Modest Growth Appears in Lincoln’s Private Market Index - yet Cracks Are Emerging

Private companies demonstrated steady, but declining earnings growth in Q4. Yet with increased leverage, an expectation of rates remaining higher for longer, and macroeconomic headwinds including potential tariffs, is this growth enough?

The Lincoln Private Market Index (“LPMI”), the only index that tracks changes in the enterprise value of U.S. privately held companies, increased by 2.3% during the fourth quarter of 2024 driven by steady growth in EBITDA as multiples were relatively unchanged. When comparing the LPMI to the public markets, the LPMI outperformed the S&P 500, which only grew 1.8%. Furthermore, the S&P 500 excluding the “Magnificent Seven” contracted 2.3% in enterprise value driven primarily by multiple contraction likely due to investor apprehension and uncertainty surrounding interest rates and potential tariffs. Despite the larger increase in the LPMI in Q4, overall in 2024, the growth in the LPMI (8.0% growth in 2024) lagged the S&P 500 (21.3%) and the S&P 500 excluding “Magnificent Seven” (10.7%).

Slowing Growth May Further Extend Hold Periods of Private Companies

While private company performance has been resilient against a myriad of headwinds, growth slowed throughout 2024. In Q4, 58% of companies tracked by Lincoln demonstrated EBITDA growth, the lowest percentage since Q3 2022. EBITDA growth in 2024 of 3% was behind the growth observed in 2023 (4%) and was the lowest since 2020. Revenue growth of 6% was less than the 8% recorded in 2023 and was the lowest growth since 2020 as well.

In addition, performance has tracked behind plan with companies missing their revenue and EBITDA targets for 2024 by 3% and 5%, respectively, on average. While performance missed plan, the goals were relatively lofty, with private companies expecting revenue and EBITDA growth of 10% and 12%, respectively.

Slower EBITDA growth and higher leverage could spell trouble for sponsors who are trying to put a company up for sale in 2025. The average EBITDA CAGR for portfolio companies which were acquired in 2021 and 2022 which have not yet been sold as of Q4 was 10.9% and 8.0%, respectively. However, despite this solid growth in performance, on average, 2021 vintage deals saw a 0.3x increase in leverage and 2022 vintage deals saw a 0.6x increase in leverage.

This increase in leverage could be attributable to a number of factors, including pro forma EBITDA adjustments not being fully realized or higher rates resulting in increased borrowing to pay for interest expense. When coupling this greater-than-expected leverage with the Fed’s revised guidance around potential rate cuts, it has some important impacts on fixed charge coverage ratios (“FCCR”). As of 2023, FCCR was expected to improve to 1.3x by the end of 2025 due to further expected rate cuts. Given the recent reversion in expectation around such cuts, FCCR is now expected to only improve to 1.2x by the end of 2025.

All the while, average buyout multiples decreased from an average of 12.7x in 2021 to 11.4x in 2024. The combination of slowing EBITDA growth, increased leverage, and lower buyout multiples equates to relatively minimal incremental equity value generated since close for the average company, posing a significant challenge to private equity returns. Therefore, in the absence of a reversion of these trends or pressure from limited partners to sell, sponsors may continue to hold assets for longer to generate higher returns prior to exiting.

“While EBITDA growth persisted in the fourth quarter, that is only one side of the story,” said Steve Kaplan, Neubauer Distinguished Service Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business, who assists and advises Lincoln on the LPMI. “Rising debt levels and lower buyout multiples may impact private equity returns.”

Competition Trickles Down in the Direct Lending Market

As 2024 wound down, the level of competition among direct lenders remained high. For larger deals, lenders faced continued pressure from the broadly syndicated market and spreads for companies with over $100 million of EBITDA leveled-out after potentially hitting a floor in order to satisfy minimum investor return requirements. As a result, larger lenders shifted attention to medium-sized borrowers to seize opportunities to deploy dry powder. As a result, spreads for borrowers below $100 million of EBITDA tightened around 25 bps amidst this heightened competition. For example, spreads for unitranche loans of borrowers between EBITDA of $40 million and $100 million now stand at S+4.75% to S+5.50%, with evidence of increased leverage and more borrower friendly covenants (if any at all).

On the back of this competition, the average fair value of loans in the Lincoln Senior Debt Index (“LSDI”) increased from 98.6% to 98.8%. Despite the increase in fair value, covenant defaults clocked in at 2.4%, an increase from 2.2% in Q3, perhaps indicating stress starting to build. However, this level of defaults is well below the historical average of 3.4% dating back to Q4 2020. Defaults were elevated for smaller borrowers relative to larger borrowers, with the largest cohort of companies with over $100 million of EBITDA averaging defaults of only 0.7%. This only tells one side of the story, however, as smaller borrowers have tighter covenant headroom, which leads to both a higher occurrence of defaults, but also brings the lenders and the sponsors to the table sooner to head off potential stress.

Not All PIK is Created Equal

The prevalence of paid-in-kind (“PIK”) interest and the number of amendments were hot topics in 2024 and may be drivers of the low covenant default rate. While PIK interest generally carries a negative connotation, in 2024 it was a popular competitive lever to pull to get a deal across the finish line. For many high-quality borrowers, a PIK toggle was offered at close to allow for flexibility to invest in growth early in the life of a deal in lieu of paying cash interest. In addition, the option for PIK interest was a competitive lever used to fend off broadly syndicated lenders which cannot offer this feature. However, outside of this context, PIK interest often indicates signs of liquidity issues and stress for private companies. Therefore, it is important to distinguish “good” PIK from “bad” PIK.

Lincoln International performed an analysis based on a subset of data in its proprietary private market database to assess trends in the varying uses of PIK interest. Of the debt investments tracked by Lincoln as of Q4, 11% had some element of PIK interest. When looking at the population of loans with PIK interest, those deals exhibited an average increase in LTV from 52.8% to 78.0% and had EBITDA losses of 17.7% per year since close.

