Putting the money to work

Record fundraising levels are forcing private equity firms to change tack on origination and exit strategies as competition for investment targets hots up

Some of the numbers surrounding today’s global private equity market are nothing short of eye watering. In 2017, the global industry raised a record $453bn from investors – leaving it with more than $1tn to pour into existing companies and new business ventures, according to industry tracker Prequin.

What’s more, private equity groups are spending the least amount of time ever on the road raising money, as yield-starved investors desperately seek places to park their cash. Prequin’s figures show that buyout funds spent an average of just 11 months raising a fund in 2017, compared with 19 months back in 2010.

Josh Farrow, Associate Director of the Jersey Funds Team at PraxislFM, says these record amounts of money being raised are fuelling competition in the market – which is in turn driving innovation and change.

“At no point in the history of private equity has competition been so great,” he says. “The number of firms has tripled globally and we’ve seen a rise in assets under management from around $600bn in the year 2000 to circa $2,500bn in 2017. The knock-on effect is competition. Fund managers are fighting to find a good deal – the right deal, at the right price."

Traditionally, says Farrow, as long as a deal offered an opportunity for return or complemented an existing asset within the portfolio, and was aligned to the specific strategy of that fund, it was what that fund manager would focus on. They would drill down into particular sectors and not really deviate from that.

“But it’s fair to say that competition in the market is leading to diversification – a willingness to explore the opportunities in different sectors. There’s a big drive in the tech and healthcare sectors, for example, and in fact on tech businesses within the healthcare space.”

Exploring opportunities

That view certainly seems to be supported by industry statistics, with the Economist reporting earlier this year that 2017 “saw a frenzy of deal activity [in the healthcare sector] – the highest by value since the go-go year of 2007”.

Of course, once a private equity fund has struck a deal for a business, it must turn its attention to how it maximises profit while ensuring that the business is ripe for an exit further down the line.

One of the criticisms often aimed at private equity firms is that they laden firms with too much debt – prioritising profit over all else.

Alex Di Santo, a Director within Intertrust Fund Services with 12 years’ experience in the offshore financial services industry, suggests this is a somewhat unfair criticism. He adds that private equity firms are focused on providing benefits for their investors while protecting the value of the asset.

“The leverage is used to produce attractive returns for investors,” he says. “There are risks to putting leverage into those structures but, done right, it is to the benefit of all stakeholders – it’s good for the portfolio company and the investors. 

“The PE funds know what they’re doing and, if they laden those firms with too much debt, then that will hamper their ability to exit that business when they want to move it on. It’s a key component of private equity and PE wouldn’t be around if it didn’t have the ability to use it.”

That said, Tony Lane, Partner in the Corporate team at law firm Carey Olsen in Guernsey, says there is a broad trend around the propensity for private equity funds to lend to other portfolio firms – driven partly by the lack of available credit from traditional lenders.

“Certainly, in the key markets, it’s becoming more and more common at the point of the deal for private equity firms to directly lend to portfolio companies rather than rely on traditional lenders,” he says. 

“That’s partly because of credit drying up, but also because it provides continuity for the private equity house by giving it a means of paying off some of its fundraising and, at the end of the day, increasing its return.”

Private equity’s end game is to successfully exit the business and move it on, preferably having reaped the profits of a successful ownership.

But are the shifts in an increasingly competitive market also leading to changes in the exit strategies of private equity-backed businesses?

Justin Hallett, Executive Director and Head of the Funds and Asset Management sector team at BDO in Guernsey, certainly thinks so. “I would normally have said that the maximum length of time for holding an investment would be five years – because three to five years is the normal cycle of a PE fund,” he says. “But I think they are getting longer now. I think that’s tied in to the amount of money out there that’s still not invested.

“If a private equity house sells an investment now, they convert that investment – which is continuing to make a return – into cash. As the market is so competitive, and because it’s not easy to invest that cash, by selling, they risk turning something that was making a return into cash that isn’t,” he continues. As a result, I think we are seeing houses hold for longer – for anything up to 10 years while they enjoy the good returns on that investment.”

Lessons for others

While private equity approaches and strategies are not without criticism, does the industry’s ability to maximise profit for portfolio businesses, while also striving to sell on its asset for a profit for investors, offer lessons for everyday private businesses?

“Essentially, every business should be focusing on value and profit – and the benefit that private equity houses have is that, while they are closely focused on the business, they are not running it day to day,” says BDO’s Hallett. 

“Many private and owner-managed business leaders are so focused on the day job that they don’t have a focus on change, urgency and immediate targets. Private equity must reach a target return, and that allows it to make considered and calculated decisions,” he adds.

“If private business owners looked at their business through the eyes of someone who was buying the company, almost through private equity eyes, they would look at it much more objectively. Private equity has the ability to up-skill, to change people and to bring in new processes without a strong emotional connection.

“It’s de-personalised. That’s to the benefit of the business and it’s just another of the reasons that private equity is continuing to grow at a record rate and continuing to create returns for all involved.”