The GP stake investing strategy represents a bet on the future growth and profitability of the investment firm behind the fund. It has grown more popular in recent years because it gives the investor a share of returns from what may be multiple funds and accounts managed by the firm. Therefore, it gives the advantage of diversification – rather than just the income and gains from one of those funds.

Asset managers are “people businesses,” reliant on fairly mobile human capital. Moreover, asset managers preserve the firm’s culture and compensation dynamics to maintain its long-term sustainability. Limiting outside investment to a minority stake allows the GP’s senior executives to maintain decision-making autonomy without disrupting the team or culture. Meanwhile, they benefit from a partnership with the outside investor that adds value to its balance sheet and business plan.

Before investing, GP stakes investors will examine a firm’s business from every angle. That includes analyzing everything from LP-GP relationships and alignment of incentives to understanding how the GP management company generates revenue.

GP stakes investors – the top players

At the heart of GP stakes investing, a select group of firms has continued to push things forward. These active GP stakes investors were relatively early adopters of the strategy, and they remain heavily involved in shaping things today.

The market continues to be dominated by three major investors: Blackstone Alternative Asset Management, Dyal Capital Partners and  Goldman Sachs Alternative Investments & Manager Selection Group. According to a recent Pitchbook report, each of them has raised funds over US$4 billion dedicated almost exclusively to this strategy. At the end of 2019, Dyal ramped up the stakes by closing its fourth fund with more than US$9 billion in the capital, making it the largest GP stakes fund ever raised.

Newcomers appear more often, with many trying to distinguish themselves through their deal structuring or targeting firms at earlier stages of development. For example, Sixpoint Partners has generated a “private equity seeding platform” with a $200 million fund. The strategy focuses on spinout managers, and the structure deals with a specified path to exit. Another newcomer is Hartford HealthCare, the $4 billion fund for diverse managers. The fund has a different model than a typical GP-stakes investment. In addition to buying stakes in investment managers, the firm plans to be an active owner that will help guide the managers as their funds grow.

What is next in the making for GPs?

Now that some of the largest GP stakes managers we mentioned above have gone public, allocators are putting money into funds that invest in smaller private equity and alternatives firms. According to Institutional Investor, Dyal Capital Partners merged with Owl Rock Capital Group and went public in May. Dyal is the GP-stakes subsidiary of the combined company called Blue Owl. Petershill, a subsidiary of Goldman Sachs, launched in 2007, was listed in London in September. Both aspired out large GPs for their portfolios.

In contrast, Investcorp Strategic Capital is looking to invest between $50 to $100 million-plus in GPs at an “inflexion point of growth,” according to the source.

In the meantime, asset managers find themselves in greater need of capital – to meet their existing GP commitment obligations and for a number of other reasons. With some of the largest asset managers already having sold stakes in their firms, demand in this particular market is exceeding supply, which opens the way for emerging managers, middle-market PE firms and spinouts.

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Today, PE investors make acquisitions that will add value to their portfolios. Typically, they won’t buy a business unless they can contribute to and accelerate, the company’s growth potential.

What’s more, PE firms are holding onto their investments longer, often seven years or more. For sellers, this longer turn time provides assurances that their employees will have a role in the new business and growth opportunities.

An example of Private Equity investment can be seen in the sale of Agrekko, a world-leading provider of mobile modular power, temperature control, and energy services. Agrekko signed for $2.79 billion with TDR Capital and I Squared Capital. Another take-private focusing on perceived weakness in UK public market valuations. Aggreko was severely hit by the pandemic. However, sponsors saw an opportunity to reposition the business to benefit from the transition to clean energy and net-zero objectives.

What are the key business benefits of Private Equity?

One of the first and far most obvious benefits for your business is the greater investment of capital into areas of your company. That said, PE groups have deep pockets and can provide the financial resources to fuel growth. These firms may provide the capital needed to renovate a facility, buy new equipment or launch a marketing effort.

PE investment can help your business to expand operations and increase brands awareness in new or existing markets. An example of this is the Agrekko deal. This is where with guidance and reposition of the business, Agrekko grows beyond its pre-existing means.