Perhaps unsurprisingly, as deals mature and they are not exited, the prevalence of PIK increases. Over 17% of 2020 vintage deals include some form of PIK interest today; however, 2022 and 2023 vintages are not too far behind at 14% and 11%, respectively, indicating early signs of stress may be percolating. The hope is this extends a company’s runway and allows it to endure any operating headwinds and focus on growth rather than debt service. Perhaps for this reason, it is also unsurprising that Consumer deals, given the inflationary headwinds and post-pandemic consumer spending declines contain PIK at a higher rate than other industries, as ~20% of consumer deals since 2020 in Lincoln’s database include some form of PIK interest today.

Peeling this back further to isolate companies which may be feeling stress, 57% of the investments that had PIK interest did not have an element of PIK interest at close, but did have a PIK interest component in Q4. When looking at the relative performance of these securities vs. those that had PIK interest at close (i.e. those with “good” PIK), LTVs were relatively flat for deals with PIK at close, but for those that have added PIK since close, LTVs have increased from 45.4% to 83.9% on average driven largely by a negative EBITDA CAGR of 20.5%. Furthermore, these deals saw an average 3.0% increase in PIK interest (i.e. the spread was comprised of 3.0% higher PIK interest) and as high as nearly 6% whereas deals with PIK at close were relatively unchanged in terms of their PIK interest component.

“Throughout 2024 we have observed lenders affording sponsors and portfolio companies flexibility in the form of PIK interest, covenant waivers, maturity extensions, and other borrower-favorable amendments,” noted Ron Kahn, Managing Director and co-head of Lincoln’s Valuations & Opinions Group. “However, private companies can only kick the can down the road for so long. The slowing growth trends we have observed coupled with the continued use of PIK in distressed situations could spell trouble for some private companies.”

2025 M&A Outlook: The Wait Isn’t Over Just Yet

Despite initial optimism coming off the U.S. presidential election, the outlook for buyout activity in 2025 may be murky. In a survey of more than 800 private equity sponsors by Lincoln International in Q4 2024, over half of sponsors expected to bring at least one of their portfolio companies to market in Q1 2025 and 45.0% expected buyout activity to return in Q1. However, since that time, the valuation gap between buyers and sellers has persisted, outlook on rates has shifted including the potential of rates remaining higher for longer, portfolio company performance has slowed, and uncertainty around the impacts of tariffs and other policy decisions occupy the minds of private market participants.

“While 2025 was initially shaping up to be a banner year for buyout activity, recent data suggests that perhaps the significant pop in activity many were expecting may be delayed,” said Kahn. “With continued pressure on cash flows due to elevated leverage, an inability to realize synergies, and slowing portfolio company growth, we may see an uptick in restructurings and at a minimum, an extension of hold periods for private companies.”

About the Lincoln Private Market Index & Lincoln Senior Debt Index

The LPMI is the only index that tracks changes in the enterprise value of U.S. privately held companies—primarily those owned by PE firms. With the LPMI, private equity (PE) firms and other investors can benchmark private companies’ performance against their peers and the public markets.

This index is differentiated from other indices as it (1) tracks enterprise values of private companies over time, (2) is based on valuations rather than executive surveys and (3) covers a wide sampling of companies across a range of PE firms’ portfolios.

The LPMI seeks to measure the variation in private companies’ enterprise values by analyzing the aggregate change in company earnings as well as the prevailing market multiples for approximately 1,500 private companies, each generating less than $250 million in annual earnings. The index is calculated using anonymized data on an aggregated basis by Lincoln’s Valuations & Opinions Group, which has distinctive insights into the financial performance of thousands of portfolio investments of financial sponsors, business development companies and private debt funds.

The methodology was determined by Lincoln in collaboration with Professors Steven Kaplan and Michael Minnis of the University of Chicago Booth School of Business. While other indices track changes to a company’s revenue or earnings, the LPMI is different in that it tracks the total value of these companies. Significantly, the large number of private companies used to create the LPMI helps ensure that the confidentiality of all company-specific information used in the index is maintained.

Further, in 2020, Lincoln launched the LSDI which provides insight into the private credit market as a fair value index tracking the total return, price, spread and yield to maturity of private credit securities. The index is developed using much of the same data as the LPMI and the methodology was determined by Lincoln in collaboration with Professor Pietro Veronesi of the University of Chicago Booth School of Business.

Important Disclosure

The Lincoln Private Market Index is an informational indicator only and does not constitute investment advice or an offer to sell or a solicitation to buy any security. It is not possible to directly invest in the Lincoln Private Market Index. Some of the statements above contain opinions based upon certain assumptions regarding the data used to create the Lincoln Private Market Index, and these opinions and assumptions may prove incorrect. Actual results could vary materially from those implied or expressed in such statements for any reason. The Lincoln Private Market Index has been created on the basis of information provided by third-party sources that are believed to be reliable, but Lincoln International has not conducted an independent verification of such information. Lincoln International makes no warranty or representation as to the accuracy or completeness of such third-party information.

About Lincoln International

We are trusted investment banking advisors to business owners and senior executives of leading private equity firms and their portfolio companies and to public and privately held companies around the world. Our services include mergers and acquisitions advisory, private funds and capital markets advisory, and valuations and fairness opinions. As one tightly integrated team of more than 850 professionals in more than 20 offices in 15 countries, we offer an unobstructed perspective on the global private capital markets, backed by superb execution and a deep commitment to client success. With extensive industry knowledge and relationships, timely market intelligence and strategic insights, we forge deep, productive client relationships that endure for decades. Connect with us to learn more at www.lincolninternational.com.

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