Speakers

Panel at the secondaries roundtable

Adam Philippsohn - BFG
James Hales - NorthEdge
Ali Al Alaf - Riverside Europe
James Macleay - WestBridge
Andrew Priest - Inflexion
Neil Patel - ThinCats
David Chapman - Palatine
Phillip McCreanor - Lincoln International
Kate Gribbon - Investec
Valentina Vitali - Limerston Capital

Moderated by
Taku Dzimwasha, Real Deals

I’d like to set the scene regarding the current deal climate. How challenging is the current dealmaking environment and how does it compare to other periods of deal decline?

Andrew Priest: In the past 12 months, despite challenging credit market conditions impacting valuations, we have maintained high activity levels by focusing on situational dealmaking. This involves collaborating with founders looking to de-risk due to external market concerns and partnering with corporate entities seeking additional capital and suitable investors. Unlike 2021, this year has seen a notable absence of highly competitive adviser-led processes. As a seller, strategic consideration of the buyer market is crucial. Identifying potential buyers and ensuring their access to the company and its management team is essential.

Currently, many processes lack competition, possibly due to widespread hesitancy amid uncertainty. This observation influences our approach to new opportunities. We believe that in challenging times, skilled individuals can effectively demonstrate their abilities, akin to expert drivers shining on wet tracks.

Ali Al Alaf: We have a strong focus on primary transactions, primarily working with non-backed sellers, founders and entrepreneurs. While secondary deal opportunities have declined during the past year, we are witnessing healthy activity in the primary market, which remains consistent with previous years in Europe. I agree that the overall market dynamics have shifted, but we continue to experience healthy dealflow in our part of the market. This year, we've successfully closed multiple deals, maintaining a performance that is in line with our historical dealmaking performance.

Valentina Vitali: We continue to receive information memorandums (IMs), although the quality and quantity of new processes have abated. There is talk of increased activity soon, but I don’t anticipate a particularly busy January for auctions.

Regarding valuations, we’ve observed two distinct types of deals this year from our end of the market. One category involves price expectations that appear slightly inflated. Advisers may have originally pitched 12-18 months ago when the company was performing differently and had higher valuations. However, by the time the business reaches the market, things may have changed, and it creates a mismatch between seller and buyer point of views. The other category is advisers soft launching a sale process where no proper documents are sent out, which makes it difficult to build up conviction and come up with a sensible valuation when asked to bid.

Where we are seeing increased activity is proactive deal sourcing where we can unlock complex situations, such as carveouts or succession in family-owned businesses, for what are fundamentally good businesses.

Adam Philippsohn: We have regular dialogue across our target companies, many showing consistent growth up until this year, which has brought challenges. Some companies we expected to be ready for investment aren’t, and others with sustained growth are facing softening forecasts. While many are expected to recover to growth next year, some are delaying taking on an investment partner due to market conditions. On a positive note, many companies we’ve followed for years are showing promising results so we are advancing our discussions.

Given our level of market activity and direct origination, we’re witnessing more bilateral discussions with the support of advisers. Entrepreneurs, who we know well, continue to show interest in our differentiated offering. The value of direct conversations, sound advice, network coverage and shadow management is driving dealflow we might not see otherwise. Relationships and rapport built, along with sector expertise, drive conviction. This confidence is especially crucial in a competitive market.

David Chapman: Self-origination is incredibly vital in today’s market. We’ve completed deals this year, such as the acquisition of an accountancy practice, which involved two to three years of groundwork. We engaged with businesses and identified the right platform for investment, and now all that prior origination work is bearing fruit. This proactive approach not only enhances our dealflow but also elevates the quality of deals we’re able to secure. It’s clear that relying solely on the market is insufficient, and we must continue pushing ourselves to explore and create opportunities.

James Hales: Our approach is roughly split between self-originated and advisor-led deals. We adopt a regional matrix with a sector overlay, all underpinned by our ESG approach, aiming to engage with businesses early to nurture relationships. While it would be ideal if companies were always ready to do business with Northedge right away, that’s usually not the case. So, it’s crucial to introduce the right advisers with sector-specific expertise. They might require legal counsel, a finance director, or a skilled non-executive to help them grow their business. Building beneficial relationships is key and we’re flexible in our approach, always trying to offer advice or helpful introductions.

