Private equity's next reckoning: the EBITDA it cannot keep
(This article is written for PE Managing Directors & Partners; if that’s not you, feel free to skip this article.)
A portfolio company can meet its cost-cutting targets and still become harder to sell. If AI, on its current trajectory of evolution, helps competitors replicate its offering, customers demand lower prices, and replacement revenue becomes more expensive to win, labor savings may never become durable earnings. That is where I believe private equity's next reckoning will occur: in businesses whose acquisition prices assumed margins and competitive advantages that no longer hold as AI creates downward pressure around assumed value and associated costs with those services.
The liquidity pressure is already substantial. Bain's February 2026 report identified roughly 32,000 unsold portfolio companies representing $3.8 trillion in value. Global buyout-backed exit value rose 47% in 2025, yet distributions remained below 15% of net asset value for a fourth consecutive year. The recovery in transactions had not resolved the industry's cash-return problem.
By midyear, Bain reported that a majority of buyout holdings, by count and value, had been acquired in 2021 or earlier. Strong assets continued to attract buyers, while older or challenged businesses faced skepticism about proposed valuations. For those holdings, describing the problem as an unfavorable exit window can avoid the more uncomfortable question of whether the original investment case still works.
Consider a managing director responsible for a platform purchased at an ambitious multiple. The underwriting depended on inexpensive financing (often based on ZIRP era assumptions), projected synergies, removing duplicate functions, and eventually selling the combined business at a higher multiple than its smaller acquisitions. Those assumptions become difficult to defend when buyers discount the projected savings and question whether the customer base will remain profitable. A business can remain viable while its acquisition price becomes economically indefensible.
Continuation vehicles offer another temporary route: assets move from an existing fund into a new vehicle managed by the same sponsor, giving existing investors an opportunity to sell or continue their exposure. That can provide legitimate liquidity and additional time to develop a strong business. It also places the sponsor on both sides of a transaction in which price, fees, and the allocation of future returns matter enormously. However, let’s be honest: most sponsors (80+% of the funds in my opinion) are not properly staffed or have lower AUM than required to be able to handle the complexity of such longer-term financial engineering.
On October 20, 2026, ILPA issued updated guidance emphasizing independent price validation, conflict disclosure, and transparency around transaction economics. From the selling managing director's perspective, the incentive to preserve a valuation and extend ownership is understandable. From the investor's perspective, an extension needs an operating justification that survives scrutiny.
Borrowing adds another temporary layer. A fund-level loan secured against portfolio value can finance distributions before an asset is sold; a dividend recapitalization places additional debt on the operating company to fund investor payouts. These arrangements change the timing of cash flows and who bears risk. They do not, by themselves, increase customers' willingness to pay, and a distribution funded with borrowing still leaves someone responsible for repayment.
Now consider a hypothetical managing director allocating institutional capital. A seller's liquidity constraint can create an attractive entry price for a new investor, even when the original investment disappointed. An investment committee should be able to justify the next dollar at today's valuation and financing terms without relying on the historical cost basis or the sponsor's distribution timetable. This is the hard reality that most PE sponsors must accept in this new AI era.
BlackRock provides a useful public example of the institutional opportunity. Larry Fink's 2026 chairman's letter describes an ambition to raise $400 billion in private markets by 2030, and BlackRock's secondaries platform explicitly targets opportunities in existing funds and companies. My reading is that this expansion has a clear commercial rationale: providing capital and liquidity can serve clients while growing the manager's fee-generating business.
Those economics deserve separate examination. An asset manager's ability to gather capital is different from an investor's ability to earn a satisfactory realized return. In a continuation transaction, selling investors receive liquidity while new and continuing investors retain the economic exposure. Funding the purchase does not automatically fund the operating improvements needed to support the next exit. Again, this additional need for operating growth capital is a shift in ideology from how a majority of funds have previously operated.
AI makes that distinction more consequential because it can reduce both the cost of delivering a service and the price customers will accept for it. Removing duplicate roles after an acquisition can produce recurring payroll savings. The vulnerability is assuming those savings remain with the owner when competitors gain access to similar capabilities and customers demand a share of the improvement.
There is already evidence of that pressure in services and I believe the margin loss from previous labor reduction margin gains will only increase over time. On its April 2026 earnings call, HCLTech management estimated 3–5% deflation in AI-disrupted services, translating to 2–3% across its portfolio. Its CEO also described needing approximately 25–30% more conversion effort to maintain the same deal value. These were management estimates, not an economy-wide measurement of customer acquisition costs, but they describe the commercial squeeze directly.
