Private equity


Financier Worldwide Magazine

April 2014 Issue

April 2014 Issue

Following a disappointing 2012, the PE industry saw a stable level of deal activity in 2013, with financing largely available and a good number of deals getting done. Bank appetite to provide financing for leveraged buyouts continues to improve, and liquidity in the market is coming from both traditional and non-traditional sources. The current level of dry powder means PE funds have plenty of cash to put to work, and competition for the best deals is fierce. However, registration and compliance obligations are reshaping the industry.

FW: How would you describe trends in private equity dealmaking over the last 12-18 months?

Day: We experienced a very busy year in 2013, consistent with a high level of activity in the private equity market generally. The year was characterised by strong exit activity, moderate buyout levels, and significant capital raising. Canadian aggregate deal value and volume was down 10 percent and 15 percent respectively, year over year. While Canadian pension plans are continuing to become more significant direct investors in both Canada and abroad, activity was down amongst them in 2013 over 2012. Canada’s pension plans were still involved in several of the most significant Canadian private equity deals in 2013. There were notable examples of club dealmaking among Canadian pension plans, as well as co-investments with private equity funds as well as some very successful exits.

MacGarty: Exits have continued to significantly outstrip investments in Europe over the last 12 months with many PE firms seeing this as a sellers’ market. Although willing, sellers are still looking to achieve strong returns on their investments and maximise returns to investors, particularly as they have frequently been holding on to an investment longer than they originally anticipated, which has impacted their IRR. Sellers have been buoyed by the recovery of the public markets and increasing EBITDA multiples on exits and are looking to achieve similar multiples. So PE firms are keen to sell but on the buy side they remain cautious, and the difference in valuations between sellers and buyers remains wide. PE firms are fully aware of the challenge of meeting targeted returns in the face of significant headwinds and are concerned about making investments which may be overvalued.

Mann: Several trends developed or continued in private equity dealmaking over the last 12 to 18 months. Private equity buyout transaction volume declined in 2013, while growth equity and portfolio add-on transactions continued to increase. Exits also increased somewhat in 2013, in part because of successful initial public offerings. Also among the trends were the continued decline in the level of debt used to fund private equity transactions in 2013 relative to 2012, and an increasingly challenging environment for deal sourcing, as the amount of capital available for investment increased and purchase price multiples rose. Another trend that occurred over the last 12-18 months was the apparent decline in the number of private equity transactions involving monitoring fees or transaction fees. That trend developed as a result of investors’ growing dissatisfaction with those fees.

Roberts: In 2013 we saw a stable level of post-crisis deal activity with financing being largely available and a good number of deals getting done. Stability might have been a negative description of the industry in 2006 – before the financial crisis hit. Today, it is a good thing. Stable growth might sound little exciting to an industry that was used to exorbitant growth rates only a few years ago. In my view, it is a healthy development.

Scott: We have seen a general pickup in the volume of quality deals coming into market. Reasonably priced debt is easily available in North America, but more difficult to access in Europe and the UK, which has made deal certainty in those regions very important to sellers. Sellers there are seeking buyers who can cover a purchase price quickly. We see quality businesses priced high and selling quickly, but weaker businesses struggling to be sold.

The days of financial engineering and multiple arbitrage are long gone, and private equity finds itself in an era where value creation is the clear driver of equity stories.

FW: Could you comment on recent deal activity involving PE firms in your region? Which key sectors do PE firms seem to be targeting and why?

MacGarty: While deals among PE firms have remained fairly flat, there has been a strong resurgence in the IPO market. This has provided a much needed route for PE firms to either fully dispose of portfolio companies or to return some capital to investors through partial dispositions. PE firms hope that this trend continues, particularly while PE firms and corporate buyers remain cautious. Exits of European businesses by IPO reached record levels of around €25bn in 2013 and included listings of Taminco, Constellium, Esure, Stille & Linde, Merlin Entertainments and Moncler. PE buyers haven’t zeroed in on any particular sector over the last 12 months, rather they have remained largely opportunistic and driven by value rather than sector, and the number of funds in the market with broad investment strategies ensures all sectors can get attention. There has, however, been continued caution about the recovery of Europe from the debt crisis, particularly among non-European funds, and investment has focused particularly on the UK and Germany as perceived ‘safer’ jurisdictions – in aggregate they accounted for over 50 percent of European deal activity by value in 2013.

