November 28, 2016
What is the most disruptive trend affecting private equity deals today?
This has to be the increased competition for assets from corporate sources given the large amounts of cash resident on balance sheets. This has led to the private equity industry looking for alternative ways to deploy capital – moving from large standalone deals towards bolt-on acquisitions within the existing portfolio companies. While these bolt-on acquisitions tend to be smaller in terms of upfront purchase price, the opportunity to unlock synergies and build from within the existing portfolio is attractive in this competitive environment. Private equity is also looking at market-driven opportunities such as acquiring carve-out businesses from corporate sellers partially driven by the rise of shareholder activism. Because corporate buyers have a shorter window to achieve synergies from acquisitions – their stakeholders tend to take a shorter-term view – competition from corporate buyers tends to be less in these carve-out situations as complexity increases. Private equity buyers can take a longer term view and have proven their ability to effectively manage these complexities. Alternatively, they’re placing bets in disruptive but volatile sectors such as energy and healthcare.
In the current economic environment, are non-traditional financing sources popping up?
Yes, and we see it in two forms and for two different reasons. The first non-traditional form of financing we’re seeing more of is equity partnerships, usually with corporations. This may mean that a PE firm is buying a business from a corporation and allowing the seller to retain an equity stake or the PE firm is teaming with a corporate partner to buy a standalone business. The reason for this form of non-traditional financing is to more effectively compete for assets- a corporate partner brings synergies and industry expertise that the PE firm may not otherwise have; and by partnering with a seller (allowing them to participate in the upside generated post-deal), PE firms can avoid an auction process altogether.
The second non-traditional form of financing is coming from non-bank lenders. It’s no secret that U.S. banks have been subject to increasing regulatory pressure to avoid highly leveraged lending. And hedge funds and PE funds are moving to bridge the gap on leverage where traditional banks can’t or won’t go. We may see this in various forms such as preferred stock or mezzanine debt, however, it’s typically more expensive than traditional bank financing. PE firms are willing to pay more for this source of leverage because it brings with it certainty around execution – they aren’t subject to the uncertainty of marketing the debt prior to closing the deal.
When looking at PE Exit mechanisms, what internal and external factors help determine the best strategy?
For PE sponsors, there are two main exit strategies – sale to a corporate or PE buyer and a sale to the public (an IPO). And they’re obviously looking to run a process that helps them get the best possible price for their asset. PE sponsors will want to gauge the market for both alternatives (where feasible) in order to drive competition and secure the best price for their investors. Given the JOBS act and the ability for some companies to file confidentially, go through the SEC comment process confidentially and “test the waters”, the dual-track has increased in popularity in recent years. One thing to bear in mind – both a sale and a public offering create significant demands on a company’s time and resources. As such, it is important to make sure you have the right team of advisors to help the team meet those demands.