This approach caters to both processes and bilateral opportunities in the current market. The ongoing challenges, including the impact of Covid, political uncertainties, inflationary pressures, supply chain issues and fluctuating interest rates, have understandably led to a dip in deal volumes. However, building consistent, trust-based relationships over time positions us well to support entrepreneurs and demonstrate the value we can add, which should lead to increased deal activity in the coming year.

James MacLeay: Our primary focus is the UK, with offices around the country, which means we spend a significant amount of time on the road. We meet with regional advisers, both larger firms and boutique outfits, as well as nonexecutive communities and lawyers, along with individual entrepreneurs. Our origination efforts focus on a combination of direct relationships with potential investee companies and key regional advisers. Many of these relationships take time to develop and we’re seeing them bear fruit, even if the deals may not materialise until next year.

Maintaining conviction in specific sectors is crucial for us. As a B2B investor, our focus is on niche businesses in exciting, high-growth markets. We’ve identified several promising opportunities in these sectors, allowing us to understand what success looks like. This knowledge enables us to have informed discussions with advisers and take decisive action.

 

With credit being more expensive, how are you viewing the deal market?

Neil Patel: The credit markets are undeniably challenging at the moment, which is affecting deals. In the past, there were numerous lenders, including clearing banks and credit funds, along with alternative lenders such as ThinCats. As credit appetite in the markets tightens, with arguably a few less active players and the cost of debt increasing, we are seeing less focus on stretching opening leverage and a greater focus on deliverability. However, it’s important to stress that funding is available for the right deals. From our perspective, we must work with our clients to ensure the deal metrics reflect our credit appetite and that we can structure and price an appropriate solution. Deliverability is a key priority for us. In these times, building strong relationships is achieved by demonstrating our ability to support the right transactions. Sponsors often need quick decisions and flexibility, and we can work with them to provide the necessary funding to close deals.

 

Are you noticing any trends regarding flexibility of terms?

Patel: With the rise in interest rates, leverage is no longer the primary focus – the emphasis has shifted towards debt serviceability. As a result, we are structuring deals and providing terms that offer the flexibility sponsors need to support their investment thesis. This might involve controls and permissions related to acquisitions or potential capital outflows at specific points. We are exploring various aspects of deal structuring beyond just leverage, because leverage is no longer the primary concern in the current environment.

 

And from a deal advisory point of view, what are you seeing in terms of the deal market?

Phillip McCreanor: Many individuals in the private equity sector are navigating a volatile market for the first time. Unlike the credit-constrained environment of 2008, the current market allows for deal execution, encompassing transactions in challenging times involving private companies and corporate carve-outs. However, competitive auction processes are currently less effective, necessitating exploration of alternative methods for building conviction. On the sell-side advisory, this may involve initiating softer processes to establish rapport with stakeholders. Additionally, it’s crucial to assess where PE funds stand in their fundraising cycle and other considerations before approaching them.

A significant issue identified is the buysell spread in sectors aggressively priced during the upswing. As the cost of capital rises, this spread expands. Sectors with the widest spreads, such as TMT, techenabled services, and certain segments of healthcare, are appealing asset classes but exhibit a more pronounced buy-sell spread. In contrast, sectors like industrials have fared better due to their initially modest buy-sell spread, allowing them to mitigate increased costs stemming from higher inflation.

Kate Gribbon: From May to August 2023, we observed a surge in pitching activity, with clients seeking insights on how various factors like elections, interest rates, the risk of asset bankruptcy and our balance sheet would impact their decisions, particularly on when best to sell. We’re commonly seeing funds running soft and hard pitches, and really taking their time to choose their adviser. Despite advisers now being appointed to sell these assets, many of these sale processes have not yet launched into the market.

Our strong adviser-fund relationships play a crucial role. Instead of casting a wide buyers net, we carefully select the top 10 PE houses aligned with owners’ goals. Leveraging our deep internal insights and technicolour lens gained through our lending, fund solutions and advisory teams, we determine the right fit for the asset. We track funds’ fundraising activities, percentage of capital deployed, attitude to debt, where they’ve missed out on a recent deal, as well as building a deep understanding of their sub-sector focus, allowing us to present bilateral opportunities to them.

While many funds will prefer to source their own off-market opportunities, having an adviser-led process increases the likelihood of successful transactions due to careful preparation, packaging and positioning of the asset to the right audience. If an asset’s financials are not prepped properly ahead of a sale, with appropriate vendor due diligence, it can cause delays and stop the momentum of a transaction mid-flow. To expedite the process, understanding where funds stand in deal origination and tailoring the process accordingly, even for a small group of potential partners, is essential.