Moving forward, Private Equity can offer you expertise and connections. The right PE firm is your path to a new community of peers and valuable business connections. They provide experts who will roll up their sleeves and work alongside you. Similar to other investments, PE firms want to know your management team is here to stay with all their expertise.

PE investments are often in middle-market companies that have expanded as far as their current resources and management team can take them. For example, these companies can team up with a PE firm that provides access not only to capital but also to a wealth of invaluable resources. A private equity sponsor can leverage its extensive network to improve management, logistics, infrastructure and other essential components of a business that can take years to develop separately.

Private equity firms are experts at creating value. Also, a study showed that two-thirds of private equity deals resulted in at least 20 percent annual growth for the purchased company.

How can you take advantage of PE?

So, what can you do to take advantage of private equity investment? With demand high for middle-market businesses among private equity firms, the best is to start marketing right away. Furthermore, the market is crowded due to the retirement of baby boomer business owners. Therefore, private equity firms are urgently searching for new investment opportunities.

If your business can serve as a potential platform company for PE firms, take the opportunity to achieve your value. With effective collaboration and investment, all sides stand to benefit and generate more revenue in the long term.

We hope that the business benefit from Private Equity investors has brought some level of knowledge and insight to you.

Like any industry, there are still “bad eggs,” but an M&A advisor can help screen PE firms to make sure you’re working with a good group. VX Associates M&A Advisors will guide you every step of the way. Contact our M&A team to arrange a meeting.

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Private equity refers to an alternative form of private financing away from public markets. Likewise, we use the term for firms that buy companies through leveraged buyouts (LBOs) in the finance industry.

• Private equity is, shortly speaking, an investment by a private equity firm in a specific company. Investors make partial or complete investments as they hope to gain higher returns.
• Generally speaking, there are various changes that the private equity firm can make in a specific company. Those include expenses reduction, management, strategies, etc., to make the company profitable.
• After a few years, the private equity sells the company generating a profit and high returns through the entire transaction.

What is the difference?

Venture capital funding can be beneficial for new companies in the early stages of growth. Like private equity investors, venture capital investors can lend their knowledge and expertise to the process. As shown in the image below, private equity firms invest in big companies that they predict could gain high profitability in the following years. At the same time, venture capitalist set their eyes on companies at an early stage that have long-term growth potentials.

Venture capital investments are generally divided into several rounds of financing, in which various co-investors usually contribute equity to the company as part of a capital increase in return for the subscription of new shares. The participation of a private equity company often takes place as part of a single transaction. That said, the existing shares of a selling shareholder are taken over by the private equity investor with the intermediary of an acquisition vehicle so that a shareholder change occurs. In contrast, to venture capital investors, private equity companies usually try to increase the company’s value by restructuring the target company.

Private markets are becoming more beneficial

Drawn in by the potential of high returns, more and more investors have entered the space, creating an influx of available capital. According to Pitchbook, With companies now taking longer to go public, many PE firms have turned their sights to crossover investments. As a result, more investors put their money into the private markets. It’s now easier than ever for new private companies to get the funding they need to grow.

They have demonstrated their ability to offer further diversification in a portfolio by lowering volatility while generating superior returns. Therefore, private markets can provide investors with attractive recurring returns and capital gains. This is not just Europe centric trend. The development of private market investing has experienced global growth. That said, we will see more of the PE-backed companies and VC-backed startups in the coming years.

Similarities between venture capital and private equity

Both venture capital and private equity investors are primarily so-called financial investors who are structured as funds and invest their capital. That means that the investment decision is made solely from a financial point of view, without any particular interest in the product or the synergetic use of know-how or economies of scale or scope. In both cases, the aim of the investment is an exit trade sale of an investment. Therefore, these are not long-term investments but in expected high returns.

The approach of venture capital investors and private equity investors is often similar. Both perform due diligence on a potential target company when the opportunity arises. Then, if they decide to invest, the participation agreements often provide for management or employee participation to incentivise the company’s management. Usually, venture capital and private equity investors also secure their investment by demanding certain guarantees regarding the financial position and business figures of the target company.

