It’s no doubt a tough time to be an Australian business. Plunging markets, vanishing consumer foot traffic and country-wide business closures are all contributing to the economic downturn we’re currently experiencing.
Yet forlorn business owners can look to an unexpected source for a glimmer of hope: Private Equity firms.
A study following the 2008 GFC, backed by Harvard, has confirmed that Private Equity-backed companies tend to fare better during economic turmoil, and that they can actually act as a stabiliser during recessions.
So, what can we learn from Private Equity firms? Here are three important takeaways:
PE firms know how to build wealth by building value
PE firms seek businesses that they can buy, build and then sell for a good yield. They make money by exiting these investments. This requires a fair deal of planning and investment over the long term. In fact, according to Ernst and Young, the last 10 years have seen ‘unprecedented growth’ for PE, managing more than $3.6 Trillion US.
So how are they going to contend with another global recession?
It’s very possible that PE Firms may see this downturn as an opportunity to release their capital, make audacious business acquisitions and look far past this temporary blip.
How can they manage this?
PE firms tend to stick to their niche market, as they know how to grow this type of business, and this puts them in a position where they can easily outperform the market. As a sector specialist, they can see what’s on the horizon, know how it will affect their unique market and know what contingency plans to deploy. This innate knowledge allows PE firms to take advantage of capital when terms are most attractive, as well as weather any storms when they are not. By striving for continued growth, most PE firms make hiring key people a top priority. This deep bench of talent allows them to leverage any operational or strategic expertise in order to grow, thereby using this knowledge to effectively combat a downturn.
The Harvard study also notes that during the GFC, PE-backed companies came up against fewer financial constraints than their counterparts, which allowed them to both grow and increase market share. And it helped financially. Loans to these companies were more than 50% more likely to be renegotiated than non PE-backed companies, meaning that they were able to use their banking relationships in order to access more credit, to invest more and to continue the cycle of growth.
What are PE firms going to be doing in the economic time ahead?
From what they learned during the GFC, PE firms are perhaps in a more comfortable position than most to navigate our current economic climate. In fact, they’re better prepared than they were a decade ago. This is for a number of reasons.
Firstly, the industry has much more capital at its disposal from the diversified investment base of family offices, sovereign wealth funds and high net investors. With these additional investments, PE firms have a significant amount of immediately deployable funds, or ‘dry powder’ which can be used whenever they see fit - $1.4 Trillion US to be specific.
They also have a wealth of learnings at their disposal from the GFC. These lessons are invaluable as they will help PE firms respond better to what’s happening presently. Non PE-backed companies can also use these learnings to their advantage:
- Don’t halt progression. PE firms were overly cautious during the fallout of the GFC. For companies who are fuelled by growth, being too cautious could actually undermine opportunities, resulting in lost capital. So during this recession, we assume PE firms will be ready to react in a lower valuation environment.
- Access to capital can support portfolios. During the GFC many non PE-backed companies were constrained by capital whereas PE firms had access via their own fund and from long-standing relationships with lenders and bankers. This allowed them to inject and consequently stabilise their portfolios in ways that other businesses could not. We’ve seen from previous downturns that the PE model provided flexibility and access to capital even during times of economic and financial market distress. This is an outcome that can be reasonably expected to play out once again
As the economy continues to remain volatile, we can expect PE firms to hunt for any available opportunities in growth sectors and in resilient assets. Even with the onslaught of uncertainty, PE firms are continuing to assess and acquire businesses in order to pick up assets. With their ability to withstand the short-term fluctuations of markets, it’s no wonder they’re out hunting for strategic acquisitions.
For business owners who may have been thinking of selling, or those who want out quick, this is a great opportunity to sell off assets quickly and easily, even if it means selling at a lower value. That’s because PE firms understand that otherwise great businesses may be starved of capital and if they can buy an asset ‘on sale’ it’s very likely that, as long as it’s managed well, as the market recovers it will return to pre-recession performance.
Where is their gaze shifting next?
According to Pitcher’s Dealmakers study we see that despite the economic downturn - there are a few hot sectors that PE firms will continue to pursue.
Technology, Media and Communications
The market for innovative digital assets like technology, med-tech and fintech industries remain very high in Australia. Disruptive tech, like AI-powered chatbots as well as SaaS companies continue to attract investors who are drawn to the powerful growth potential, opportunity to scale and stable recurring revenues. Also, there remains plenty of interest in data centres, registries and cables as we know that data security continues to be the only area that constrains that sector’s tradeability.
Healthcare, Pharmacare and Biotech
This is another sector which isn’t facing nearly as much volatility. That’s because the industries are based off of a simple growth formula which doesn’t waver - economic instability or not. It revolves around a consistent, ageing population which is supported by an equation of dependency which generally rises year-over-year.
As we enter Q2 2020, analysts expect to see agriculture increase. Australia’s current climate, combined with the technological advances in agriculture, are expected to drive the industry forward as demand remains high.
PE firms are the ultimate role models for increasing company value. While market forces, economic conditions and many other variables can cycle up and down, PE firms keep their eye on the end-game. They stick to a structured set of disciplines and have the need to provide strong returns to their investors (known as limited partners or LP’s) within a defined time frame. This creates a relentless focus. When this is coupled with rigour, talent, liquid capital and niche expertise, it leads to value creation over a period of ownership (generally 3-5 years). If a business owner's most crucial task is to make their business more valuable - we should look to how PE firms do this.
With the uncertainty expected to continue well into the future, our eyes will be on the movements of PE firms and how they will leverage the opportunity. While it appears they have an edge, their model is something we can all learn from and master.
If you would like to learn more, get in touch. At Exit Advisory Group we help business owners, at all stages of their journey, understand how to build and exit valuable companies. Whether you want to know how much your company is worth, find an investor, understand how to build to a certain valuation, or you want to exit now.
CEO and Founder, Exit Advisory Group
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