What is the Impact of a Shrinking Private Equity Industry?

I read this article the other day and it got me wondering. It’s not that this was the first time that I have heard about a potential tightening of the private equity market, but I was at the desk, as opposed to a conference; it probably was the first time that I sat down and thought what the impact might be to a firm like ours that is a service provider to small and emerging private equity fund sponsors.

There are some obvious reasons why consolidation might occur. One is cost pressure. Running a PE firm has never been cheap, but the bar is getting higher. Regulatory compliance, technology investment, reporting standards, cybersecurity all come at a (often significant) cost. Large incumbents can spread these costs over billions of dollars of AUM. Smaller or mid-sized firms don’t have the same buffer, which could lead some to close their doors or seek merger partners.

Another factor is fundraising dynamics. Limited partners are becoming more selective, concentrating their commitments with managers they view as “safe bets.” No-one ever got fired for hiring IBM, as they say.

That often translates to capital flows going to the biggest, most established brands. If this trend continues, emerging managers will find it harder to raise their first or second fund and even established but sub-scale firms may struggle to maintain momentum. In other words, industry shrinkage may be self-reinforcing: the bigger firms get bigger, while the rest fight for the remaining oxygen.

So, it seems reasonable to expect some element of shrinkage in the next few years. Key, however, will be the extent of the potential shake-out. If the universe of private equity firms narrows significantly, we risk reducing the choice of private equity investor for smaller businesses – the backbone of America, indeed. To be clear, I doubt that the capital available to smaller private companies will dry up, it’s just that there might be less potential investors to choose from (the good news for those investors being that they can dictate better terms, of course).

Launching a new firm would also become even more daunting, because breaking into an environment where the AUM floor is higher will likely be trickier. Investors, too, could feel the effects: fewer managers might mean less variety in fund size, sector expertise, or investment style. For a limited partner looking to build a well-balanced portfolio, that’s not an attractive prospect.

But I don’t think the story is all negative. In fact, a shrinking industry could also create space for the right kind of smaller players – and independent sponsors in particular. If some existing smaller, generalist funds get absorbed into medium-sized platforms, gaps will open up in specific niches. Investors frustrated with “one-size-fits-all” funds may look for differentiated opportunities, whether in geographic specialization, sector focus, or deal size. A smaller firm with a sharp edge could still win the trust of LPs hungry for alpha beyond what the largest shops can offer, and for independent sponsors, there could be fuel here for growth in LP co-investment initiatives.

What’s more, consolidation can sometimes spark innovation. When the mainstream moves in one direction, agile newcomers can deliberately swim against the current. For example, a boutique firm focused on complex carve-outs, or on under-served geographies, might find it easier to stand out in a world where the bulk of dry powder is chasing larger, standardized deals.

From where I sit, the next two to three years could be defined by a barbell effect. At one end, we’ll see the mega-managers pulling further ahead, buoyed by scale, diversification, and access to capital. It’s been happening in hedge funds and will probably happen here. At the other, we’ll still see entrepreneurial managers carving out spaces in highly focused areas. The real squeeze will be in the middle: firms that are too large to be nimble, but too small to compete on scale.

So, will the number of PE firms decline? Possibly. But I don’t believe that’s synonymous with reduced opportunity. The industry will evolve, and evolution always creates winners and losers. For those of us thinking about the future of private equity, the challenge is to understand where the white space is likely to open up – and to be ready to move when it does.

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Anthony D. Mascia is Managing Partner at EFSI. Connect with him on LinkedIn here.

EFSI is an independently owned, SOC-1 compliant, full-service fund administration firm. We provide accounting, reporting, administrative, and capital introduction services to a wide range of alternative investment funds including hedge funds, funds of funds, private equity funds, real estate funds, venture capital funds, and family offices. The center of EFSI’s service incorporates resilient technology and accomplished staff, providing clients a tailor-made service with exhaustive transparency. Give us a call today or reach out to our support team online. We look forward to hearing from you soon.