Mann: Recent private equity deal activity in the US has been strong. The Mid-Atlantic and the South were leaders in attracting private equity investments in 2013. According to industry data, in 2013, private equity transactions in the Mid-Atlantic and the South comprised approximately 20 percent and 17 percent, respectively, of all US private equity deal flow. The Heinz, Dell, BMC Software and Neiman Marcus buyouts, together with other large transactions, caused the Mid-Atlantic and the South to lead in capital investments in US companies in 2013. Private equity firms appear to be targeting a number of sectors that have significant growth potential over time. Broadly, and in no particular order, some of those sectors include technology, information technology, life sciences, communication, healthcare, education, business services, energy and consumer goods.

Roberts: Unsurprisingly, the landscape has not changed much since 2012. Funds continue to see their highest potential in the traditional mainstay of German small and medium-sized enterprises, the core of which is engineering and industrial innovation. We also found a rising interest in targets in business services and the consumer industry.

Scott: We’re seeing many very interesting tech deals and very compelling consumer goods deals. The market is strong for companies with very good brands, like Tyrrells English Crisps or Fever Tree. We’ve also seen German confectionary coatings specialist Capol and Italian swimwear producer Arena generate nice returns and we are excited about our recent purchase of Mec3, an Italian gelato ingredients company. These upper-end branded businesses are thriving. The health of premium products is a good sign for the broader market. Additionally, the tech sector seems very healthy. We’re seeing a lot of activity in Poland, Scandinavia and elsewhere driven by very clever tech concepts and emerging tech businesses.

Day: Overall, Canadian deal activity by volume fell slightly in 2013 and was dominated by several large transactions, which accounted for more than half of aggregate transaction value. Canadian deal activity in the buyout space rose 5 percent year over year, reaching C$12.3bn, its highest level since 2008. Much of this activity was carried out by domestic managers, and was focused on exits. In 2013, the oil and gas sector led Canadian private equity investment, with mining coming in second as the resource sector continued to attract strong interest. Lower commodity prices have driven sponsor involvement in both the oil sands and related services. The mining sector has historically not been a major focus for private equity funds due to risks associated with rich valuations and underlying commodity price and earnings volatility. In recent times, however, Canadian and US managers have given greater attention to mining, through raising sector focused funds and increasing or adding mining allocations to existing funds.

FW: How healthy is the appetite of banks to provide financing for leveraged buyouts? What equity contributions are PE firms typically required to make towards transaction values?

Mann: Bank appetite to provide financing for leveraged buyouts is good and continues to improve. Although the availability of credit and the terms on which it is provided vary based on financial metrics and creditworthiness of the borrower, overall there have been significant improvements in the supply of credit since the days of the credit crisis. In order to increase demand for bank credit, in some instances banks also are making loan covenants less restrictive. In our experience, in the mid-market, debt levels are typically in the range of 60 to 70 percent, with equity contributions ranging from 30 to 40 percent, although equity contributions are significantly higher in some transactions. In some larger transactions, debt to equity ratios may be higher. Generally, leverage multiples are now in the range of 4 to 4.5x adjusted EBITDA for senior debt, and 6 to 6.5x adjusted EBITDA in total leverage. Recently, a few larger banks have declined to fund certain large very heavily leveraged buyout transactions as a result of concerns that they would exceed guidelines issued by banking regulators that limit the debt to EBITDA ratio for such transactions.

Roberts: In 2013, only a small number of funds wanted to utilise, or were able to obtain, debt financing over 50 percent of equity value, whereas in 2006 the ratio of equity to debt might have well reached much higher levels of 60 percent and more. The average equity to debt ratio is much more conservative today with 40 percent, appearing to be the new norm, however we are noting on the larger transactions at the start of 2014 that this ratio has begun to increase again, reflecting confidence in the underlying global economics and the quality of the assets concerned.

