with a lot of the companies, where they were initially in denial, now we’re seeing a lot more negotiation, and I think in 2023, we’re going to see a lot more acceptance that valuations are at much more modest levels and that they’re going to have to accept what the market is bearing if they need capital. 


MUCHA:    The past two years have seen private markets shift considerably from 2021’s frenzied deal activity and lofty valuations, to the potential buyer’s market we see today. Now as we begin 2023, set against a backdrop of economic weakness and market, and of course, geopolitical volatility, many investors are wondering well, what’s next? To help us navigate today’s increasingly complex private market landscape, I’m joined by Michael Carmen, Wellington’s co-head of private investing. Now Michael has been with Wellington nearly 25 years, has a deep experience level investing in public and private markets across economic cycles, and is one of Wellington’s most dynamic and shall we say, charismatic leaders. Michael, welcome to WellSaid

CARMEN:   Thanks, there’s nothing like going in with high expectations. 

MUCHA:    I set a low bar. 

CARMEN:   Mm-hmm.

MUCHA:    So Michael, one of your pieces of advice to investors in a recent, we call them Lessons Learned, internal presentations here at Wellington, was to trust your gut. So, let me turn that question on you, what’s your gut telling you about the state of the private markets in 2023? 

CARMEN:   So, if I’m going with my gut, which my wife tells me I should always pay attention to, because when I haven’t paid attention to my gut, I’ve made many mistakes in my career, I would say right now I’m reasonably constructive. And you got to start with the macro backdrop, I believe, because that’s what’s been driving the market over the last really probably 18 to 24 months. And when I think about that, we obviously have higher interest rates than where we started, but the real question is what happens with inflation, and when I look anecdotally, what I’m seeing in the environment, is it seems like the Fed’s work is starting to have an impact, right? You look at lumber prices, you look at housing prices, you look across the board, you’re definitely starting to see an abating of inflationary pressures. And I think as that starts to happen, the likelihood of the Fed starting to slow down on their interest rate increases, there’s a good chance we’re going to start to see that. And so, the other side of this is, I always think about well, what’s the next economic cycle going to look like? And if we’re going to have a recession or negative earnings growth, let’s call it over the first half of this year, then markets generally discount six to 12 months before you start to see that turn. And so if that’s what we’re looking at, we’re in that window right now, if we think that mid to the second half of this year, ’23, is going to see some level of improvement, we’re in a window where I think asset prices are starting to try to figure it out, and the markets have kind of been flattish to up a little bit over the last several months, when I look at valuations on the public side, they look much more reasonable, and the best example of this is in software, where software valuations in November of 2021, on average, were over 20 times sales. Historically, over the last 15 years, the range was 5 to 10. And so, it was two to four times higher, and companies that were losing money were selling for over 30 times sales. Fast forward to today, the average software company is now under six times sales, or at the lower end of the long-term range, and so that coupled with the fact that I believe we’ll see economic recovery in the back half of this year, into ’24, is making me constructive about the underlying environment, and the ability for the private markets to perform on the venture side over the longer term.

MUCHA:    It’s good to hear a little bit of positive macro analysis there. How do you get your macro analysis? 

CARMEN:   Well the first is to rely on the macroeconomics at Wellington, and -- 

MUCHA:    Good answer! 

CARMEN:   Is that the right answer? So, I definitely put a lot of credibility on that. And then there’s obviously a lot of pattern recognition, this is not my first rodeo. I’ve been through a few cycles, I was investing as a portfolio manager during the tech bubble, during the Great Financial Crisis, and so there is a lot of pattern recognition, and when I look at what we’re seeing today, it reminds me a lot more of a run of the mill recession from kind of the ’80s and the ’90s, versus the special events that we’ve really seen over the balance of the first two decades of the 2000s. And so, a lot of it is based on that, and then a lot of it is really bottom-up, right? It’s really talking to companies, seeing what, listening to what they’re seeing, what’s in their results, what their customers are saying to them. And so a lot of it is taking some of that macro aspect of what we’re hearing from our global economists, and matching that with what hear from companies and using that to really kind of like, at least give us a roadmap in terms of how we want to think about the underlying environment. 

MUCHA:    Great, so taking that top down, bottom-up framework, we’ve obviously had lower deal activity, reduced valuations in 2022. But you think there are still attractive, innovative, private companies seeking capital, right? 