 

With the challenges facing the deal market, how can you ensure that you’re in the best position to close deals?

Chapman: For us, it’s about leveraging your credentials and your extensive experience within the sectors you’ve worked in. This provides confidence to the management team. Furthermore, when assessing a deal, your in-depth knowledge of the industry is indispensable. You can also harness the strength of your brand and convey a powerful message. For instance, our firm places a significant emphasis on ESG and the impact it can have. We use this as a key element when engaging with management teams, aiding them in their endeavours.

MacLeay: The notion of partnership is highly relevant. The market has gone through a period of relatively aggressive processes where closing the deal was of the essence. At WestBridge we have always had an emphasis on forming relationships with the management teams we aim to work with. In the current geopolitical turbulence and macroeconomic backdrop, along with considerations about credit availability, proving our capability and demonstrating that we are the right partners for navigating potentially turbulent times is paramount. Sharing stories about how we’ve managed bumpy roads in certain sectors can be invaluable to vendors and management teams alike. It’s about offering concrete evidence of how we handle hardship, which goes beyond mere statements on a website. This helps prospective partners gain a clear understanding of who they’ll be collaborating with for the next three to five years.

Gribbon: We’re seeing several interesting trends in the market. Many funds are investing in due diligence upfront, often before the IM even reaches their inbox. This proactive approach involves a substantial financial commitment to conduct thorough commercial due diligence. It provides advisers with confidence that the fund is genuinely interested and brings a unique perspective to the table compared to other funds or trade buyers in the process. Additionally, there’s a surge in creativity when it comes to deal structuring. The secondary market has seen significant growth, especially with continuation vehicles or fund-to-fund transactions. Often, these start with a test of the market, leading to competitive auctions. When the valuation falls below the bid value, funds have to get creative to satisfy their LPs. This creativity can involve equity and debt packages for minority investments or co-investing with other funds. Some impact funds are also joining forces with mainstream buyout funds, offering a diverse skillset, which is exciting for management teams and founders. It requires a willingness to think outside the box and adapt to the challenges of the current market.

Philippsohn: Being proactive with diligence work is key. Entering a deal without proper preparation is not credible. Early on in our process, we ask the question: ‘Why is this a BGF deal and how do we win it?’ Our regional teams, sector coverage, structuring flexibility and value add are our real differentiators in appealing to entrepreneurs. We leverage our scale using our talent network, digital enhancement support and ‘expertise on demand’ to drive due diligence efficiently and this also assists the management team in achieving its goals.

Al Alaf: We’re also spending a lot of time building on that conviction piece that’s been mentioned. We dedicate significant resources to careful deal selection, emphasising the importance of seeking strong conviction in our investment decisions and combining that with learning from our 30-plus years in the market. Early commitment involves making a decisive agreement to move forward with a deal at the outset. It offers a competitive edge, builds trust and enables efficient resource allocation. At Riverside we focus on the business segments and markets that we well understand and apply internal best practices we have garnered from having completed close to 1,000 deals across Europe, the US and Asia.

 

Considering the current debt market, what suggestions do you have for PE firms to ensure they’re in the best position to close deals?

Patel: Having an engaged conversation throughout the deal with your lender is key. Providing the latest view on diligence findings, current trading trends and proposals, if any, around management structures and further growth opportunities will ensure we’re able to provide real-time updates internally, minimising any risk to deliverability.

Kate Gribbon
Kate Gribbon, Investec

Even if a company scores highly on the model and in theory ticks all the boxes, technology does not pick up the nuances of why the target might not actually be fit for purpose

How are you leveraging technology to support deal origination? Are you using any AI platforms?

Priest: It feels like we’re just coming off peak hype about AI for this generation of available tools. That said, we’ve used technology as a valuable tool for many years but it hasn’t fundamentally altered how we interact with founders. Internally, we’ve integrated structured and unstructured data from various sources into a single in-house platform called Tearsheet. This provides a more informed and immediate view of companies and markets, enabling us to target those companies we want to meet and then be better prepared for meetings. It’s both a platform we can use to help source new investments but also for portfolio company bolt-on acquisition opportunities. For us, the goal is to gain access to the right opportunities and build meaningful relationships by offering valuable insights during meetings. Technology doesn’t replace the human element of identifying and engaging with companies; it aids us in the process.

