A better rebuild: Private Equity in the new reality

Keeping the financial markets moving  |  Towards a better tomorrow  |  Making an impact |  A force for good

Amidst the uncertainty and disruption of 2020, one beacon of light continued to shine brightly for investors: Private Equity. In part, the sector’s resilience was a self-fulfilling prophesy; its constant focus on finding value opportunities and its long-term outlook on investments provided the sector with a certain level of insulation against the gyrations of the markets.

Private Equity’s focus on providing strong management capabilities alongside capital proved invaluable. While other growth companies quickly found themselves isolated and uncertain about the future, PE portfolio companies were able to tap into a wealth of expert advice, support and management services to help them deal with the initial impacts. They worked together to overcome obstacles and challenges. They pooled their resources and shared ideas.

The fact that most PEs were well capitalized coming into the crisis also helped. Indeed, as the broad economic and social impacts of the pandemic became clearer, Private Equity funds were able to assess their portfolio companies against expectations for the ‘new reality’ and invest accordingly. Since the start of the pandemic, we have worked with dozens of PE clients to help conduct regular ‘pulse checks’ on their portfolio companies, enabling PEs to better pivot and prioritize as the market evolved.

Many looked to enhance operational capabilities across their key companies. Transformative investments were quickly made into new technologies to support HR, CRM, workflow management and supply chain optimization, for example. While government funds were helping other companies survive the pandemic, many PE portfolio companies were investing for the next stage of growth. 

The impact PE has had on the resilience of the global economy is worth noting. Consider, for example, the economic benefit created by ensuring a significant proportion of the world’s fastest-growing private companies remained liquid and operational. Many of the largest PE funds actively dissuaded their portfolio companies from taking government emergency measures. This resulted in more funds left on the table for the mom-and-pop shops who couldn’t call on a deep-pocketed investor.

Beyond being more financially resilient, PE-backed companies are also better positioned strategically to help drive the return of growth in the new economy. Where public companies are often focused on surviving the next quarter, portfolio companies are figuring out how to grow the future. And that gives them the opportunity to drive the type of innovation and creativity that will be needed to support regrowth in the new environment.

PE also provides a somewhat obvious financial market benefit by creating value through their investments. Throughout its history, PE has always had a strong reputation for finding value opportunities and growing their investments. And this market has created a mountain of value opportunities. PE has flooded capital into the gap (2020 set records for the number of PE investments made¹).

PE’s resilience has certainly been noteworthy, but it is the sector’s contributions towards ‘building back better’ that are most worth celebrating. Indeed, PE is rapidly emerging as a positive force for sustainable and equitable long-term growth. Investors, stakeholders and citizens are pleased.

The trend towards longer-term PE investments has been underway for the better part of the decade. Whereas in the past, PE often took a ‘buy and divest’ approach, many PE funds are now taking a much longer-term view focused on buying, holding and growing their investments. They are often more interested in the intrinsic future value of the asset than the current book value of its parts.

Indeed, rather than breaking companies apart, most PE funds are now focused on bolting them together to build something bigger than the sum of their parts – so-called ‘platform plays’. Essentially, these PE funds are focusing on highly-fragmented (often emerging) sectors where they use their capital and management expertise to bring together a handful of compatible companies into a single platform. Sometimes it’s creating an end-to-end technology platform. Other times, it’s creating the largest network of urology labs in the region.

Regardless, the focus on long-term value creation is clear. And that translates into stronger, more vibrant and forward-looking companies that are not only better placed to serve their customers and stakeholders, but also better positioned to withstand future disruptions and economic shocks.

The trend towards more equitable and sustainable investing within the PE sector seems to be moving into the mainstream in earnest. Just a few years ago, most managers we talked to seemed to see a natural conflict between ‘impact’ and ‘returns’.

Today, few (if any) have the same misgivings. The majority of large PE funds have announced the launch of a major – US$1 billion plus – Impact Fund over the past two years. Specialist funds focused on environmental technologies, sustainable products and social impact have been popping up at an increasing rate. More and more, managers seem to be competing to see who can deliver the greenest returns rather than the biggest returns.

Many funds are also refocusing their attention on their Environmental, Social and Governance (ESG) records. Take Diversity and Inclusion, for example; recognizing that the sector has often lacked gender and racial diversity, we have seen most reputable PE firms now start to take a much more active role in addressing the issue.

On the one hand, they are setting some expectations around board and management diversity within their portfolio companies. At the same time, they are also working hard to diversify their own management teams. Over the past few years, we have seen the proportion of women and minorities entering the PE sector increase. Many funds have also been actively recruiting veterans and other service personnel. Positive action on the diversity agenda is good news: a greater diversity of views at the fund management level and at the portfolio company level will inspire new ideas, broaden perspectives and, ultimately, lead to stronger growth, better returns and enhanced risk management.

At the same time, we have seen a number of PE firms take positive action on key issues such as climate. Many believe that they can enhance overall sustainability and profitability of their portfolio companies by ensuring they pay their employees a living wage. No data has yet been produced. But anecdotal evidence suggests a strong causal relationship does exist.

Clearly, it will take some time – maybe years – before the full impact of the pandemic and the effectiveness of PE strategies can be properly assessed. No doubt, hindsight will reveal many lessons. However, our view suggests that the PE sector has delivered great confidence and certainty in a period of disruption. It has provided a critical lifeline for countless private growth companies. It helped drive capital towards value opportunities and the creation of bigger, stronger companies. And, now, it is serving as a positive force for good in the drive to rebuild a more sustainable and equitable world economy.