Scott: It’s quite clear that banks are returning to the markets in places like the UK. Banks have a good appetite for deals, but their processes are more thoughtful and are requiring more time. While debt is available for good companies, it can be a lengthy process. If a private equity firm has the ability to underwrite a deal and ensure deal execution, it is a competitive advantage in this market. For example, when we acquired military training simulation specialist Bohemia, we did not have senior debt finalised, but we were able to use a dedicated short-term credit facilities that we have through established banking relationships, and then finalise senior debt later.

Day: Availability of financing from both US and Canadian lending institutions remains strong and is generally available on favourable terms. In Europe, many of the banks have dramatically reduced their appetite to lend to small and medium sized businesses, and a number of ‘alternative’ or non-traditional lenders have stepped in to fill this gap. While leverage multiples have been steadily rising, they have yet to reach the levels seen leading up to the financial crisis. In 2013, the average debt or EBITDA multiple paid in the US was 5.3x, compared to 6.1x in 2007. Dividend recapitalisations continue to be of interest to fund managers who are looking to drive returns to their investors given current low interest rates.

MacGarty: The debt market is buoyant and there is good liquidity in the market, both from traditional lenders and also credit funds and other new lenders. Lenders are particularly focused on the best assets where competition between US and European banks and the high yield market has driven down pricing and led to enhanced terms including a shift back towards covenant-lite financing terms. As traditional lenders have focused on safer assets since 2007, the new lenders have filled the need for higher risk lending, and unitranche is becoming more common, particularly on small and mid-sized deals. As traditional lenders’ appetite for risk begins to return, we are also starting to see collaboration between traditional and new lenders, such as the recent arrangement between Barclays and BlueBay.

PE firms are struggling to understand and react to a raft of regulatory changes seen over the last few years. The main issue causing headaches for PE firms at the moment is AIFMD.

FW: Are PE firms employing any particular strategies or techniques to complete deals in the current market?

Roberts: It is unsurprising that secondary or tertiary buyouts rank below primary transactions as the key source of new transactions in the current environment, as the equity story is usually clearer and the potential for value creation greater. This underscores the increasing focus on origination that we see amongst the private equity houses, with certain of them using dedicated origination teams. Other prominent changes to have occurred are more focus on active portfolio management with an increasing use of in-house operational partners, and a rise in cooperation with strategic investors. From what I see there is also tendency for private equity houses to be a bit smaller. A private equity fund that had 10 employees before the crisis might only work with a team of six or so today, but the set-up is more operationally focused and the mix of staff correspondingly different to what it was five years ago.

Scott: Funding is the key. Firms must be very clear with sellers about how they can close the deal, and around the level certainty of debt prior to close if that is required to do the deal.

Day: Fund managers are constantly seeking to differentiate themselves from their competition in terms of deal sourcing and relationship building. Firms are increasingly expending significant effort on building their networks and utilising advisers to further expand the reach of their investment teams’ dealmaking ability. Fund managers see relationship building and differentiated deal sourcing as means of becoming preferential buyers and hopefully an opportunity to reduce pricing pressure. While proprietary deals are mostly non-existent, certain managers are often able to generate unique and differentiated deal opportunities.

MacGarty: The current level of dry powder means PE funds have a lot of cash they are looking to put to work. The same is true of corporates who are looking to get some form of return on their increasing cash reserves. These drivers, mixed with the availability of cheap debt, mean that competition for the best deals is fierce. And not only are PE firms up against other PE funds and corporates, many sellers are pursuing IPOs and other exit strategies simultaneously alongside auction processes to maximise that competition and achieve the best return. When PE firms are engaged in a multi-bidder scenario, they are pushing harder than ever to get ahead in the race and secure exclusivity while at the same time hedging their bets – holding back as much as possible on detailed due diligence and minimising adviser costs to minimise abort costs. Some PE firms are choosing to sit out competitive processes as they don’t believe they will be able to secure the investment on favourable terms, instead focusing on proprietary deal sourcing and increasing the value of their existing portfolio and returning value to investors in other ways.

Mann: In the current market where the supply of transactions is limited relative to demand, some private equity firms are targeting smaller transactions that may be easier to gain access to and complete. They are also participating in some transactions by making co-investments with others. In the current market, which is characterised by slow economic growth, private equity firms are making more growth equity investments, meaning acquisitions of minority interests in growth companies that are substantial and profitable. Growth equity investments usually involve a small amount of leverage to increase returns and can be more effective than organic growth. On the sell side, some firms are using auctions to improve efficiencies and to increase sales prices.