CARMEN: Yeah, so I think we saw a massive reset last year. There wasn’t a lot of activity last year, or a lot less activity, because a lot of companies were smart, right? The old adage, raise money when you can, not when you have to, played out in spades with a number of companies, particularly in the late stage market, and even beyond, even companies that were raising Series As, Bs, and Cs raised a ton of money, and so a lot of those companies didn’t have to test the waters last year, which they knew the answer was going to be that valuations were coming down over the course of the year, and a lot of times we’ve talked about this as the five stages of grief with a lot of the companies, where they were initially in denial, now we’re seeing a lot more negotiation, and I think in 2023, we’re going to see a lot more acceptance that valuations are at much more modest levels and that they’re going to have to accept what the market is bearing if they need capital. Last year they didn’t need capital, so they were able to punt to 2023. But we think increasingly, companies are going to need to come back to market, whether it was a company that thought they were going to go public, and the public markets are really not open for IPOs, or it was a Series B, Series C company that was initially thinking it was going to be one year, a two to four X improvement in valuation, and now it’s going to be 18 to 24 months, and it could be flat, it may be down, and we’re seeing an increasing number of companies that are willing to either have down rounds, or highly term structured rounds, and so I think the realization is that period, from really call it, you know, the beginning of COVID through the end of ’21, that period is over, and now we’re going back to a more normalized environment. And the other thing I’d say is that we think that the regime change is going to be very stark in that burning all the capital that you can, and raising money in inordinate amount of times is no longer going to be the refrain of what’s going to happen in the private markets. You’re going to need to balance top line growth with a path to profitability. I don’t think a Series A or Series B company needs to profitable, but they need to show that the economics of their business work.

MUCHA:    How to get there, right.

CARMEN:   Correct. They need to show how they’re going to get there. There needs to be, at some point, an inflection point when you start to show contribution margins that suggest that you can have strong profitability over the longer term. 

MUCHA:    Now Michael, you mentioned you’ve lived through a lot of different economic cycles, the good, the bad, and the ugly, over the past 25 years. Clearly, we’re in a highly complex macro environment, we’re in a really uncertain geopolitical environment. How do these factors play into how you look at private markets? 

CARMEN:   The flip answer would be, I don’t pay a lot of attention to all that, right?

MUCHA:    I hear that. 

CARMEN:   The macroeconomic environment matters on the margin, but it doesn’t matter in the whole, in terms of the ability of a company, like a, to come public in 2004, which was after the tech bubble, it was a really bad period for tech investing for the most part, but growing 30, 40, 50 percent on a compounded basis, there’s going to be a market for investors who want to own a company like that, and so whether the economy’s growing 3 percent or 1 percent, on the margin it’s going to impact that company, right, if their customers are not doing well, it could impact their growth. 

MUCHA:    But there’s a fundamental reason why they want to invest in that company, beyond the macro. 

CARMEN:   Correct. I remember Peter Lynch once said that if you spend more than 5 percent of your time as a portfolio manager on the macroeconomy, that’s too much. And I totally agree with that, but that 5 percent could help you a little bit in terms of where you want to spend your time, and what areas of the market may or may not work, right? If you think you’re going into a recession, well you probably want to be a little careful about investing in companies in the travel space for instance. Or other highly cyclical areas versus if you think the economy’s going to be a little bit more of a tailwind than a headwind, but ultimately when you’re looking at companies that are market share gainers, and are being disruptive in really large industries, finding the winners is going to be a lot more important than trying to figure out what GDP growth is going to be in the third quarter of 2023. 

MUCHA:    Now, you also have a long history of looking at ESG, even before that acronym was named. So, why is good governance in E, and S, and G terms, important in this private market context?

CARMEN:   Yeah, I think that it’s a great question, and I’ll answer it with three letters. F, T, and X. Right? You look at a company, and what happened at FTX, in that situation, and at the core, it was all about governance. It was about lack of oversight, it was about a lack of a true board of directors. But at the end of the day, that situation is the poster child for why good corporate governance is important.  And corporate governance that’s been put around that company to protect that company against their worst impulses, per se. Not that everyone has bad impulses, but it’s -- 

MUCHA:    Checks and balances. 

CARMEN:   You got to have -- correct! You have to have checks and balances. There is no scenario in my mind where G is not super important. ESG is important on a number of different levels, not just the G, the E and the S are important, also. 

MUCHA:    Now on the G, on the governance piece of it, obviously once you make an investment there’s some ability to influence the G. So, what can you say about Wellington’s resources and support that it provides to private companies throughout the life cycle of the firm? 