Chapman: AI’s current use case revolves around leveraging your data. This is particularly valuable in deal origination. It helps you understand the sources of dealflow, such as regions, advisers and sectors. Additionally, it enables a retrospective analysis of past investments, identifying what contributed to their success. One strong area for AI application is in the context of buy-and-build strategies. By using your data, you can identify potential markets with numerous buy-and-build opportunities. This helps guide your deal origination efforts. It’s essential to avoid delving too deeply into subsectors that might not align with your objectives. By using your data, you can make more informed decisions about whether to invest more effort into a specific sector or move onto other opportunities.

Vitali: We use an AI-driven platform to support our market mapping, especially when looking for companies outside the UK. This helps us also create a long-term pipeline of opportunities that we can keep monitoring and action at the right time. This streamlines the process of target identification, saving time and resources compared to traditional methods.

Gribbon: While technology has undoubtedly advanced our capabilities, it has its limitations. Whether on the advisory or investor side, we can use technology to efficiently narrow down potential targets by applying rule-of-thumb criteria to a vast database of 100,000 companies. This process can yield a selection of hundreds of promising companies to pursue. However, the human element and review of targets remains indispensable. We’ve developed an in-house propensity model using our proprietary data, which has proven to be a valuable tool, especially for SME companies. Nevertheless, even if a company scores highly on the model and in theory ticks all the boxes, technology does not pick up the nuances of why the target might not actually be fit for purpose. The continuous growth of data, with or without AI, underscores the need for sophistication in working with existing data.

Al Alaf: At some point in the future, AI will be transformative to deal origination and it’s important to be prepared for that. During the past 25 years, we've been accumulating millions of data points across the US, Asia and Europe, and I'm convinced that it will eventually prove invaluable to us. I agree that there's a lot of hype around AI, and its practical applications may not be fully realised yet, but the moment of clarity and meaningful use will eventually come.

Philippsohn: Like most private equity firms, we capture intelligence from our research, talent network and adviser conversations. We harness technology to enhance our efficiency in capturing and sharing this intelligence to make it actionable. This technological integration didn’t quite exist five years ago. Today, we can leverage our conversations and data in ways we couldn’t before. From a data perspective, we’ve invested heavily into our CRM and sourcing technology, consistently improving our process towards greater efficiency. There’s more data and technology available today to make sure no stones are left unturned.

MacLeay: One point to add is that in the lower midmarket, many of the targets we’re considering have only filed abbreviated accounts. While data can be valuable for sector stratification and getting a sense of what businesses exist, it becomes quite challenging beyond that. So whilst data is important, there is no substitute to meeting a vendor and/or management face to face.

Hales: Having a robust CRM system is now a fundamental requirement for sharing intelligence and making informed decisions. We’ve developed our own in-house AI tool for deal origination over seven years. This tool was born out of the frustration with limited data from abbreviated accounts, particularly in light of outdated industry classifications. Our AI tool focuses on identifying key triggers in financial metrics and creating a ranking system for top targets, especially for entrepreneurs as the majority of our investments are first time to private equity. We use it not only for deal origination but also for mapping potential acquisition targets within our secure portfolio companies. While technology can help assess and streamline processes, building relationships with management teams remains a crucial aspect that technology cannot replace. It’s easy to get overwhelmed by data, but having a solid CRM system and understanding your total addressable market so you know where to play is essential.

Priest: I’d add that the UK has more comprehensive data, especially on private companies, compared to most other European markets and even the US. Interestingly, there are hardly any centralised data sources in the US. The origination models that aid us in developing strategies in the US often rely on more traditional approaches, like ‘smile and dial’, where people just have to put in legwork to generate origination leads. Technology certainly works when the necessary infrastructure is in place. However, it is reliant on improving internal data management and leveraging existing knowledge, which is a crucial initial step.

 

The exit market is tough. What are the key strategies for achieving an exit in this current market?

Hales: In the past year, the business environment has grown more challenging for new investments and exiting businesses. It’s vital to engage top advisers early on, especially when preparing a business for sale. Despite a struggling IPO market, creating options for your business is crucial. Collaborate with advisers well in advance, considering ESG diligence for market appeal. The landscape has changed; aggressive, quick deals are rare. Understand your business, identify key value drivers and communicate them for a successful exit.

Realism about exit multiples is crucial – aligning with management’s preferences may involve leaving some value on the table for a successful exit.