FW: What methods are PE firms using to build value across their portfolios and improve returns on exit?

Scott: There’s a general theme of applying operational skills to businesses to help them grow. This differs between firms. We apply two strong levers to drive value. First, we have a very broad operator network because we’ve been doing it for decades. You need to have a very effective way of deploying these resources. Secondly, we leverage our international infrastructure. This is vital in the EU, where many firms need international growth to really thrive. Our resources in Asia-Pacific and North America are really helpful. We have people on the ground that understand local markets. This helps us support expansion without heavy investments. Bohemia opened a small but very strategic sales office in Poland – we used our staff to support that with legal, HR and other help to greatly reduce costs on Bohemia. Our LPs expect to be able to identify clear operational gains and plans. Without tangible resources to add value, firms are looking more and more like dumb money.

Day: Fund managers learned lessons about the imprudent use of leverage during the financial crisis. Post-crisis investment strategies have focused less on the use of leverage in driving returns, and the era of purely financial private equity deals is over. LPs have realised that financial engineering is less of a source of true value-add than is operational enhancement, and that leverage is indeed a significant source of portfolio risk. Firms have shifted to a focus on using operational expertise to build value across their portfolios. There has been a drive towards taking a holistic approach to value creation in portfolio companies, through the use of multiple levers including through operations excellence, and the implementation of proprietary business improvement frameworks.

MacGarty: First and foremost, the availability of cheap debt has allowed PE firms to refinance on better terms and improve the cash flow and profit margins of portfolio companies. When PE firms have not been focused on exits in the last year, they have been focused on refinancing. PE firms have also become more actively involved in the management of portfolio companies in recent years – they have always looked to create efficiencies and cut headline costs, and they are continuing to do so, however they are now also using methods traditionally more relevant to strategic buyers. They have focused on synergies among current portfolio companies and also with potential acquisitions – seeking to leverage overlaps in their portfolios to reduce costs and put pressure on seller pricing terms; proactively cross-pollinating clients; scrutinising management and sales teams; focusing on best practices and so on.

Mann: Private equity firms sometimes implement a buy and build strategy in order to build value and improve returns on exits. The strategy can be effective when there is a strong management team to integrate the target companies into the private equity firm’s existing portfolio. Other methods include hiring talented and experienced operating partners to manage portfolio companies; appointing independent directors with industry expertise and an operating background to the boards of portfolio companies and compensating them with equity; and reducing portfolio company costs and creating efficiencies.

Roberts: The days of financial engineering and multiple arbitrage are long gone, and private equity finds itself in an era where value creation is the clear driver of equity stories. Operational improvements and ‘buy and build’ were top of the strategic agenda in 2013 and will continue to be the strategic focus in 2014. The increasing trend of hiring operational and strategic partners into the private equity firms themselves to support is something we consider to be a feature of the ongoing operating model that has redefined itself post-crisis.

One of the challenges is the change to funding and the way deal fees and management fees are being reduced. This gives management challenges to firms, as firms’ revenues are changing dramatically and rapidly.

FW: What legal and regulatory issues are shaping the PE industry at present? In your opinion, how will compliance challenges impact the asset class in the long term?

Day: Private equity has been impacted by a number of high profile regulatory changes following the financial crisis. Dodd-Frank, Basel III and Solvency II have all altered the North American and European private equity landscape through adding costs, creating challenges, and opening opportunities for various players in the space. While the full impact of these changes – and others – has yet to take shape, firms have felt added pressure to staff up compliance departments, and have faced added costs in anticipation. Banks and insurance companies have begun to pare down their proprietary investment shops, and have reduced the amount of capital exposed to private equity risk. This will continue to have a positive impact on the supply of opportunities available in the secondary market.

MacGarty: PE firms are struggling to understand and react to a raft of regulatory changes seen over the last few years. The main issue causing headaches for PE firms at the moment is AIFMD. There has been so much uncertainty over the directive, when it will be adopted and how it will be interpreted in each country. The uncertainty has made it very difficult for PE firms to decide whether they want to be within the directive and benefit from the marketing passport or whether they want to keep outside and minimise the burden and costs that come with it. This issue is particularly difficult for some smaller PE firms which are not set up to handle the complexities it requires. Where PE firms are staying outside the directive, they need to work out a marketing strategy which differs on a country by country basis to ensure they are not caught within the regulatory net, thereby requiring registration.

