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Challenging times ahead for Mid-Market Private Equity (PE)? – Turning looming risks into opportunity

Posted by | Mangesh Kolhatkar

A time of reckoning

Following a decade-long bull run, exuberance in the public markets is in its final stages. This is a consequence of influential paradigm shifts – not just in financial markets, but in the economic outlook, geopolitical changes, and the rising interest rate regime – all of which are putting downward pressure on assets of all classes. The macro-environment, as Jamie Dimon of JPMorgan Chase, summed it up recently, is “in the midst of a hurricane.”

Private markets, however, remain more insulated – if only for the moment. Although there is still a relative lag, private markets – including Private Equity (PE) – aren’t immune from the ensuing economic cycle. On the one hand, the PE industry is still primed after record-breaking years in fundraising that has led to an abundance of “dry powder” – uninvested but available money. On the other, such distortions in correlation with the current conditions in the public markets are vulnerable to being reduced by arbitrage.

This is, therefore, a time of reckoning for PE.

 

Specifically, the three key determinants that matter to a PE firm’s returns – earnings growth for portfolio companies, rising multiples, cost of debt (and the amount borrowed during financing) – are going to be fundamentally challenged.

Over on the fundraising front, investors are beginning to get concerned about lackluster prospects on future returns. All forms of PE, whether growth or buyout, are under growing pressure to perform. Yet sourcing suitable targets is ever more intensive with several funds competing for a good deal. Even with existing investments, exit paths are uncertain and now potentially longer. Markdowns on asset prices can create hurdles in selling to other entities such as, private investment firms or corporate buyers. Even if the fall in asset valuations is yet to be fully captured in unlisted portfolios, PE firms are against the clock given finite holding periods for exits.

Now consider the cost side.

Consultant and analysts’ costs during Due Diligence – from preliminary, to Indication of Interest stage, to LoI to MoU stages – these costs only keep rising; further putting downward pressure on IRRs and margins for PE partnership. If returns suffer, that could particularly affect PE firms, especially those in the middle market, where numbers have swelled (because of the “democratization” of the PE asset class.)

A scenario of risks? Or, an Opportunity?

While it’s clear that it is no longer business as usual, how does a PE firm *still* continue to beat the market? How can a crisis be turned into an opportunity? The answer lies in recognizing – and identifying — where there are still opportunities and real value in PE.

 

First, in the middle market, PE owners and GPs could professionalize companies or achieve consolidation within fragmented industries. Likewise, there continue to be excellent opportunities for funds that uncover growth trends in niche segments – energy transition, digitalization, urbanization, ESG, technology adoption in improving home healthcare to name a few.

Then there are opportunities for managers to get involved and make a real impact while benefiting from valuation uplifts, as they improve operations.

Driving Change

So, what does it take for a PE firm to gain such competitive advantages – to capitalize on, to get ahead, to differentiate?

The answer is access to relevant, actionable, focused, specific insights, to help it make the right – and smart – decisions at each stage, whether it is to identify better opportunities, improve portfolio engagement and performance, or to drive profitable growth.

To achieve this, a PE firm needs to partner with the right research services and analytics provider that possesses deep domain expertise across sectors, with the right mix of capabilities in providing richer insights, that translate into value, scale, and competitive differentiation for the PE firm – all the while keeping the TCO as low as possible

So why now?

In addition to the challenges that macro volatility brings, there are new, emerging ones bound to rear their head. These could range from reticence on the part of LPs and even possible (yet lurking) LP defaults on capital calls, to reduced PE allocations owing to denominator effect concerns, to valuation markdowns on PortCos, or even, to debt finance constraints resulting from diminished leverage ability. These, to name a few. Therefore, doing business the old way and without considering the disruptive benefits of cost-effective, timely, value-added solutions to PE; is not merely a lost opportunity, it is also fraught with risk.

Fuld’s Solutions for PE

Fuld provides a range of services for PE. Once it has assessed a PE firm’s needs and created viable, cost-effective solutions, it will not only enable it to successfully navigate through this turbulence but will turn risk into opportunity!

Fuld compelling competencies assist, enhance, and add scale – in short, complement a PE firm’s research requirements. Whether these range from scoping studies to feasibility analysis to segment/geography deep-dives. Or whether, it is Sector or market research, Industry and while spaces analysis, deal sourcing or due diligence support, or onboarding with operations in a portfolio company, our teams deliver unique, actionable, timely insights that are both valuable and sustainable.

A Case in point

Recently, a mid-market focused PE firm was seeking to acquire a carve-out from a large geological equipment and services conglomerate, as this was no longer a “core” asset for the firm. It partnered with Fuld once it had indicated interest in the target. Fuld began by assisting the PE firm with its confirmatory analysis of the sector within which this carve-out target operated and concluded that the firm could affect transformational growth for the target’s business by contributing to scale, stability and expansion.

Our team developed an actionable and insightful plan to grow the sales, help develop new offering, compete better, and most importantly find a way to connect the firm with its customers.  Our analytical dashboard provided a deep dive, quantifiable but easy to use systems to keep a tab on the progress and allowed Portfolio manager to add significant value to firm in an organized and sustainable manner.

The experience demonstrated “why Fuld?” and “why now?” while giving the PE firm a competitive edge vs other firms that were competing for this target and once acquired putting them path of accelerated success.

These activities are all in a day’s work for PE fund managers, yet, in this uncertain and fluid macro environment, the better informed they are, the better positioned their PE firm will be when it comes to delivering outstanding returns & dividends to their LPs while simultaneously getting the best equity deals from its financing partners, and above all, driving transformative growth in those handpicked companies in whom the firm takes a stake.

To learn more about our solutions please contact us at Fuld & Company – Delivering Competitive Intelligence.

Authors:

  • Mangesh Kolhatkar – Vice President Research & Analytics Services at Fuld & Company

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