Vitali: The exit strategy is a key component of our investment process and is discussed in detail among the investment committee, including what types of buyers we target on exit, for example. Our model of operational improvements and buy-and-build is key to developing what we believe are inherently attractive companies on exit. We have a team of operating partners supporting this value creation strategy. Currently, our portfolio includes several businesses where we are seeing inbound interest. In the current market conditions, we will only consider exiting portfolio companies where the interest and valuation levels deliver the expected returns for that investment. Such exits need to be carefully planned, with the right set of advisers and a clear process in place.

Priest: A few years ago, we established a formal realisation committee, which now wields significant influence over all parts of our business. This committee largely comprises the same members as our investment committee but its focus is on assessing the exit opportunities at the time of investing. During the past couple of years, we’ve recognised the value of having clear insights into the most likely exit partners. It’s essential to ensure these potential partners are up to date with the business. For example, we recently sold a business called The Goat Agency to WPP. This aligns with our initial investment thesis that WPP and similar firms would need to develop expertise in the social media influencer and marketing space. So we created an asset tailored for this industry and, as expected, most of those players expressed interest in being part of the exit process. Having clarity and alignment on exit partners from the outset is key.

While focused on realisations, the realisation committee gives us valuable insights into the minds of buyers, which we can then use when we are looking at our own new investment activities.

McCreanor: Similarly, on the sell-side advisory side, we spend a considerable amount of time thinking about what the investment thesis is for private equity firms. This involves extensive analysis of the market landscape to identify buyand-build opportunities that can leverage international resources. By understanding the market dynamics, we’re better positioned to present a compelling pitch to potential PE firms. This proactive approach ensures that even if the decision is not to exit, the company is in a strong position, often with untapped growth potential.

The market has evolved significantly from a broad selling approach in the early 2000s. Specialisation became prominent, initially in large-cap banks and later extending to €5-10m Ebitda businesses. This trend signifies a positive trajectory, emphasising increased sector and product knowledge over time. Despite a current blip, the industry is expected to rebound, benefiting from growing efficiency and sophistication.

Chapman: Working on your exit strategies early is crucial. You have to assess right from the initial stages of an investment by mapping the landscape of where and how the business will be exited. Collaboration with adept advisers becomes pivotal to determining the opportune moment for exit, considering both valuation and avoiding a prolonged process that might distract the management team. The timing decision is a collective effort, involving your judgement, adviser insights and the management team’s input.

 

The challenges in the market are likely here to stay as we go into the new year. What trends do you expect to see in deal origination in the near future?

Gribbon: Despite earlier predictions of increased market activity, the anticipated outcomes have not materialised. It’s crucial to approach predictions cautiously and avoid overcommitting. There’s a recognised need for a longer deal origination runway in both advisory and investment realms. A thorough understanding of all deal aspects, including the management team, private equity partners, chair and other key stakeholders, is deemed crucial. Building relationships with all of these, beyond a pre-deal formality, is integral to the origination process.

The advisory community emphasises upfront relationship building, extending efforts beyond winning a mandate to proactively knowing key players and buyers in advance. This trend spans small to large-cap deals. Furthermore, the biggest trend we’ve seen is a ramp up of P2P activity and this is expected to continue, driven by undervalued listed businesses, offering opportunities for PE firms.

McCreanor: Looking ahead, fundraising cycles are anticipated to compel funds to engage in transactions. While funds can typically afford inactivity for about a year, exceeding this timeframe risks lagging behind and concerns for LPs. This signals a potential shift, motivating funds to transact to align with market trends and investor expectations. Expecting increased activity around the end of Q1 or start of Q2 next year, there’s recognition that certain dynamics will necessitate heightened transactional involvement. This aligns with private companies positioning themselves, considering potential elections, but reaching this point demands substantial effort and diligence.

Priest: In these markets, proactive planning, sector focus and relationship building are crucial. Despite relying on specialisation and conviction, the use of creative deal craft remains a consistent theme. Reacting swiftly to favourable opportunities and aligning with investment theses has been evident this year. Mobilising the entire firm, including ESG directors and the investment committee, demonstrates a commitment to securing high quality assets. In primary deals and partnerships with entrepreneurs, timing may be uncertain, but in complex macroeconomic and political landscapes, entrepreneurs often seek risk reduction. Highlighting the valueadded aspects, such as technology and AI discussed today, reinforces credibility.