Mann: The legal and regulatory landscape is becoming increasingly challenging for the private equity industry. Registration and compliance obligations stemming from Dodd-Frank, FATCA compliance and AIFMD requirements are among the issues shaping the private equity industry. As a result of new compliance requirements, firms are implementing new systems, policies and procedures which are changing their operations significantly. Those changes are increasing costs and stretching resources substantially. In some instances, legal and regulatory changes are creating uncertainty and causing unintended consequences. For example, due to uncertainties regarding AIFMD requirements, some fund managers are declining to offer interests in Europe, which could have the effect of decreasing the number of private equity funds available to European investors. Prohibitions against sponsorship of private equity funds and restrictions on ownership of private equity interests by insured depository institutions and their affiliates mandated by the Volker Rule also are shaping the industry.

Roberts: The industry is faced with a continually increasing regulatory environment, though this is not a recent development as demands for greater transparency and regulation have been a feature of the private equity space for many years now. As with the redefinition of their operating model, the industry continues to adapt to meet these demands, with the fundamental basics of why private equity is a robust and attractive asset class remaining intact. The industry has welcomed these challenges and will accommodate them as required.

Scott: It is very clear that the need for rigorous compliance to financial standards is present in all we do. It adds cost and complexity, but it’s useful and reasonable, and it benefits LPs for us to adhere to strict standards. It adds a layer of complexity, but it is very worthwhile and reasonable.

FW: What are the major challenges facing fund managers in the current market? In your experience, have PE firms made a concerted effort to enhance their approach to risk management in recent years?

MacGarty: The major challenge is deciding whether or not to invest, and when to sell investments. There is a pressure on PE funds to invest cash, to put the money they have raised to work in order to start generating returns for investors – and themselves. They will need to build up a solid track record for the next fundraising and show investors that they can invest that level of commitments. However, PE firms are aware that a poor track record will have a detrimental effect on future fundraisings and so remain cautious – there have been so many horror story investments over the last few years that some PE firms fear making all but the safest investments. This is putting PE firms in a quandary in terms of the best approach to take on investments. A similar dilemma confronts them on exits – other than those investments which attract significant interest and a competitive process, it is difficult to find a valuation which is attractive to potential buyers while also generating a good return on the investment, and some PE firms are preferring to hold the investment in the hope of a better return in the future, particularly as the global economy continues to improve.

Mann: One of the major challenges facing fund managers is sourcing quality deals in a very competitive investment environment. A closely related challenge is acquiring investments at reasonable multiples. Funds have record levels of capital available for investment and that capital is chasing a limited number of transactions. Managers that are unsuccessful in securing investments may find themselves in the unfortunate position of returning capital to investors and foregoing management fees and the potential for additional investment returns. Where managers overpay for investments, returns are compromised and losses could be incurred. In both circumstances, the reputations of fund managers may be tarnished. As noted, regulatory compliance is another principal challenge faced by fund managers. In my experience, in recent years private equity firms have made a concerted effort to improve their risk management systems. They have adopted and implemented risk management measures and have trained their staffs to employ those measures in their day-to-day work.

Roberts: The major challenge we see currently within the German market is the concern over a sufficient number of quality assets coming to market to make use of the available levels of capital and debt. This is slightly paradoxical given the availability of funds and the economic outlook both locally and globally, which would indicate that this should be a ‘seller’s market’, however, nobody is predicting, at least at the moment, that there is a boom on the horizon. While Germany itself remains a core focus for European private equity investment, the challenge remains to put the money to work in this deal flow environment, which is stable at levels significantly lower than pre-financial crisis times. Risk management was always a key focus of funds, with governance and sustainability topping the agenda in recent times. The regulatory environment has enhanced the need for transparency in this respect, but not necessarily a change in the underlying approach to managing the risk itself.

Scott: One of the challenges is the change to funding and the way deal fees and management fees are being reduced. This gives management challenges to firms, as firms’ revenues are changing dramatically and rapidly. This is very much gearing private equity to longer-term success, and requiring firms to run lean and look hard at the value of everything they do. It’s also having a necessary effect on improving risk management.