To summarise, anytime you bring on investors, you’ll give up a certain amount of control over your business. Private equity investors require a majority stake in the company, whereas VC investors only ask for a minority stake. However, the forms of investment venture capital and private equity have many points of contact. We’ve seen some significant differences. In venture capital, different investors usually invest pure equity in several financing rounds in early-stage, growth-oriented startups and accept a particularly high risk of total loss. On the other hand, private equity investors aim for a partially leveraged majority stake in mature companies where they can take control of the company’s assets and create value through structural changes.

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According to the latest report from OECD, FDI could play an important role in supporting economies during and after the crisis. The FDI help could include financial support to their affiliates, assisting governments in addressing the pandemic, and through linkages with local firms.

Public health measures have caused economic disruptions that impact the foreign direct investment decision of firms. We learned from the past crisis that small and medium-sized enterprises show greater resilience due to their linkages with the financial resources of their parent companies.

According to the OECD Investment Policy Response, FDI is expected to decline sharply as a consequence of the pandemic and the resulting supply disruptions, demand contractions, and pessimistic outlook of economic actors.

In addressing the medical supply shortage, governments should leverage investor networks and investment promotion agencies. Some governments have already embraced imports of essential good, while some businesses have started producing medical essentials such as medical masks etc.

Moving forward, cross-border partnerships and collaborations between companies can facilitate finding long-term business solutions, such as ways to resume production while protecting workers’ health.

Foreign Direct Investment flows is expected to face major drops as the supply chains are facing disruption. Meanwhile, capital inflows will be impacted as companies put some mergers and acquisitions (M&As) on hold.

As an example of earning in 2020 of large MNEs are expected to fall. According to the latest statistics data gathered from Refinitiv, there will be large year-over-year drops in earnings in the energy, consumer discretionary sector, industrials, and materials sectors. On the other hand, it is expected that there will be year-over-year increases in earnings in the health care, technology, and communications sectors.

The latest data from Refinitis M&A database shows a significant drop in completed M&A deals in the first quarter. However, there is no evidence on the deals withdrawn. That leads to the conclusion that investors are focused on closing deals rather than withholding from it. In the short term, equity capital flows will fall due to so many deals being put on hold, but it could mean that there will be an increase in the future as these deals are completed as the economy recovers.

To read the full report and in-dept insight into FDI investments, please visit the OECD official website.

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Meanwhile, a Pharmaceutical company Zentiva Group completed the acquisition of Alvogen’s CEE business in Romania, Bulgaria, Croatia and several other countries.

Private-equity (PE) investors own companies but are not like those that raise money by selling their shares in stock exchanges. There is a big difference. Public companies are those that shareholders list on publicly available registers. Secondly, listed companies make regular announcements. If they’re backed by private equity, there’s no need to do so: it’s all private. Therefore, Private Equity backed companies tend to value that freedom.

Private equity investments in CEE companies

Private equity and venture capital investment into companies in Central and Eastern Europe (CEE) reached a record €3.5 billion in 2017, according to data from Invest Europe.

From the Invest Europe, 2018 Report, 3,750 European companies exited in 2018, a 3% decrease on the previous year. By the amount of former equity investment (divestment at cost), the total value was €32bn, a year-on-year decrease of 28%. The most prominent exit routes by the amount at cost were trade sale (32%), sale to another private equity firm (31%) and public offering (10%).

Buyout funds in the region raised a total of €1.1 billion, whilst CEE venture capital funds attracted over €500 million of investor cash for the second year in a row.

The number of private equity and venture capital-backed exits in CEE reached an all-time high with a total of 128 companies divested in 2018. With an exit value of €575 million, Poland accounted for nearly half of all exit activity. The biotech and healthcare sector took the lion’s share of CEE private equity investment, making up just over 30% of the total value for the year. Consumer goods and services companies also fared well, receiving 27% of the overall funding.

What is private equity looking for in 2020?

According to online media, private equity markets are looking for technology companies where covid-19 is not worthy of mention.

It will be some time yet before the bargain hunters are searching for opportunities in manufacturing industries with complex, international supply chains. Meanwhile, creditors will be more focused on a conservative business plan for the underlying companies.

Overall we maintain a positive outlook for the performance of new commitments to private equity in 2020. Investors’ emphasis on ESG will increase further in 2020. That also aligns well with private equity’s long timeframes and higher engagement. This is becoming especially important for private equity in CEE; Central and Eastern Europe.