Retention deserves equal attention. Qualitate's September 2026 research, based on more than 4,800 senior software-buyer discussions across studies, attributed 27% of planned vendor-spending reductions and 18% of planned churn to AI. These are purchasing intentions within its research sample, but they challenge the assumption that recurring revenue will renew on yesterday's terms.
My concern is the resulting cost per dollar of revenue retained or acquired. Smaller contracts can require more sales effort to replace the same revenue, while renewals require discounts, additional functionality, or greater service investment. AI may also improve conversion and retention, so rising acquisition costs are not inevitable. The underwriting needs to establish which effect dominates for the particular business. Customers have access to AI that allows them to understand whether the pricing they are being provided is justified in a way that we’ve never seen before.
Consider a simple illustration: a company generates $100 million in revenue and $20 million in EBITDA. Payroll reductions save $5 million annually. If prices then fall 5%, with sales volume unchanged, and annual acquisition and retention spending rises $2 million, EBITDA falls to $18 million, holding other costs constant. The payroll savings remain real; the company has lost more elsewhere than it saved.
That is why an investment thesis built primarily around human capital redundancy elimination becomes fragile in an increasingly competitive market. Lower labor requirements can improve productivity without creating a lasting advantage, and a buyer will eventually assess the earnings the business can retain after competitors respond. Refinancing can provide time to adapt, but the operating response still has to justify the capital.
For a roll-up, that means identifying an underserved customer problem and building capabilities the combined business can defend. A niche only matters if customers value the specialization enough to pay for it. AlixPartners' analysis of more than 500 privately owned software companies identified proprietary data and vertical specialization as important defenses against AI disruption. Simply combining similar businesses under a platform label establishes neither. I am of the strong opinion that this is the only non-temporary route that actually delivers real portfolio liquidity in the long run. All the aforementioned financial engineering levers eventually are exposed to the existing downside realities of today's capital markets.
Finding that position is difficult because an apparently overlooked market may be small, expensive to serve, or unwilling to pay. The work involves understanding customer workflows closely enough to distinguish an unmet need from an unattractive opportunity, then integrating the acquisitions so the company can address that need better than its competitors.
The leadership implications are substantial. Sponsors need C-suite executives who can connect technical capability to customer economics, identify where expertise remains scarce, and decide which products deserve investment even when those decisions disrupt existing revenue. They also need leaders who can distinguish a genuinely integrated platform from a collection of acquisitions carrying shared overhead and a common valuation assumption.
That requirement extends to the PE firm's own bench. Sponsors whose returns depended heavily on financing and multiple expansion will need to develop operating capabilities they have not previously required at the same depth. That means professionals who have actually led product development, pricing, commercial execution, and technology integration, with the authority and resources to work alongside portfolio leadership. An operating partner's title carries limited significance unless the firm can demonstrate how that capability improves results across its investments. Bain's 2026 analysis makes a similar case for deeper operating expertise and repeatable execution.
The rigor required has to extend from underwriting through ownership. Each initiative needs an accountable owner, committed resources, and a review cadence that connects decisions to customer retention, realized pricing, delivery costs, and cash generation. Investment professionals must understand implementation well enough to challenge assumptions and intervene when results diverge from the plan. A firm cannot credibly underwrite an operational transformation while leaving responsibility for its execution entirely with the management team it acquired.
AI is also putting the economics of the sponsor's analytical work under scrutiny. Current systems can already perform portions of financial research, modeling, and sensitivity analysis, although complex outputs still require expert review. As those capabilities become more accessible, I believe LPs will become less willing to accept analytical sophistication alone as justification for premium management fees and carried interest. Commercial justification for carry fees becomes harder to defend when the manager cannot explain its contribution beyond work investors can increasingly reproduce at lower cost. Selecting investments, exercising judgment, and executing improvements remain substantial responsibilities; the firm needs evidence that it performs them well beyond the traditional investor decks sent to LPS (which at this point have become mostly noise).
For sponsors unable to build that capability, I expect the consequences to extend beyond a disappointing vintage. Weak distributions and an undifferentiated operating proposition can undermine the confidence required to raise a successor fund, leaving the firm managing an aging portfolio as new commitments move elsewhere. Over time, that can become an orderly run-off and eventual disappearance from the market. Elite operational execution will increasingly determine which firms continue earning the right to manage institutional capital.
Financial discipline remains essential, but I believe the next phase will reward sponsors who can demonstrate why customers will continue choosing the businesses they own after the cost of producing comparable work has fallen. For a managing director defending a portfolio valuation, that is the evidence worth funding. The next owner will be underwriting the cash flows the company can sustain based on operational rigor and, more importantly, a deep understanding of its customers' problems, regardless of how many structures have financed it along the way.