The private equity market entered 2020 riding 10+ years of momentum. Emerging GPs started new funds while established firms pounced upon the low costs of capital to raise increasingly larger funds. As competition for large deals increased, funds were forced to diversify strategies, with many funds moving down market and utilizing innovative strategies in search of value. Despite increased competition and elevated valuations, GPs continued to deliver strong returns to LPs and raise additional capital.
However, the COVID-19 pandemic and associated market uncertainty have put the brakes on new deals and forced investors to alter their strategies. While some reactionary GP strategies were focused on near-term survival, we predict others are here to stay as investors adopt to the “new normal”.
Four thoughts on how COVID-19 will have lasting effects on the PE market:
Auction Preemption: The elevated valuations caused by increased competition for a smaller number of deals have increased the attractiveness of proprietary deals, accelerating a trend of auction preemption already well established before the pandemic. Additionally, liquidity concerns at acquisition targets have driven some companies to seek a more rapid infusion of capital, leading management teams to forgo time consuming auctions. BCE projects that investors with significant dry powder will increasingly be willing to pay slightly elevated valuations for the certainty that comes with a proprietary process.
One-Stop Financing: Uncertainty caused by the COVID pandemic caused credit lenders to increase rates, tighten lending criteria, and reduce access to capital, contributing to the reduction in leveraged investments and buyouts. On the flip side, one-stop-shops with flexible financing offerings capitalized by funding a mix of equity and debt transactions through their own in-house capital. BCE expects that an increasing number of traditional equity funds will roll-out debt offerings, strengthening their value proposition to potential targets and increasing their ability to rapidly secure financing and finalize transactions.
Portfolio Operations: Pandemic uncertainty and a lack of new deal opportunities combined to force sponsors to deploy increased resources towards actively managing portfolio companies. While the initial triaging and managing of liquidity have largely passed for most portfolio companies, BCE projects that sponsors will continue to more actively manage portfolio company financials and operations to position investments for success. While the market awaits a deal volume rebound, look for sponsors to roll up their sleeves and pull value levers for active investments.
Social Activism: Social activism has increased throughout our culture, including the private equity world and BCE expects this trend to accelerate going forward. LPs will consider the meaning and purpose behind their investments as well as the returns, and GPs will adjust their strategies accordingly. Look for funds to include social activist initiatives such as board diversity, sustainability, and social justice in investment criteria. Other funds will roll-out explicit social impact funds, capitalizing on LP sentiments to drive monetary and social values. Returns will persist as the foremost marker of a successful fund but “reputational currency” will become increasingly valuable to GPs and LPs alike.
As the world and investment markets evolve, private equity funds will be at the forefront of change, adopting to the new normal and tailoring their strategies to the needs of LPs in search of value.