As we mentioned in the previous article on ESG growth, heightened awareness of climate change are important drivers of change. Nevertheless, the European Commission’s Sustainable Finance initiative is as well, highly important driver.

According to Pitchbook, private equity is on a long-term growth trend, and there seems to be little that will stop it. Private equity has long been an important contributor to value creation in the real economy and for investors’ portfolios alike.

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In the latest Economic Outlook chapter, economic experts describe a baseline scenario. In the scenario the pandemic fades in the second half of 2020 and containment efforts will slowly loose. Moreover, the global economy could show growth by 5.8 % in 2021 as economic activity normalizes, helped by policy support.

When looking at the latest chart from the IMF Economic Outlook, a high rise in GDP is expected for the countries with advanced economies. With this in mind, companies can incorporate the latest data related to covid-19 into their equation. With coronavirus, the acquired or merged-in firm’s revenue stream may not be as predictable as in the past. The quality of the firm is not the question. Moreover, a firm’s value can drop if the incoming firm’s client revenue shrinks.

What are the remaining challenges in the M&A?

No matter the covid-19, the selling factor remains the same. In M&A challenges, there is an ongoing concern of whether or not the team can bring in sales. Partners do not want to risk payout on a team with no record of selling.

Here’s how to look at the firm value in any CPA M&A deal, pre- or post-pandemic. Value has been, and will always be, what the buyer/acquirer feels it is worth.

Make sure that there is no risk of revenue loss. In that case, the seller or upward-merger firm should not be worried about getting paid in full.

How do you increase the value of your firm? To maximize value, you need to understand the market value of your firm in today’s environment and the drivers that increase or decrease firm value.

Software industry changes in the M&A

In the software industry, private equity-backed providers are helping in subtle ways. They are offering their products and services to government agencies to help them respond to the pandemic or track its spread.

The world of private equity ownership often provides for higher authority over a company’s strategic management. That said, businesses can promptly shift direction to respond to market challenges. Moreover, the technology sector shows that a lot of companies are constantly producing innovative technological solutions.

A recent example of the tech company is digital assistant Andrija, developed in Croatia to help fight against coronavirus. This “virtual doctor”, powered by artificial intelligence, has been developed by Croatian IT companies in cooperation with epidemiologists.

The idea of ​​the assistant is to assist healthcare professionals, doctors and epidemiologists in controlling the development of the Covid-19 epidemic. In addition to that, users are able to determine if they are covid-19 positive.

In short, many software companies are looking for new ways to thrive after the crisis. The post-pandemic situation will bring some economic difficulties for many companies. Meanwhile, tech giant Facebook is already working with health researchers and nonprofits. Facebook will provide anonymized and aggregated statistics about people’s movements. The project is called desease-prevention maps.

Changes in the M&A: Investors still on the hunt

With 170 deals completed in the first three months of 2020, deal volumes are significantly down. If we compare with the previous quarter, deal volumes are the lowest since early 2014.

Moreover, covid-19 crisis has significantly disrupted the normal flow of M&A deals. With the global economy change in mind, companies are more likely to prioritize short-term actions over long-term initiatives. However, those that are able to stay on the course, will more likely establish foundation for continued success once the crisis ends.

Although M&A activity as a whole is expected to be down this year, the deals that get done are expected to involve the same technology disrupters that make attractive targets in scope acquisitions. In the survey, company Baker McKenzie predicted global M&A drop 25% this year, from $2.8 trillion to $2.1 trillion. However, the deals that will get done will involve technology of disrupters. In the repor, data shows that across all sectors, companies will seek to acquire the advanced digital technology.

To sum up, technology sector will continue to receive increase in interest from financial buyers. Moreover, the changes in the M&A will result in fewer acquisitions. In addition to fewer M&A acquisitions, the buyers will take companies in a new directions.

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Reports by Pricewaterhouse Coopers and Kaufman Hall showed a decline in mergers and acquisitions, but still reported sustained interest from buyers. Healthcare M&A Deals in 2020 note a minor decrease in mergers and acquisitions in the first half of 2020, however, some major deals and acquisitions were closed.

