December 3, 2020 – Much of the talk among U.K.-based PE investors in recent years has concerned the Brexit related risks of potential investments, the sky-high valuations being sought by vendors, and the highly fertile fundraising environment which has led to record levels of dry powder and the most competitive capital deployment market that most can recall. According to a new report by Wilton & Bain, 2020 has brought an altogether different set of challenges for obvious reasons.
“It has been interesting to observe the general mood among investors throughout, and to notice on a more situational basis how individual portfolio companies have coped, struggled or even thrived in some instances,” said David Marsh, private equity and financial officers practice lead at Wilton & Bain. “Most funds, partly by design, have a natural level of diversification within their portfolio which produces a range of outcomes in times such as these, and a net effect less severe than might be expected.”
The report pointed to the third fund managed by Exponent Private Equity as a choice example. A business dependent on tourism such as Leisure Pass Group will inevitably have struggled through this calendar year, whereas an online gifting business such as Moonpig has likely benefitted from an environment in which customers are eschewing traditional retail either by choice or necessity.
“Widely held among seasoned investors is the view that in any downturn, be it due to underlying structural factors or the kind of ‘speed bump’ which we might label COVID-19 as, a well-refined strategy undoubtedly plays second fiddle to a robust capital structure and a cost base sufficiently flexible to weather the storm,” said Mr. Marsh. “This has proven the case in many instances, with some businesses such as those at the luxury end of the travel market managing to remain convincingly afloat despite unprecedented drops in revenue. Those with a larger and less flexible cost base, in particular asset-backed businesses in leisure and other analogous sectors, will naturally have had a much tougher time and in many cases have changed hands and/or seen their lenders take control.”
Flow of New Investments
The flow of new investments, albeit in lower volumes, has continued despite the obvious headwinds, and is largely still being driven by growth-focused firms at this point. “We can, however, expect ‘value’ equity investors with a ‘good business, bad balance sheet’ mantra to thrive in 2021, and distressed debt funds will be well poised to capitalize on the swathe of liquidity issues that will undoubtedly arise,” Mr. Marsh said. “Management change and augmentation within portfolio company leadership teams has equally continued to a reasonable extent. From an executive search perspective, it has always been apparent to me that post-deal or mid-cycle leadership changes are inevitably situational; tactical responses to something awry or addressing a specific skill gap ahead of a planned event.”
David Marsh works with a range of private capital firms, appointing board members to their portfolio companies and supporting investment professionals in pre-deal scenarios. Primarily undertaking search mandates for chair, CEO and CFO positions, he has worked across multiple sectors with particular focus on consumer, services, industrials, and technology. Additionally, Mr. Marsh has completed non-board finance mandates for both privately backed and public companies.
Unsurprisingly, Mr. Marsh said the CFO seat remains one that is commonly changed. The most frequently augmented or newly created position seems to be CIO or CTO, reflecting both the long-term trend towards digital and technological enablement, and the current climate which places greater emphasis on this aspect. “There has also been an increased appetite to appoint new non-executives, who may bring specific functional or situational experience to help businesses either deal with current challenges or press their advantage where there is a perceived market opportunity,” he said.
Notably however, Mr. Marsh said “most investors have seemed inclined to back incumbent CEOs rather than tend towards the type of succession planning that might normally be afoot in underperforming assets. A likely factor is the desire for continuity of leadership, particularly from a cultural standpoint in organizations which may have seen widespread furloughing of staff or more permanent re-sizing. CEOs do, of course, come in different shapes and sizes, some being better suited to turnarounds than others, but by and large this is an area in which investors have opted to hunker down and stick with the status quo.
Availability of External Talent
“The availability of external talent should also be considered on this front,” Mr. Marsh said. “I can comment from a personal perspective that CEOs have seemed more averse to moving from one PE-backed organization to another in recent months, whether because of broader market uncertainty or an inherent and commendable loyalty to their current businesses given the present climate.”
Moreover, it is less likely, given the dramatic and unprecedented impact of COVID, that management teams in assets which are suddenly “behind plan” have foregone their opportunity for personal wealth creation. “There seem to be many instances of investors necessarily resetting their ambitions and adjusting their management incentive plans accordingly, such that they can retain leadership teams who are clearly not at fault for the turbulent trading environment,” said Mr. Marsh. “Assets being taken over by lenders can also fortuitously improve the net debt position, often making upside milestones more achievable.”
3 Qualities Private Equity Firms Seek When Picking Portfolio CEOs
One sector seemingly immune to the current global health crisis is private equity. As deal making rages on, leaders will be needed in droves. But a recent report by human capital advisory firm FMG Leading says that many PE firms are not always equipped to choose the right CEOs to run their portfolio companies, even in the best of times.
“The sheer level of dry powder around is proof enough that the private equity market in Europe and beyond will continue to be exceptionally active in the coming years; the money must find a home somewhere,” Mr. Marsh said. “That being said, the deployment environment is likely to remain exceptionally competitive as such lofty levels of available capital inevitably drive multiples and valuations ever higher, as does asset scarcity which will prove a prominent issue in the aftershock of a global pandemic; yes, there may be a backlog, but that is no guarantee of quality.”
“Ultimately, as the adage goes, putting capital to work in private equity is easy – just write the biggest check,” Mr. Marsh said. “Achieving market leading returns, however, is a much more complex and arduous pursuit. We can expect to see processes involving secondary buyouts and corporate carve-outs to be more hotly contested than ever, and whilst a low interest rate environment obviously augers well for leveraged buyouts, investors will feel the pressure to be increasingly innovative and resourceful in how they approach value creation if private equity is to continue to outperform rival asset classes to the same extent that it has in recent years. The combination of financial engineering and a ‘rising tide’ economy will not be enough on its own.”
Private equity firms have long been acutely aware of the value of management teams that are exceptional rather than just passable, and we can expect to see an increased focus on this as an accessible value creation lever. Mr. Marsh said the days of investors only taking interest in the appointment of chairs, CEOs and CFOs are long gone; the focus will increasingly extend across the C-level and even below, along with a more deliberate focus on diversity and cohesiveness within management teams.
“There is little to suggest that the future is anything but bright for private equity as an asset class and industry,” Mr. Marsh said. “However, it is a more competitive landscape than ever before, and I anticipate that investors will become even more focused and resourceful both in their pursuit of new assets and the management of those already under ownership.”
Contributed by Scott A. Scanlon, Editor-in-Chief; Dale M. Zupsansky, Managing Editor; and Stephen Sawicki, Managing Editor – Hunt Scanlon Media