Private equity funds stage multi-faceted growth
The private equity sector has enjoyed robust growth and must now structure and organize to address the value challenges it faces.
It will hardly come as news that the private equity business – both buyout and infrastructure – has been outperforming equivalent listed asset indices. For example, the sector notched up an average performance of 12% over a sustained period in France, while 50% of investment vehicles posted an internal rate of return (IRR) of more than 9%[i]. However, the surge in the sector’s growth is a more recent trend, with 88% of buyout fund-raising rounds worldwide reaching or even exceeding their hard cap (maximum fund size) [ii] in 2021, i.e. an average rise of 20%[iii]. The industry has proven resilient during the Covid period, with 54% of world investors in 2022 confirming [iv] that they had upped the proportion they allocate to private equity over the past two years: in this context, French sponsors have performed particularly well, recording 78% growth in amounts raised in 2021 78% vs. 2020 and a 36% jump as compared with 2019[v]. Even with the war in Ukraine, 2022 looks set to be an extremely active year in terms of fund-raising. With a range of possibilities on offer, limited partners – or LPs as they are known in the industry – have their choice of pickings, and some fund-raising rounds will be extended by a few months to ensure they are eligible for these investors’ 2023 allocation. However, the landscape worldwide has changed: volatility is more severe and interest rates are on the rise, while at the end of 2021, 91% of European private equity teams already felt that M&A transactions involving financial sponsors carried excessive valuations[vi]. The fundamentals for underlying AuM growth remain solid, with strong performances, traditionally resilient showings during previous crises, growth in the addressable market, solid interest and diversification in the investor base. However, more than ever, sponsors will need to plan for the various impacts and look to their partners to offer them the most tailored solutions.
Broader and more tailored support
Looking beyond the figures alone, growth in the private equity industry has been multi-faceted, which means that it now needs a more comprehensive range of services from its banking partners. Progress in the unit amount of certain funds may stall temporarily, but the development of new strategies – whether in terms of size (small/mid/large), development phase (venture/growth/transmission, etc.), sector (tech, healthcare, transition, etc.), geography or governance (minority or majority investment) – means a considerable increase in the number of funds managed by any one given sponsor.
Sponsors now expect their main partners to support them and their investments on an increasing number of areas of expertise with (i) a broader range of LBO acquisition finance, infrastructure, real estate, and growth for both majority and minority investments. They will also expect corresponding M&A teams with expertise in their respective geographies to provide support on each individual asset class. Additionally, (ii) progression in both the size and number of funds has driven the matching development in equity bridge financing needs, typically equating to 30% of the fund’s size. This situation prompts sponsors to adopt underwriting solutions that simplify the process for them and pave the way for additional liquidity where needed. Sponsors are also relying on (iii) NAV financing to provide an additional – and very welcome – source of funding so that the fund can finance acquisitions by companies in the portfolio when a significant portion of the fund has already been deployed. This type of operation requires both solid experience and strong relationships. Meanwhile, under the impetus of their LPs, sponsors increasingly view (iv) solutions that incorporate an ESG component as a must-have. This can take the form of Sustainable-Linked (Corporated Based) or “Use of Proceeds” (Asset-Based) investments with the corresponding financings structured thanks to the input of dedicated and experienced teams of banks. Over the past five years, 64% of European Limited Partners have pursued the application of ESG criteria[vii] and reinforced their lists of sectors excluded from their investment scope. Last but not least, it is key to bear in mind the importance of (v) currency and interest rate risk management and the very specific way that this applies to the private equity business, with specialists to focus on this aspect.
A structured approach to tackle the challenges of value creation and sustain development for the long term
Recent IPOs by certain companies such as Bridgepoint and Antin carried attractive valuations, reflecting very strong investor interest in these asset-light GP (General Partner) models, even beyond the usual institutional investors. On the back of this trend, some sponsors are now seeking to diversify fund-raising with individual investors and developing distribution agreements with private banks that they feel are well established in this ecosystem.
Not all sponsors will seek stockmarket listing, but there is widespread agreement on the potential harbored by GPs. Management teams set great store by confidentiality and with this in mind, they select a highly trusted partner with a robust track record to set up financing for the management company. This so-called “GP financing” offers the resources required to support the growth of existing funds, launch new strategies or stage acquisition-led growth moves, which can then herald a fresh stage that may involve a decision to open up capital.
Private banking services could also provide financing of carried interest, which is often a key point in transmission between the more senior partners and the more junior. Considerable scope for development remains, and in the current context, sponsors have higher expectations of their partners and will rely on their support to grow.
[i] Activité du non-coté français - France Invest
[ii] Global Private Equity Report 2022 p22 – Bain & Company
[iii] Global Private Equity Report 2022 p28 – Bain & Company
[iv] Global Private Equity Barometer Summer 2022 – Coller Capital
[v] Activité du non-coté français - France Invest
[vi] European Private Equity Outlook 2022 – Roland Berger
[vii] Global Private Equity Barometer Summer 2022 p5 – Coller Capital