Laborie Medical Technologies’ $525 Million Acquisition of Clinical Innovations

LABORIE Medical Technologies executed the definitive agreement to acquire Clinical Innovations for an enterprise value of $525 million. The transaction is subject to customary approvals and is expected to close in early 2020. Clinical Innovations is expanding its global presence while directly researching and developing state-of-the-art technologies and innovative medical devices that fulfill its mission of improving the lives of mothers and their babies throughout the world.

Align Technology’s acquisition of Exocad — $420 million

Align Technology announced it has agreed to acquire dental software company Exocad for approximately $420 million in cash. The move will add Exocad’s experience in restorative dentistry, implantology, guided surgery, and design to Align’s technology portfolio, which includes Invisalign clear-aligner orthodontic and iTero digital solutions. Exocad will also bring nearly 200 digital dentistry partners and more than 35,000 licenses installed worldwide to the deal, according to San Jose, Calif.-based Align.

Baxter International’s acquisition of Sepra Products business of Sanofi — $350 million

According to Reuters, Medical supply company Baxter International Inc, said to buy Safoni’s Seprafilm unit, which makes specialist surgical products, for $350 million in cash.

According to PWC’s research, in Q2 2020 deal values versus Q1 2020, three sub-sectors saw increases: Behavioral Care (900%), Hospitals (11%), and Physician Medical Groups (6%).

Moreover, due to the pandemic, there are a few interesting healthcare asset types that seem more attractive. That is; accelerated growth of remote work, virtual healthcare, home health, and behavioral health. In terms of consumer needs, health services companies must deploy technology that enhances experiences while improving efficiency.

Moreover, there are yet more opportunities for healthcare environment deals to shine. These were major Healthcare M&A Deals in 2020.

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Many factors lead to a massive increase in planning uncertainty at the present. First, long-term health implications cannot be evaluated orderly at the moment. Second, governments around the world found themselves forced to arrange significant economic restrictions in light of these health-related insecurities. Especially the shutdown of entire industries has affected the economy in a negative manner. Third, nobody can anticipate how long those restrictions will last.

The effects of the COVID-19-crisis are not limited to the short view, long-term aspects have to be considered additionally. Even though the global development of the current situation cannot be anticipated accurately, it can be assumed that long-term negative effects on cash flows strongly depend on a company’s business model and thereby its robustness and resilience.

Due to the current market situation, cash flows need to be adjusted in the detailed planning phase. Nonetheless, whether the crisis has to be considered in the terminal value strongly depends on the underlying business model and is therefore not that clear. This also applies to the growth rate within the terminal value. At the present, there are no hints indicating the requirement of adjusting the long-term valuation parameters when the underlying business model can be seen as robust.

Negative Interest Rate

Since the base interest rate is usually seen as a proxy for the risk-free rate, it plays a crucial role in business valuation. In the context of the Capital Asset Pricing Model (CAPM) the base interest rate plays an important role in determining the cost of capital as well as the market risk premium. To begin with, the low-interest environment has existed even before the COVID-19-crisis. By the mid of 2019, negative risk-free rates were already observable. However, after the interest situation has somewhat improved and interest rates turned positive again (at least temporarily), the COVID-19-crisis has triggered a renewed downward trend. The spot rate of the 10-year Croatian Government Bonds fell to an historical low of about 0,99%.

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The COVID-19 Beta Effect

For some companies, we observe that Beta as a measure of the volatility of the company’s equity value relative to the market has decreased. This reflects an increase in correlation between the company’s equity return and that of the overall market. To the extent an analyst believes the cost of equity should have increased to reflect a higher risk in the projected financial information, an offsetting adjustment can be made to the company-specific risk premium that compensates for the change in the risk-free rate and a possible beta decline. The order of magnitude of any adjustments to the company-specific premium will depend on the company’s specific risk profile in terms of factors such as profitability relative to its peers, financial and operating leverage, liquidity, operational efficiencies to name a few.

In finance, the relationship between an equity’s returns and that of the overall market is measured by beta. Stocks with betas over 1.0 have greater systematic risk than the market as a whole. So if the market rises 1%, high beta, riskier stocks like tech, pharma, and luxury goods companies will increase by more than 1%. Conversely, if the S&P 500 drops 1%, they will fall by a greater percentage.