Day: The primary challenge currently facing fund managers is competition in both fundraising and dealmaking. The industry has seen a notable increase in competition in many segments of the market. There are a record number of private equity funds currently raising capital following a strong 2013, all of which are seeking capital from investors that are becoming more discerning and selective in their due diligence and investment decisions. The growing preference of many investors to make relatively large allocations of capital to a relatively smaller number of managers with whom they are most confident has magnified the other forces driving competition. In our experience, private equity firms have made an effort to enhance their approach to risk management through building out operations-focused portfolio management teams and through developing independent advisory committees. Canadian institutional investors see these developments as positive, and continue to monitor the progress of these efforts.

Limited partners continue to be focused on the length and quality of track records, stable and deep management teams, as well as sound investment theses.

FW: How has private equity fundraising fared in the last 12 months? What characteristics are limited partners looking for when committing funds?

Mann: Private equity fundraising during the last 12 months generally fared well and yielded significantly better results than in 2012. Top-tier firms generally have been quite successful with their fundraising efforts. Some funds have been oversubscribed. As a result of increased investor demand, some fund managers enjoy superior negotiating power relative to investors. On the other hand, some first time fund managers and firms with less impressive prior performance histories did not reach their fundraising targets.

Roberts: The consensus prevails that fundraising is more difficult than before the financial crisis, however we have seen numerous successful and large new fundraisings in the last 12 months. The terms are getting more stringent and the time taken to get to closing has on average increased, however the continued robustness of the private equity model remains intact and the industry is, as before, an attractive asset class for investors.

Scott: The fundraising market in the last 12 months has been almost binary, with top-quality funds closing at or near their hard cap within a few months while other funds struggle to gain traction and may stay in the market 18 months or more. LPs seem to be increasingly selective when choosing which GPs they are going to support, with both new and existing relationships. In terms of quantitative metrics, LPs are looking for a GP with a proven track record, cohesive senior team, multiple realisations in the most recent fund and clear sources of value creation across the portfolio. On the more qualitative side, LPs want to see how a GP expects to generate deal flow, what lessons they have learned from investments that went wrong and how they think about the market landscape.

Day: Strong fundraising momentum continued in 2013, with the largest amount of capital committed since the financial crisis in 2008. According to Preqin, 2013 saw $481bn raised by 955 private funds. In Canada, private equity fundraising reached C$16.1bn by 35 managers, more than triple the amount raised in 2012 and the highest level since 2006. There continues to be a bifurcation of managers with access to certain funds being highly competitive from the LP perspective, while other fundraisings continue to take place over protracted timeframes and are relatively easy to access. High profile funds are closing very quickly and are often oversubscribed. Terms in these instances are often nearly fixed, and priority is given to re-upping LPs and those that help diversify the manager’s LP base. Less competitive raises see LPs negotiating with GPs for preferential terms over significantly longer timeframes. Limited partners continue to be focused on the length and quality of track records, stable and deep management teams, as well as sound investment theses. We maintain relationships with a global stable of high quality managers that have met these criteria and believe that these managers will continue to outperform.

MacGarty: Fundraising has generally been strong, with 2013 seeing the highest amount raised globally since 2008. Investors are maintaining broadly consistent allocations to the asset class. However, a continued flight to excellence among investors combined with the number of PE firms out in market throughout 2013 means the number of failed or disappointing raises remains significant. Investors have been focused on PE firms with the best track records – both in terms of returns they are generating and in terms of their ability to exit investments and return cash to investors. They have also been focused on stability of the investment team. These concerns have made it difficult for first time funds, however there have still been PE firms launching successful first time funds, generally where they had clearly identified investment strategies which have resonated with carefully targeted investors.

FW: How has the relationship between general partners and limited partners evolved in recent years? What affect is this having on the fundraising process and on fund management in general?

