Private Equity: a look ahead in times of uncertainty

With political uncertainty at an all-time high and asset prices sky rocketing, some investors are acting with caution, but should they be? Private equity veteran, Tim Farazmand, discusses what to expect from the sector over the next financial year and how investors should navigate the challenging landscape.

What are the biggest challenges and threats facing the private equity market right now?

The amount of dry powder is causing fierce competition, which is in turn pushing up prices, the confused political situation in the UK, that is what’s really worrying the market right now.

How can investors mitigate these risks?

Private equity is a very competitive market nowadays, there are more players. The stakes are higher; therefore, due diligence must be far more comprehensive than it used to be.  As the market has matured, approaches to deals need to be more sophisticated, investors need a more informed view to do the right deal with the right structure.

In what way is due diligence more comprehensive now?

At Palatine we have a suite of advisors looking at everything from political, digital, insurance, legal, financial, commercial, management, ESG, IT and cyber. These multiple streams require a massive network of DD, which has typically been siloed. Historically financial and commercial DD may have been connected but now when you kick off the DD process, it is imperative to get as many people into the room as possible to input. It’s important to have a more joined up view of DD and avoid duplication and to make sure you don’t miss anything.

We are also are seeing increased use of vendor DD during the exit process. Objective and comprehensive vendor DD enables the process to be quicker and better controlled. Investors have the opportunity to verify the VDD findings and top-up as appropriate rather than starting from scratch.

You mention Environmental, Social and Governance due diligence, why has there been a sudden interest in ESG considerations?

ESG is not a fad – and should be more than just a tick-box exercise. It is increasingly becoming the norm and the requirement for comprehensive due diligence processes will continue.  As investments come under a microscope, the frequency and consistency of ESG will only increase – it’s not on every deal at the moment but it will undoubtedly move that way soon.

The ESG agenda is primarily being pushed by investors – especially pensions funds who want more clarity on the probity of deals. While ESG has been driven by the source of capital, the more enlightened GPs don’t wait for their LPs to push, they recognise it’s a better way of doing business. More ESG and impact led investment will build better businesses; and the better PE houses will have already been taking ESG factors into account.  Building a more valuable businesses creates staff loyalty and a sticky customer base as a result. It’s simply good business.

With high prices, increased diligence costs and economic uncertainty, is now really a good time to invest?

With regard to Brexit, which is causing great economic uncertainty, it’s hard to generalise because we have never been down this path before and there are so many unknowns. Some investors will respond by sitting on their hands and not doing anything until there is some clarity. The one known related to Brexit is the expectation of a negative drag – we have seen some already – on the economy. It could be either a short-term downturn or a full recession. Not investing or lending will only compound a recession and investors could miss out on some opportunities. Times of economic uncertainty increase the importance of undertaking sensitivity analysis, including the pricing, structure and debt considerations, and anticipation of issues that might arise in the downturn. There were some clever funds in 2008 that continued to invest rather than waiting, and they backed the right businesses which emerged even stronger, generating some great returns as a result. I believe that UK centric firms will keep doing UK deals rather than venturing into the unknown and going international.

Aside from a Brexit-caused recession, how much of a threat is a Labour Government, and what can the sector do to mitigate the risks posed by Corbyn?

Private equity must understand the Labour Party and its policies to ensure future success. Given our minority Government an early general election is not out of the question. Firms must do scenario mapping. They need to be asking questions on how policy will be created and what the priorities will be. It’s also important to keep an eye on the impact of the Independent Group. Will that force moderation from the ERG and Corbynistas to counter the move? We are in the middle of uncertain times.

What is clear is that private equity and their portfolio need to keep abreast of both macro and micro policy issues as they evolve – and this is exactly where GK can help.

See more articles by Tim Farazmand

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