Value Creation Outlook for Canadian PEs in 2025

M&A Market for Canadian Private Equity Remains Subdued

In 3Q24, Canada recorded the fewest number of private equity (“PE”) deals since the early pandemic period.¹ The decline in decline in PE activity, which has been ongoing since 2022, is largely attributed to rising borrowing costs, high inflation, regulatory concerns and a persistent gap in valuation between buyers and sellers.

Figure 1 - Canadian Private Equity M&A, Quarterly Deal Volume

Source: CVCA,YTD Q3 2024 Private Equity Overview

In the meantime, exit routes have slowly been closing off for sponsors: the IPO market is less attractive than in the past, while PE firms remain unwilling to sell mature investments at a discount to perceived value when market multiples stagnate — often below their five-year average levels, though recovering slowly in recent months.

As a result, delayed exits have become a common trend, with firms waiting for more favorable market conditions. These extended holding periods have resulted in less proceeds for Limited partners (“LPs”) who are now increasing their pressure on General Partners (“GP”) to return capital on the more mature investments. These demands have been mainly accommodated through secondaries, offering only short-term relief. Given this context, GPs have been focused on finding ways to increase the performance of their portfolio companies to maximize future returns when market conditions improve.

Value Creation Is Now a Cornerstone of the Investment Thesis

Given the challenging backdrop and the absence of traditional financial levers to help raise valuations, value creation has become the most powerful lever for PEs to increase the value of a business in preparation for a potential sale. Whilst the nature of the value creation initiatives can vary greatly — from quick wins and tactical cost savings to transformational plans or setting up a “value creation office” — the bottom line is that a majority of the PE industry has responded to current market challenges by establishing some form of value creation framework.

Most sponsor-owned firms started their value creation journey by focusing on tactical initiatives to grow their revenues, control their cost base and protect or grow cash flows. This often translated into strategic budget reviews, resource optimizations, sales performance analysis, costs savings considerations, hiring freeze and other initiatives implemented top-down by management.
Other firms invested further and implemented wider transformations of their portfolio companies. This typically starts with refining or redefining the corporate vision and business model and then validating the assets, technology, people, capital and other resources required to support this plan. This effort often involves intensive strategic prioritization, rebalancing and zero-based budgeting activities, ultimately resulting in material value creation opportunities. One of the largest upsides of this process is the ability to align with the management team where value can be created through additional investment, including from growth-related initiatives.
Finally, some PE funds have decided to institutionalize these activities through the development of their own value creation office, often supported by third-party advisors. In particular, we noted a significant interest in the centralization of back-office operations into a single company or platform to service multiple portfolio companies and achieve economies of scale.

Although the value creation framework implemented by PE firms can vary materially, the finance and technology functions continue to represent two main target areas, often supported by the introduction of disruptive technologies. More recently a number of themes such as hyper-automation have started to emerge and have been considered in specific sectors. We believe that these trends will only intensify and accelerate over time.

Perceptions of Value Creation Can Differ Between Buyers and Sellers

One consequence of such focus on value creation over the last few years will be the need for future buyers to be even more vigilant to assess the “true” value created. Most “Confidential Information Memorandum” and “Vendor Due Diligence” documents distributed by sellers feature adjusted EBITDA figures impacted by these value creation initiatives. How real are they?

It will be critical to effectively assess the nature of these initiatives and test the “quality” of incremental EBITDA created. In essence, premium valuation should only be attributed to persistent and sustainable savings. In fact, temporary savings and rapid cost-cutting activities — while demonstrating the ability of management to flex operations and costs when needed — could actually lead to value destruction under some scenarios (e.g., employee turnover, diseconomies of scale, lack of competitiveness in key markets).

A Premium for Transformed Businesses in 2025

The current year should see an increase in M&A deals for Canadian PE activity. Although it is too early to assess if this will be a moderate or robust recovery, there seems to be a consensus of agreement across key stakeholders that more M&A mandates will be executed this year. In that context, transformed businesses that have been able to fundamentally restructure their cost base and prepare their organization to capitalize on growth opportunities are expected to represent preferred M&A targets:

Strategic buyers will pay a premium not only based on higher EBITDA levels but also because these deals often enable them to acquire enhanced capabilities to scale up across the entire organization. Acquiring transformed businesses also provides them with the option to leave newly acquired companies running on a standalone basis while they finalize their integration roadmap. This would not be possible if the business were loss-making, materially underperforming or simply not operating efficiently, as it would require some urgent intervention.
PE buyers favor unoptimized business — giving them more opportunities to achieve larger upsides — but a significant portion of the incremental value created has also been captured through roll-ups and bolt-on acquisitions. It is not uncommon to see a standalone portfolio company being acquired by another PE-owned firm before being successfully leveraged as a platform investment. In that context, some premium could be extracted for a transformed business that would be positioned as the main platform for other acquisitions and integration. Further, we note that in certain industries, it can prove challenging to achieve meaningful structural changes (e.g., regulatory, contractual, and union considerations). As such, acquiring a business post-improvements can prove invaluable in some cases.

Although we expect to see more deals for Canadian PEs in the coming year, this assumption remains far from certain given relatively modest domestic growth expectations combined with an expected challenging international outlook, including U.S. tariff threats and China’s potential retaliation tactics. This could lead Canadian PEs to extend their investment holding periods, pushing the value creation imperative even further.

Footnote:

1: “YTD Q3 2024 Private Equity Overview,” CVCA (2024).

Related Insights

Related Information

Published

February 19, 2025

Key Contacts

Antoine Mavel

Senior Managing Director