CARMEN:   Sure, so what we tell our entrepreneurs is that we can help them on that last mile from the private market to the public market. Most of their investors who were involved in that company prior to us getting involved are usually earlier stage investors. And so generally, if you look at an early-stage investor’s bio, you’ll see a whole bunch of companies that they’ve invested in, and for the most part, usually 90 percent plus of the companies they’ve invested in, either it didn’t pan out, or they were taken out by a larger company. And I would suspect the average VC has maybe seen two or three IPOs in their career. And you look at what we do at Wellington, which is predominantly on the public side, you look at what I’ve done over the course of my career, as I probably have sat across the table from hundreds, if not over 1,000 companies that have gone public, as well as other people on our team, and so we have a lot of pattern recognition in terms of what works and what doesn’t work in the public markets. And so we’re seeing a company that has done an amazing job of building scalability on the private side, and so our job is to do everything we can to help them from the private side to the public side, which includes anything and everything, as well as thinking about ESG, and I think we have brought in Hillary Flynn, who leads our team, to work with our companies, and what I’ve found so interesting is they love it. They love the fact that we’re bringing in an ESG lens, because they understand that this is more important to public investors, and the great news is that most of them are Gen Zs or Millennials, and so they have a predilection to being more compliant from an ESG angle, and so they’ve been incredibly receptive. In addition to that, we think through strategically and tactically the decisions that they’re making today, and what are going to be the ramifications when they go public, whether it’s something that’s going to reduce gross margins, or increase gross margins, moving into other geographies, introducing new products, how is that going to be viewed by the lens of a public investor? And so, we can really step in and help with all of those issues, to the extent that those companies want our help, and for the most part they’ve been really receptive to it, and so that’s been a really fun part of what we do, and hopefully impactful in terms of creating value from the time that we make our investment, to the time and subsequent to their liquidity event. 

MUCHA:    So, it’s that last mile there - how do we get into the public markets? And then you can draw upon all the resources that Wellington has in that area. So that’s the value proposition in a lot of cases.

CARMEN:   Absolutely! And it goes, and it goes back to the start of our due diligence process, when we can bring to the table global industry analysts who have been covering their sectors for 10, 20, 30 years, and can talk the talk and walk the walk. I love situations when we get involved in these areas, or these industries that are not typical VC industries. You think about like, logistics, and we can bring global industry analysts to the table who are experts in logistics, and you almost can see the entrepreneur’s eyes lighting up that they finally have somebody that actually speaks their language, versus more of a generalist that is looking at their opportunity but doesn’t understand the dynamics of their industry, and so that’s really fun, and we could do that across fintech, and healthcare, technology, consumer discretionary, and so that’s I think a really, really big advantage. 

MUCHA:    Now Michael, one of the things we like to do on this podcast is sort of put our investors under the microscope. So I’m going to end with a couple of questions in this area. And I know that exercise is an important part of your daily life, as it is for a lot of us here. So in what ways can exercise help an investor with let’s say idea generation? Particularly in such a complicated market. 

CARMEN:   I love that question. And when I think about my passion around exercise, and I like to be very balanced between things that are cardio versus things that are around strength training, one of the things that comes to mind, particularly as I’ve gotten a little older, is flexibility. And it’s flexibility of my body, and I can’t tell you how many hours a year I now have to spend on stretching, which was not a thing when I was younger, but when you think about the metaphor for that, is that I’ve also felt, as an investor, that having a flexible mind is a sign of strength and not weakness. And you have to be willing to move in different directions, right, as you get more information. Like I’ve changed the way that I’ve worked out over the last several years as I get more information, and I’ve had to really focus on the flexibility of my body so I don’t get injured, and you know, those are the mistakes of exercise, versus the mistakes of being an investor, is being willing to change your mind. You know, the second part is about having balance, right? Is not just focusing on one area, and balance, to me, is kind of like a portfolio manager approach. I see people who only do cardio, or only do strength, and that’s not the path to improving your lifespan, and I think being too concentrated as an investor is very dangerous also. We look at a lot of funds who were investing 24 by 7 in software the last few years, and that was great until valuations, as I noted earlier, went down basically 75 percent in a very short period of time, and so I think that perspective of having a very balanced and diversified portfolio is super important. And the other part of exercise that I think is super helpful is that I usually find some of my better ideas while I’m exercising. Mostly I’d say when I’m walking, I try when I’m doing strength training to focus on the fact that I’m carrying around a lot of weight, but when I’m doing my cardio, I have found that, that some of the better ideas that I’ve come up with comes from really freeing your mind. Like one of the things I actually don’t do a lot of, not that I don’t love your podcast, but I don’t listen to a lot of podcasts while I’m walking and doing things like that, because I can’t come up with great ideas if I’m listening to what other people are saying, and so I try to like, spend a lot of time just listening to music, and just trying to think through some of the problems that we’re dealing with and what we’re trying to accomplish on the private side. And I find that it’s just very freeing, and so I think exercise, for me is an exercise in creating new ideas. And so that’s a super important part of my framework of being successful. 

MUCHA:    What musical genre produces the best ideas? 

CARMEN:   That’s a good question! I get, usually my default is something around, you know, a Spotify Bruce Springsteen radio station, so I don’t just listen to Bruce, although I probably could listen to him if I was just offered one artist for the rest of my career. But the other thing I love rap music and hip-hop. And I just love the creativity of the lyrics around a lot of the artists in that genre. So I’d say that those are the two genres that I probably spend the most time on. 