Scott: The relationship between GPs and LPs has certainly evolved over the years. We find today that LPs increasingly require more information from the breadth of diligence materials requested during fundraising to the depth of information in quarterly reports once an investment is made. While the degree of transparency varies, many GPs aim to have an active and transparent dialogue with their LPs, informing them of significant events that may affect their investment or giving in-person updates outside of fundraising. We see a trend towards LPs looking to consolidate the number of GPs in their portfolio and with that an increased level of diligence even on investments that are re-ups with an existing manager. GPs certainly need to make sure that they are placing the appropriate emphasis on their investor relations efforts to ensure that their LP base is well-informed and is satisfied with their performance.

Day: The relationship between investors and managers has evolved significantly in recent years. LPs have become more active and empowered throughout the investment process. GPs have started to seek out ‘smart money’ LPs who can add value throughout the life of a fund as opposed to simply providing capital. In general, fund terms have become more beneficial to LPs over time, while LPs have become more demanding in terms of the fund management processes they expect to find. Strong LPs expect to have frequent updates with managers, both in person and through conference calls and online. Another significant trend is the increasing prevalence of ‘shadow money’ in the private equity sector. Institutional investors are putting capital to work in ways that are outside the traditional GP-LP relationship. Part of this trend is the growing interest of LPs in co-investment and separately managed accounts. Large Canadian institutional investors have also been at the cutting edge of building in-house teams to source and invest in deals directly without the involvement of a GP.

MacGarty: The balance of power has shifted significantly towards limited partners in the last few years, leading to pressure on fund terms and an ever growing laundry list of requirements. In particular, the level of management fee has come under scrutiny, both in terms of the headline rate and in a move towards 100 percent offsetting of fees. Investors have been seeking enhanced transparency, disclosure and governance. Due diligence processes are far more laborious than they were even five years ago. Investors are also looking at ways of improving their returns through deeper relationships with PE firms – in return for large or longer term commitments, investors are looking for tailored structures or separately managed accounts, increased co-investment opportunities on lower or no fee/ carry terms and, in some cases, a share of management fee revenue and carried interest. Despite having to concede on some of their economics or operational flexibility, PE firms are welcoming both the large cheques and the stability this brings.

Mann: During and immediately following the financial crisis, fundraising was a challenge for many funds, and, generally, the balance of negotiating power between general partners and limited partners seemed to shift in favour of limited partners. During that time, certain limited partner approval rights and other corporate governance provisions, reporting rights and general partner disclosure obligations were incorporated in the governance documents of some funds at the request of large institutional limited partners. Also during that time, some large institutional limited partners began to evaluate their relationships with general partners with which they had investments and began to terminate some of those relationships based on performance and other factors. More recently, for many funds, the balance of negotiating power has shifted back a bit, due to the abundance of demand for fund interests. Notwithstanding that apparent shift, some governance provisions, reporting rights and general partner disclosure obligations continue to be included in the governing documents of many funds, which has helped to balance the relationship between general partners and limited partners. Improving corporate governance and transparency and expanding limited partner rights has helped to make some funds more attractive to limited partners.

The ability to use general advertising and general solicitation in the US in connection with certain private placements will be a key opportunity for many private equity firms in the coming months.

FW: Going forward, what do you predict will be the key opportunities and challenges facing private equity firms over the coming months? How do you expect PE activity to fare through 2014?

Scott: It is going to be a more active, busier and positive year. A number of markets are heating up nicely. We see a lot of opportunities with exciting growth-oriented businesses. Now is a great time to take exciting businesses that are thriving in one region and helping them enter new regions like Asia, where supercharged growth is possible. The challenge is in identifying truly exceptional businesses and not overpaying for those companies. There are fantastic opportunities in consumer goods and technology. If you can overcome the operational challenges, you can take good little companies and really accelerate growth.

Day: Overall, we expect an active market in 2014 with stiff deal competition on the horizon, fuelled by a significant amount of investable private equity capital resulting from a strong fundraising year in 2013. This deal competition will translate into more competitive processes in all fund strategies and frothy valuations. Key areas of focus in 2014 include identifying opportunistic secondary transactions, minority stake investments, and investing in segments below the typical range of enterprise value and revenue most firm’s target. Canadian deals are increasingly seeing new names involved in public and private company auctions, as large global private equity players are dedicating more time and personnel to investing in and raising equity within Canada to broaden their opportunity set and LP base. We expect the middle market as well as minority equity investments to be active areas in Canadian private equity in 2014.

