TEN YEARS IN PRIVATE EQUITY
To mark our ten year anniversary in London, the private equity team reflects on ten developing themes since 2010, and provides bold forecasts and predictions for the decade to come.
TIPPING POINT FOR ESG
The industry is at a tipping point for authentic ESG action
With so much recent focus on geo-politics – Brexit, populism and trade wars – it is easy to be surprised by the developments in corporate and investor responsibility over the last decade. These, ultimately, may have a more fundamental, enduring impact. 2008 left many questioning pure capitalism, 'homo economicus' and the lack of global corporate responsibility. This – and the growing concern over the climate and environment – is leading to a profound change; agreed standards on corporate responsibility, a greater dialogue over stewardship, investor prescription, and the emergence of environmental, social and governance accreditation bodies, such as the B Corp process and PRI. As one PE GC succinctly put it: "We're spending other people's money. Of course ESG is now front and centre of our job."
The cynics ask about the resulting actions. From our conversations with the market, we believe it is at a tipping point. Not only will every PE portco be analysed by ESG criteria, we believe ESG stewardship will come to the forefront of our industry's argument for purpose.
SPA terms have shifted to the benefit of sellers
Across Europe, and now increasingly in the US, deals are being structured with a reduced level of risk sharing between the seller and the buyer. Locked Box mechanics facilitate diligence – diligence not financial recourse is now the buyer's primary source of comfort. This is in part due to the M&A market terms being impacted by private equity exits – and the desire of PE sellers to avoid recourse. The buyer market has needed a white knight and over the decade this has come in the form of warranties and indemnity insurance, which we cover below.
Will this trend last? Yes, we believe it will. An almighty correction will be needed in the way businesses are sold for the clean break to the broke
The white knight proving its worth
From niche to ubiquitous in a decade. From a mere handful of insurers – and even fewer brokers – to 25 W&I underwriters and managing agents looking for USPs and white knight status. USPs both in terms of price (although premiums currently settled at c.1% (RoL)), retention (0.25% tipping to nil in some cases) and ease of process. USP combat on legal terms too: knowledge scrapes, 'phantom' tax covenants, alternative loss regimes and nondisclosure of buyer diligence and data rooms, to name a few.
The big question for many buyers remains: Is it worth it?
Cognisant of this scepticism, insurers and brokers have started publishing their claims data, as have some PE houses. Continuing with this open approach will be crucial to answering the question of worth. Perhaps more cumbersome will be the next challenge – to reduce the time and cost spent on diligence while maintaining a sensible scope of cover. The 'wasted' cost of a policy involves the time spent diligencing non-critical matters.
Having benefited from some serious growth over the past decade (c.35% p.a. based on number of policies placed, c.300 in 2011 to 3,200 in 2018 Aon Report 2019), the signs are that the product is now here to stay.
WORTH THE PAPER IT'S WRITTEN ON?
The value of Legal VDD is rightly questione
Have we come a full circle on legal vendor due diligence (VDD)? It has become commonplace during the previous decade, but many buyers (particularly in the US) have remained cynical about it. Towards the end of the decade fewer helpful legal VDD reports are being provided in auctions and our analysis suggests legal VDD actually adds to the cost of legal process.
We predict legal VDD will fall out of fashion except in particular circumstances where businesses are more legally complex and such a report can genuinely help buyers understand the business more accurately and more quickly. For most deals, a comprehensive legal Q&A in the data room will become sufficient.
The negotiation of the management terms has become more sophisticated – and this is a good thing
The management term sheet and the role of management advisers, both financial and legal, has become a feature of the European private equity market – and rightly so. Management are critical to success, and it has to be right that they are advised in what is being sold to them as their 'life changing' opportunity. Has the advice led to significantly worse deals for private equity clients? In our view, No. It has more often ensured that the specialistled negotiations are more consistent (advisers know the market) and that management teams are not inadvertently prejudiced. We do not believe equity terms have become more management friendly. Indeed, leaver provisions have, if anything, become more sponsor friendly.
Our prediction is that the management adviser role as facilitator will grow further in the next decade, in Europe and in the US market.
BUY, BUILD, SELL
Whilst the industry will continue to drive organic growth in its portfolio, getting the buy-and-build strategy right may be the difference between winning and losing
Search 'PE Buy and Build' and be struck by the headlines containing words and phrases such as 'boom', 'the New PE Model' and 'a strategy of the times'. This is reflected in our clients' portfolios. It is perhaps an inevitable consequence of an economic environment where exponential organic growth is rare. We believe the trend will run unabated over the decade to come, but challenges will appear as these consolidated businesses are sold. Are the businesses properly integrated? In an age when the 'cultural' strengths and conformity of businesses will deliver value and mitigate risks, will the buy and build generation sell well?
Our prediction is that the industry will focus more on the management challenges around a consolidation strategy and look to more holistic approaches across portfolios.
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