Before this fall’s stock market crash, mergers-and-acquisitions activity remained steady among private equity firms that focus on middle-market and small-market companies. Although the giant private equity firms—think Blackstone Group and KKR & Co.—may have slowed their activity this summer, midsized players like Arcapita Bank of Bahrain, and Navigation Capital Partners and VVS Capital, both of Atlanta, continued to swing deals. Arcapita acquired CEPL, a European warehouse logistics service in August, while Navigation and VVS teamed up in May to purchase Brown Trucking Co.

Now even that segment of the M&A world has dried up. King & Spalding partner Ray Baltz [left] in Atlanta, who is co-chair of the law firm’s private equity practice group, discusses the factors that have forced private equity firms to sit on billions of dollars of capital, with nowhere to place the money. The conversation has been edited for brevity and clarity.

Private equity firms have raised billions of dollars in capital, and it’s waiting to be invested. Are private equity firms sitting on the sidelines, waiting to make acquisitions, until the market normalizes?

Private equity firms continue to look for attractive investment opportunities. That’s what their organizations are set up to do. A large part of what’s going on is that there are not very many attractive business being put on the market for sale in this environment. If you are a business that is at all tied to the credit markets or to the housing industry, you are in a nuclear winter. Now is not the right time to put yourself up for sale, unless it’s a truly distressed sale. And there are some private equity firms that look at nothing but companies in distressed situations.

Even for healthy businesses, now is not the time to sell either. If you operate in an otherwise stable industry (not housing and not tied to the credit markets), and your business hasn’t declined at the same rate as valuations on Wall Street have declined, it’s still not time to put your business up for sale.

If you are a private equity firm or a buyout group, it’s not that you are unwilling to buy, it’s that there aren’t a lot of businesses on the market available to buy.

I also think sellers are being advised, perhaps incorrectly, by some investment bankers or financial advisers that because there is no leveraged financing available, if you put yourself up for sale, the private equity firms won’t participate in a sale process and you won’t get fair value.

It has been said repeatedly that credit isn’t available.  Is it true that your private equity clients are unable to obtain debt financing for acquisitions?  

There were alternative sources of leveraged financing available up until September. In September and October, everything stopped. I would have suggested up until September that the private equity firms and buyout firms operating in the area of middle-market companies remained fairly active, and they were active through the end of summer. But given the turmoil this fall, almost everything has come to a halt.

Can you elaborate about some of the other reasons why M&A activity has virtually ceased?

It just became very hard to value anything. You could start discussions on an acquisition or on a sale and if it takes four months, from the initial discussions to consummating a deal, you would have these wild fluctuations in price. How do you go from the beginning to the end of an orderly acquisition process when your original assumptions on price may change the next day? Because there has been such volatility, it just became impossible to value anything. Whether we’re at the bottom or not, what we really need is stabilization and calm in the markets. Even if stabilization comes with depressed prices, it will give confidence to buyers and lenders that we are at or near a bottom, and that you can at least value something.

If a private equity firm has a portfolio company that is struggling right now, does the private equity fund sell the company at a loss?  Or does it hold on to it?

Private equity funds differ from hedge funds in that most of the time their investors cannot force redemptions of their limited partnership interests, such that the private equity fund would be forced to sell some of its holdings to raise cash to distribute to its limited partners.

A hedge fund, which is more of a trading vehicle, typically would have a mechanism to return their investors’ capital, which is what forces a hedge fund to sell assets to send cash back to investors. That’s not a feature that is common in a true private equity fund.

Investors in private equity funds know that it’s a long term investment, that the money will be tied up for 5 years, for 10 years. You know it’s an illiquid investment. You don’t make that investment with a private equity fund with the intention that it’s going to turn to cash at any point in the near term.

Once the market normalizes, are private equity funds increasingly going to invest in banks that are regulated by the Federal Deposit Insurance Corp., since banks are so desperate right now for capital?

I do think that you have a very large pool of capital sitting on the sidelines in the form of these private equity funds. And you have a financial industry that needs capital. One would expect those two groups to engage in some type of dialogue.