MacGarty: The IPO market for 2014 looks set to continue the strong trend from 2013, with a host of early listings including Pets at Home and Poundland. That should encourage further strong exit activity this year and continue to provide liquidity to investors and fuel returns. That, in turn, should further allay investor fears over the illiquidity of PE investments and encourage investors to put that money to work. There remains a huge amount of dry powder which PE funds are looking to spend. So the outlook is bright in 2014. However, the extent of the reliance on public markets makes this a fragile recovery: the level of sales to PE firms and corporate buyers needs to pick up in order to help stabilise the market. PE funds are continuing to extend their funds’ terms as they struggle to realise remaining assets, and they are looking for ever increasing EBITDA multiples to try to recover their targeted IRRs on those assets. So, while the outlook for fundraising and dealmaking in 2014 is more promising, the growth looks set to remain slow and steady rather than exponential as PE firms gradually look to exit the mature investments that have accumulated over recent years.

Mann: The ability to use general advertising and general solicitation in the US in connection with certain private placements will be a key opportunity for many private equity firms in the coming months. Use of general advertising and general solicitation has the potential to increase exposure for private equity firms, which could result in more successful fundraising for many of them. With respect to transactions, one of the challenges facing private equity will be acquiring quality investments at reasonable prices in the face of intense competition for a limited number of deals. Foregoing conventional buyout strategies and developing more innovative deal strategies could create significant opportunities for private equity firms. Legal and regulatory compliance, such as implementation of AIFMD and FATCA will continue to challenge private equity firms in the coming months. Although it appears that deal sourcing will be a challenge again in 2014, I anticipate that private equity activity will fare well through 2014, absent any significant hiccups in the economy. 

Roberts: Even though the larger exits from private equity funds have been dominated by secondary or tertiary transactions, I believe that overall strategic buyers will continue to dominate the buyer landscape. As for future sources of deals, we expect an increase in deals from private owners and corporate spin offs. This reinforces the fact that deal origination is now even more important than before, with less of an appetite for secondary transactions. In any case, we are excited to see how the industry will develop. The majority of funds share a more optimistic view than in prior years. Stability and moderate growth best describe the current state of the industry. We expect this trend to continue throughout the next few years. As stated earlier, concern remains over a sufficient number of quality assets coming to market to make use of the available levels of capital and debt.

Martin Day is a partner at Caledon Capital Management, an independent private markets investment specialist and portfolio manager based in Toronto, Canada. Caledon provides customised global private equity and infrastructure investment solutions for institutional investors by building unique portfolios of funds, secondaries and co-investments. Mr Day has over 20 years of experience in private equity and corporate M&A. Prior to Caledon, he was managing director at OMERS Private Equity.

John MacGarty is a partner in the London office of Kirkland & Ellis International LLP. John’s practice focuses on both private equity fund formation, including structuring private equity funds, managed accounts and co-investment platforms and sponsor management and advisory vehicles, and on M&A and corporate financing transactions, as well as general corporate counselling.

Kimberly V. Mann is a partner in Pillsbury Winthrop Shaw Pittman LLP’s Corporate & Securities practice. She is the leader of Pillsbury’s Private Equity group. Ms Mann focuses her practice on investment fund formation and maintenance. A significant aspect of her practice also involves representation of large institutional investors in connection with their alternative investments.

Steve Roberts leads PwC’s Private Equity practice in Germany. He has worked exclusively within the M&A field since 1998. Having primarily worked on cross-border transactions during his time in the UK, he transferred to the Frankfurt office in July 2001 where he has focused upon serving the private equity market and was promoted to partner in July 2005.

Martin JJ Scott joined The Riverside Company in 2012. Prior to this he served as a partner and head of Operations at KPMG; investment managing director at Crownway Private Equity, and a consultant at McKinsey & Company. Mr Scott holds a Ph, D. in Machine Learning and Artificial Intelligence from Cambridge University and a BA Computer Science from Trinity College Dublin.

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Martin Day

Caledon Capital Management


John MacGarty

Kirkland & Ellis International LLP


Kimberly V. Mann

Pillsbury Winthrop Shaw Pittman LLP


Steve Roberts



Martin JJ Scott

The Riverside Company

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