Private equity in 2019 – managing through uncertainty
Opportunities, risks and predictions
INSIGHT ARTICLE |
2018 was a year for sellers. As deal values remained high, principally due to the high levels of capital to be deployed and a limited inventory of quality assets on the market, sellers took advantage of the market conditions and businesses traded hands. This is not to say all was rosy. As 2018 continued, economic and trade uncertainty became larger issues for buyers and an increasing number of deal processes stalled. As 2019 rolls into full gear, how will the private equity market respond and tie up loose ends from 2018? In this article, we explore opportunities ahead and key risk areas that we see as likely to be evident throughout the year.
1. Creative deal structures
As 2019 evolves, sellers will have to be mindful of evolving market conditions trending towards the negative. Creative deal structures, which balance the risk and reward between the private equity fund and vendors, may be more apparent if we see a continuation of the deal volume and valuation multiples of 2018. Increased time-based payments, higher rolled equity amounts and greater contingent structures are likely to be prominent features of the deals that close through 2019.
The buzzword for 2018 was uncertainty and 2019 looks to solve nothing. Private equity firms have to adjust to a world of continued uncertainty as trade, regulatory and political change is the new normal. Deals are going to be underwritten with some cloud of uncertainty and with that, risk mitigation and management will be crucial to maintaining fund performance. Cross-border deals may become less inviting as risk-averse funds may limit their operations to known jurisdictions. Only opportunistic funds may see prospects to be contrarian in markets others are avoiding.
How to operate in a potential downturn will be front and center of many managers, as economic conditions, particularly on a geographic or sector localization, become more challenging. An example would be those manufacturing companies that are exposed to significant cross-jurisdictional supply chains given the tariff issues being debated and utilized in broader political negotiations. Deploying capital in these markets and, as importantly, managing an existing portfolio through a downturn, will be critical issues to position for in 2019.
3. Industry and sector specialization
With high valuations continuing to exist and the cloud of uncertainty, it is likely private equity funds will focus their time and attention on what they already know. Continuing to buy and build on platforms already in hand while vertically integrating through the value chain will reduce the concerns on these issues as it’s easier to get comfortable with a known commodity.
Funds are increasingly specializing by industry and even those that are not are focusing on specialized themes within their broader investment mandate. These specializations allow the private equity funds (and their limited partners) to get more comfortable with the risks that would otherwise be inherent in deal opportunities.
Tapping into industry expertise, through the use of industry-focused advisors and operating partners, will grow throughout 2019.
4. Fund structures
The rise of family offices and other traditional limited partners that are now doing direct investments and buyouts is leading to an increase in funds that are not the traditional five to seven year fund structure. Long-hold funds reduce the need to exit assets within a more restricted time horizon that may otherwise limit the return during economic cyclicality and allows businesses ample runway for growth.
Such structures seem to also resonate with vendors that are divesting 100 per cent of their business. Without the limited time horizon, they can be more confident they have a financial partner that is with them for the long haul.
In addition, private equity funds are trending to a diversification of asset class from the pure private equity model to investing by way of venture capital as well as mezzanine and alternate debt structures. The shift to debt structures will be increasingly useful as the senior debt lenders become more conservative during broader economic uncertainty to ensure the maintenance of liquidity in the market. Debt products are also becoming more necessary to meet the return targets of the limited partners from a risk-reward perspective as well as to vendors and businesses that are seeking non-traditional deal structures.
New fund launches in 2019 will likely continue these trends and show a diversification of structure and investment strategy.
5. Talent, talent, talent
One of the biggest concerns facing private equity funds is the access to the right talent to execute on their growth plans. At the front end of a deal, a review of the management and team supporting them is a key diligence item. However, post-deal execution and, as the portfolio company and private equity firm focus on growth initiatives, the labour pool represents a key risk item that needs to be carefully managed. It’s an area that is featuring heavily in the decision making process on plant expansion and geographic diversification, notwithstanding the other incentives jurisdictions put forward, such as tax and other credits and incentives.
With risk comes opportunity, and while private equity funds will look to utilize technology and other solutions to minimize risk at the labour line, it will also be a focus of investment and deal activity. Those businesses that assist companies with this risk, through outsourcing and technology-based solutions, will become increasingly interesting deal targets. ’Everything-as-a-service‘ will be a highly sought after feature of 2019 deal opportunities.
6. The technology imperative
Being at the forefront of technological change at the fund and operational level will be key to staying competitive. Throughout the deal lifecycle, technology will continue to be an important aspect to the private equity fund toolkit. We will see the use of tools at the deal evaluation level, supporting and enhancing the sourcing and due diligence processes, through to more effective and real-time reporting on financial and other key performance indicators at the portfolio company level.
Understanding the technology roadmap that is on the horizon, how to utilize the changing technology landscape in an effective fashion and implementing change in an efficient manner, both at the private equity and portfolio level, will be key issues in 2019.
7. Risk and regulatory management
Risk management and dealing with the changes that are inherent with evolving risk and regulatory frameworks are big issues for private equity fund managers. 2019 will not get any easier. From cybersecurity concerns at the fund, portfolio company, and even on a target level during due diligence, through to maximizing opportunity in the developing tax and accounting worlds, private equity managers are relying on their advisors to be proactive. Limited partners will especially demand strong proactive management in these key areas as managers look to raise additional capital for their next funds.
Private equity managers will have a lot on their plate during 2019. Ongoing economic and trade dialogue as well as evolving legislation such as the upcoming 2019 Federal Budget will require fund managers to continuously adapt their practices in order to maximize their opportunities and return. Proactive planning and effective risk management practices will be the order of the day.