MUCHA:    I listen to a lot of hip-hop as well, and I find, and I talk with, with a lot of investors at Wellington about this, but I do find that there is something about artists who can see around corners, and so I’m always looking for, you know, what are trends in popular culture that maybe haven’t bled into the markets yet? And I find that hip-hop in particular, but you know, all sorts of genres sort of point to the future in a lot of interesting ways. 

CARMEN:   Absolutely. 

MUCHA:    So, you know, that goes to my next question too which is about books, authors, obviously we’re all big readers here, Michael. So, can you recommend, you know, a book that has influenced you or, or could help our listeners better understand private markets? 

CARMEN:   Yes, the quintessential podcast question. I’ll give it to you from a couple of different angles. On the private side, I don’t like to read a ton of books about business, actually. Because you know I like to use this as a way to escape and I, you know, I’ve actually read a lot about how reading could really help you in terms of, you know, creating synapses in the brain -- 

MUCHA:    Sure.

CARMEN:   -- to come up with great ideas. And so I don’t like to read a lot about what I do every day, but I would say one book that I would recommend to people who have an interest in the private markets is the book Blitzscaling by Reid Hoffman. He’s someone who has started companies, is a really successful venture capitalist and does a great job of really explaining how to scale startups. It’s probably less popular right now, given that people don’t have as much access to capital, but I think it’s a book that stands the test of time, and I think it’s really, it’s one that I would recommend if you want to understand what it’s going to take to be successful as a startup. But what I really love reading is biographies. 

MUCHA:    Mm.

CARMEN:   When I’m reading nonfiction. And the reason is that number one, there’s always a lot of great wisdom. But I think the commonality of pretty much every famous, successful person that I’ve read a biography or an autobiography, is that every one of them has faced failure. And the key differential between those that faced failure and were never successful, and those who have been successful, it seems to me, is always about how they embrace failure, and what they learn from it. And so, two books that I read probably in the last couple of years that I thought were amazing was Bob Iger’s biography, The Ride of a Lifetime, and then the other one is Phil Knight’s, Shoe Dog, that talks about really the advent of Nike. Two obviously super successful people in the business world. But they both experienced failure, Phil Knight almost didn’t have a business, and it was really from losing his business that Nike became what it became. It didn’t actually exist until then. I just love that. Like I’ve read so many biographies about presidents, and others, in every single case, they’ve experienced pretty unmitigated failure in their lifetimes, but they made it to the highest echelons of whatever they were trying to aspire to, and I like to believe that also. Going back to my lessons learned, one of my first lessons learned that I always talk about with younger people is embrace failure. Right? You’re going to have it, it’s impossible not to have it, and the better that you embrace it, and learn from it, the more successful, I think, that you’re going to be over the longer term. And you have to be able to, you know, pick yourself up off the ground and dust yourself off, and then say like all right, I’ve just learned that, but I’m not going to let it paralyze me, and I’m now going to go and continue to take risk, and make investments, but I just know that that lesson I just learned, I got to apply it to the next investment, and every investment subsequent to that. 

MUCHA:    Helps to know that others have failed, and have learned from it, as well. 

CARMEN:   Correct.

MUCHA:    All right, last question, my friend. Now if you were not co-head of private investments at Wellington, what career could you envision for yourself? 

CARMEN:   So, I always love that question, and my answer for many, many years was center fielder for the New York Mets. I loved baseball growing up, I played it, wasn’t that successful with the curveball, but it was always one of my passions. So if I had to have my plan, that would be it. Now, I think I’ve slowed down a little bit over the years, so I don’t know if I can actually cover center field at any stadium in the country, but I think if I was going to do something different today, I would love to be a CFO of a startup. I would just love to be on the inside and see a little bit more of the making of the sausage and see if I could apply everything that I’ve learned from all the startups that I’ve looked at and be successful from that role in working with the CEO, and working with a team, and helping to build something successful. So I think that would be my new go-to on what I would be doing if I’m not doing this job. 

MUCHA:    Obviously Michael, you’ve got a lot to offer in that area, but I wouldn’t give up on the center field dream. 

CARMEN:   (laughs).

MUCHA:    Especially your focus on exercise, I think you still have got it in you, man.

CARMEN:   We’ll see.

MUCHA:    All right, well once again Michael Carmen, co-head of private investments at Wellington Management, thanks for joining us on WellSaid.

CARMEN:   Absolutely, thank you. 


Views expressed are those of the speaker(s) and are subject to change. Other teams may hold different views and make different investment decisions. For  professional/institutional investors only. Your capital may be at risk. Podcast produced August 2023.

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