03 Apr 2024
Fresh thinking on repairing broken processes in Private Equity deal fundraising
The private equity (PE) industry currently finds itself in a perfect storm where tried and trusted processes for getting deals from drawing board to conclusion are increasingly broken. When valuations and exit multiples were high, the industry came to rely on a ‘cookie-cutter’ approach to transactions. Deal processes were broadly similar, with a well-trodden path and the returns were significant. Those days are gone.
We have the combined impact of lower valuations, a lack of debt available to PE funds, fewer businesses coming to market and economic headwinds. Our Private Equity Trends 2024 report found that 66% of GPs have seen more broken processes in the last 12 months compared with 2022. Failed auctions have become more commonplace.
However, our report finds the Private Equity (PE) model is as relevant as ever. The symptoms that led to a hyper-charged market up to 2021 are being replaced by a new norm. PE is finding creative solutions to tackle and address the broken processes.
Why are private equity processes broken?
- Sellers can’t achieve the valuations they want. PE buyers face a lack of debt availability so must lower their valuations. Meanwhile, trade buyers (who typically use less debt), follow PE buyers with lower valuations.
- Fewer businesses are coming to market. Sellers are holding out, waiting for conditions to improve. A harsh economic environment is negatively impacting business performances, profits are lower and hence exit valuations have declined.
- The UK general election this year is adding to uncertainty for sellers and buyers, particularly around possible changes to tax legislation.
- Business owners, be it entrepreneurs or PE firms, face a choice: go to market now, in a softer market when valuations are lower, but avoid a potentially higher capital gains tax (CGT) bill. Or continue trading for another year or so before selling, hope that multiples are better to thereby achieve a higher valuation but perhaps face a bigger CGT hit.
Private equity restructuring – How to repair a broken process
The previous cookie-cutter approach could see 50 or so PE funds and trade buyers bidding in an auction to win a mandate. Today’s processes are much more refined and curated. Advisers are working harder to win over business owners to bring their business to market and PE funds are having to be more creative in how they structure deals.
Careful curation becoming the norm
PE owners need to align with company management’s expectations. A closer meeting of minds is needed between parties. Sellers’ expectations are finally starting to lower as greater realism sets into the PE market, apart from those prized top-decile assets, which will always attract high values.
Better curation of deals includes more careful preparation of businesses for sale by their advisers. With valuations under pressure, advisers are presenting the most compelling case to buyers. Greater attention to detail and a more in-depth understanding of the PE buyers’ mandates sees fewer, but more appropriate, buyers at auction. Enough to ensure competitive tension among a smaller number of bidders, but only after careful vetting to ensure they will be the best fit for the seller.
Picking the right moment
In the current economic climate, the timing of launching a process to sell a business is more important than in the past.
Market participants are choosing a window when interest in the business is peaking. This is when market enthusiasm for the sector is at its highest. Consideration must be taken to avoid launching a sale into a crowded market when an asset might not shine as brightly in front of potential buyers.
Offering more exit options
Broken processes are being tackled by putting more options on the table in addition to an outright sale. The PE firm could opt for a continuation vehicle so they hold the asset for longer, in the expectation that it will increase in value. A business owner might prefer to sell only a minority stake and continue running their company for a few more years.
Alternatively, the PE fund could co-invest with other funds, and benefit from a complementary set of skills and experience or recommend a public listing. The key is for sellers to engage advisers early, and in turn build relationships with both PE and trade buyers to determine the preferred and optimal route for the business.
Finally, a forward-looking view of a business sale should anticipate the future exit of the incoming buyer. They will be more willing to buy and pay up if they can envisage their own future exit from the business.
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