This far into private equity’s boom is bound to leave both LPs and GPs wondering how much longer the good times will last. They aren’t retreating so much as proceeding with caution and preparing for stormy weather, whenever it might arrive. The upside is there are ample ways to strike that balance, as the best GPs are stepping up their game to identify targets and sharpen diligence, while simultaneously planning for the worst.
There’s been a lot written of late about soaring multiples and the amount of dry powder still ready to invest. Bain’s 2019 Private Equity Report is no different. It looks back at the past year and finds that the average multiple for leveraged buyouts in the US and Europe has hovered around 11 times EBITDA in recent years, above the levels that led up to the global financial crisis of 2008.
With high multiples hanging over their heads, along with a common expectation that the economy is bound to slow down at some point – even if no one can say with certainty when - fund managers are taking several actions to protect their returns.
First, they are paying closer attention to time, and reducing hold periods to avoid having to sell into the face of a recession. They may be willing to give up a bit of IRR near-term, so they can return to fundraising mode to build new and bigger funds that can provide fresh fee income and capital to invest. Time compression is also being fueled by strong demand for assets by both corporate buyers and other sponsors.
As a result, the median hold period fell 10% last year to 4.5 years, after drifting slowly down from a peak of 5.9 years in 2014. In addition, “Quick flips,” which Bain defines as sales of assets held for less than three years, rose to 24% of total deals – well below levels seen at the end of the last cycle, but still above recent norms.
The second action the Bain report points to is an increase in specialization. GPs employing specialization can leverage their sector-specific expertise, strong industry networks, and accumulated knowledge in ways that generalists can’t match.
This advantage allows them to find attractive assets at the right price, and create added value for extra turns at exit. This strategy is particularly in play in the healthcare and technology sectors.
Buy-and-build is another strategy that can offset high multiples. Bain defines “buy-and-build” as an explicit strategy for building value by using a well-positioned platform company to make at least four sequential add-on acquisitions of smaller companies. Buy-and-build strategies grant GPs a way to take advantage of the market’s propensity to assign higher valuations to larger companies.
It’s not always easy to pull-off, however. Those who do it well may also benefit from the specialization approach as sector-specific expertise can allow for the smart assembly of assets with increased upside potential.
The final strategy of note in the Bain report is growth equity, which can provide access to fast-growing assets with less risk than venture capital, and lower leverage. Since 2014, $367 billion has been raised globally for the strategy, much of it by traditional buyout firms.
This last strategy can be a bit tougher to execute, particularly for funds used to focusing on operational improvements or buy-and-builds. It requires a different approach, centered on developing a clear vision for growth, a compelling story around that vision, and solid execution on the initiatives that will drive value creation.
In our work with PE firms and their portfolio companies, we’ve identified several key areas that can be make-or-break for growth.
This may be a tall order for private equity managers today, but as Bain’s report warns, the competitive landscape will likely only get tougher from here on out.
Download the full 2019 Global Private Equity Report from Bain & Company.
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