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Company specific risk premium

If Covid-19 happened to affect the subject company more dramatically than its competitors due to specific circumstances (e.g. severe outbreaks and/or lockdowns in locations of manufacturing plants, contingency plans, and procedures not put in place, key personnel being in quarantine or caught in a lockdown abroad, etc.), an increase in company-specific risk premium may make sense. Still, because this premium is very subjective, it should be considered only if the valuer is not able to assess the duration and intensity of adverse circumstances on cash flows.

Conclusion

It is sensible to put more effort in developing reasonable forecasts of cash flows or scenarios, instead of risking overestimating a discount rate. This is especially the case if V-shaped or U-shaped recovery can reasonably be expected for a subject company, implying quicker recovery. Valuers also need to keep in mind the long-term aspect and avoid undue wariness. Arguably, residual value calculation and assumptions do not need to be changed.

This is not the first nor the last crisis, it shall also pass, and recovery will follow. On the other hand, not all industries have been affected dramatically, or even adversely, global demand for certain products has increased, many have switched to e-commerce, shifted to remote working, etc. In terms of methods to be employed, depressed multiples due to sell-off will definitely be a conundrum for some time. Possible distressed M&A activity may also distort transaction multiples. Therefore, results obtained from an income approach may be more meaningful than those from the market approach.

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There was an increased interest in transparency and accountability and in developing ESG policies by private equity firms, according to research. Increasing demand has been noted in terms of transparency and accountability, particularly around ESG policies.

Investment companies are adopting ESG policies for practical reasons as well. Decreasing utility bills and focusing on energy efficiency are the cornerstones of ESG, and in the light of the pandemic, these policies can be effectual methods of saving.

Moreover, some sources state that ESG investing has become mainstream. With the global pool of exchange-traded fund (ETF) assets under management considered ‘ESG-focused’ now reportedly exceeding $100bn (£76.2bn). Companies are raising their ESG credentials in AGMs and annual reports and on occasion, companies perceived to have strong ESG credentials appear to enjoy enhanced valuation compared to their peers.

Private Equity ESG Intentions and Actions

In 2020, private equity firms have raised in excess of $370bn (about £282bn) of commitments to funds that integrate ESG principles into their investment decisions, according to data provider Preqin. But a recent survey by Institutional Investor found that fewer than 10 per cent of 8,810 global private equity firms, with a total of $3.4 trillion under management, are signatories to the UNPRI.

Analysis by Institutional Investor shows that the majority of the private equity firms reporting to PRI have a responsible ESG investing or ESG policy. However, ESG policies focus on process, not outcomes. To assess ESG progress at PE firms is to examine their reporting. Overall, the opacity of ESG reporting by PE firms contrasts with the increased transparency provided by many public companies.

Private equity still has considerable room to deliver improved public – social and environmental outcomes. The growing prevalence and severity of environmental and social challenges have elevated the issue set to the highest ranks of PE firms.

According to a report by Private Equity International, “The current state of affairs allows flexibility for GPs to choose how much to report and how often to do it, which leaves the door open for managers to cherry-pick examples of favorable outcomes while burying unfavorable ones.” In addition, GPs can determine if they want to share ESG information at the GP or the portfolio company level.

Lastly, to address climate change and challenges, institutions, including those in finance and private equity, will have to play a more active role in social and environmental problem-solving. The current support for ESG investing appears to be a combination of several factors. The holy grail of investments that not only generate acceptable rates of return to owners and advance the better interests of stakeholders and society is obviously appealing.

Standardisation of ESG

For those working and investing in private equity, the inclusion of ESG criteria in the investment screening and decision-making process is often a recent adaptation and a learned process.

Approaches should become more standardised and more authentic, with skills more broadly disseminated. For now, there is still an experience gap that makes implementation challenging. One of the early challenges identified in the space is the plethora of metrics, standards and styles of reporting on ESG. Recently, several industry leaders agreed to make more collaborative efforts to harmonise measurement standards.

Positive change is possible and happening. Increasing the transparency and rigour of assessment and reporting will benefit performance.

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