Economic Undertakings

Resilience provides opportunities for the private equity market

According to Global Private Equity & Venture Capital Report Preqin 2021, the global private equity market is now worth more than $4 billion. The UK, long the most developed private equity sector in Europe, remains at the center of this trend. However, as we come out of lockdown, there are two aspects to this chart: the dry powder available to private companies and the impact of the pandemic on private equity vehicles.

Supply and demand meet

Covid-19 has undoubtedly been one of the biggest challenges the UK economy has ever faced, and so has the private sector. However, for businesses large and small, government support has been available in the form of loan schemes, job retention schemes (also known as furloughs), and moratoriums on rents and tax debts.

While cash flow may look strong today, the reduction in government support will begin in a few months and, for some, pressure on balance sheets will follow soon after. That’s not to say that the financial pressures businesses face will drive many into insolvency, but dealing with increased working capital requirements is a challenge that many business owners face in the short term.

Potential changes to capital gains tax are also beginning to capture the attention of many business owners who may now see this as a time to invest and even sell.

For many, public ownership has fallen into disuse as an exit strategy, and selling to a competitor, especially in the current circumstances, can come with its own business risks. The private equity market has benefited from a trend that has continued for more than a decade after the last major economic shock in 2008.

While the supply of investment opportunities looks healthy, what does the demand curve look like?

As mentioned earlier, there remains a high level of market liquidity and strong investor willingness to invest in quality companies, with private equity funds remaining a preferred route to market for institutions, family offices and high net worth individuals. In other words, the investment and acquisition opportunities are plentiful. This has already been demonstrated, with global M&A activity in the first quarter of 2021 at its highest level in over a decade.

However, while there is a lot of dry powder, the stage at which a private equity fund was in the normal fund life cycle when the pandemic hit will have a potential impact on the success of that fund and its ability. to raise its next round of funding. . How a fund’s investment portfolio has been managed during the pandemic and how it recovers after the pandemic will be crucial.

Portfolio resilience

Private equity firms themselves have faced their own challenges due to the pandemic. The funds briefly halted active trading in March 2020 as economies shut down and people were told to stay home. All attention has instead focused on a near-urgent “triage” assessment of their portfolio companies at the start of the pandemic, with origination and portfolio teams working together to support their portfolio management teams.

Ironically, many sponsor-backed businesses have found it difficult to access government-backed loan schemes in the UK, such as the Coronavirus Large Business Interruption Loan Scheme and the Coronavirus Business Interruption Loan Scheme, due to the laws of EU on state aid to “companies in distress”.

The typical private equity investment structure using quasi-equity debt instruments to finance investments was the root cause. However, most took advantage of the job retention scheme by laying off employees and sought to access grants and deferment of accumulated debt from HM Revenue and Customs to weather the storm. Needless to say, in some cases this resulted in a squeeze on working capital, and any additional funding had to come from existing lenders and/or equity injections from the private equity firms themselves. The question now is how much of this dry powder was used to support their portfolios to maintain the status quo for 12 months, and what impact does this have on their ability to make new investments?

However, despite the uncertainty, many private equity firms are adapting and are keen to acknowledge the patience and understanding of their backers in a difficult time for the business world. Similarly, there will no doubt be opportunities to acquire certain assets more cheaply as some businesses fail in the post-pandemic market. These can provide complementary opportunities for existing portfolio investments or create a new investment in the platform.

We are undoubtedly entering uncharted territory and, unlike previous recessions, the pandemic could have long-term effects on consumer behavior and business patterns.

Like all other markets, private equity must negotiate the current economic crisis induced by Covid-19. However, the industry is extremely well positioned to weather the storm, as one of the key characteristics of private equity is its ability to be agile and react quickly to changing trends.