The Deal and Donnelley Financial Solutions recently broadcast “The State of Private Equity: Current Trends and Outlook,” a panel discussion featuring host Daniel Perez, Director of Business Strategy for Venue Virtual Data Room at Donnelley Financial Solutions. Daniel sat down with Andres Saenz of Parthenon-EY Practice, Richard P. Prestegaard of High Road Capital Partners and Shamit Grover of MSD Partners to discuss the current state of private equity and the trajectory of transitions among private equity firms. This is part three of an overview of the hour-long discussion, which is available online from The Deal. You can review part one here and part two here.
 

Fundraising

Last year, 807 private equity funds raised almost $350 billion. So far, 2017 has seen the same level of success. One of the strongest driving forces behind this success is the investment into private equity. Pension funds, for example, have to address funding gaps. Placing capital in alternative assets, such as private equity, can bridge the gap.

“If anything, they can’t meet their own allocation target of how much they want to put into private equity,” said Saenz. “I do think that sends some of the capital, probably disproportionately, into the larger funds, even if they recognize that there might be higher returns in different types of funds.”

These pension funds have to deploy a lot of money while they also try to lower the complexity of managing that money. And as the returns on investment in private equity are projected to be higher than the public market and fixed income returns, money will continue to flow in.

Of the funds raised and closed last year, 10 percent were first-timers. New, smaller funds want to get their capital deployed, but it’s tough because they have to produce a track record of returns—a tall order in a competitive environment with high valuations. These new funds need to prove their model as a new fund, but that takes 3-7 years. However, first-time funds tend to outperform the average, partly because the people leading these funds have a track record and an established set of relationships. Beyond that, today’s first-time funds are after smaller deals and are therefore less competitive. They have highly motivated general partners trying to get deals done and an incredible amount of focus on what they’re after, where they’re going to add value and how they’re going to return capital.
 

Potential Deals

Every equity firm has their own strategy for pursuing and closing opportunities. High Road Capital Partners focuses on the smaller end of the market with businesses of $3 million to $10 million in EBITDA and transactions of $100 million or so, and casts a broad net to look at as many deals as they can as efficiently as possible. They spent a decade building efficiency and casting their net more and more broadly. They started out focused on bank deals, but today there are more channels for deal distribution in addition to bankers, such as deal aggregators, alternative advisors (wealth advisors, consultants, lawyers) and independent sponsors. High Road’s strategy is to be efficient and find deals that are right for them through any channel. Last year they looked at 1,500 to 1,600 deals that met their criteria and spent time digging into 500 of those.

MSD Partners, on the other hand, approaches M&A with a deep-dive philosophy. The team's members debate which particulars interest them most and then whittle it down to two broad areas of focus they can align themselves around. MSD purposely starts their funnel in terms of industries, then gets a good angle on these industries, builds relationships and finds the opportunities. Last year MSD Partners looked at more than 200 potential acquisitions between their two areas of focus (control equity and structure equity), then spent time on due diligence and negotiations for six or seven of those opportunities.

MSD’s deep-dive approach is becoming more aggressive, with potential buyers attending tradeshows, judging competitions and getting to know the future CEOs of companies they will eventually hope to acquire. It’s an approach that allows the people working in the private equity space to connect many dots and do what they enjoy—work in businesses and help them grow. They spend time with entrepreneurs, managers and founders to get a comprehensive understanding of a business.
 

The Evolution of Sourcing Deals

In 2007, roughly 30 firms had dedicated deal sourcing. Today that number has expanded to several hundred. Private equity is, again, competitive. Firms are more efficient and more focused on keeping their pipelines full. Bankers have grown more efficient in knowing who the right buyers are, so instead of presenting deals to more people they zero in on showing the right deals to the right people. Owners are more informed about their options and alternatives, so while ten years ago an owner was likely to ask a potential buyer, “Tell me about private equity,” today’s owners are already familiar with that information.

Everything across the private equity space is more efficient, more competitive and likely to stay that way.
 

This Year, in Private Equity

Projections for the coming year start with the geo-political climate. Higher volatility and uncertainty impact macroeconomics, interest rates, etc. Private equity has to remain steady while also being nimble enough to find opportunities and pivot the firm as needed.

With all of the dry powder, competition and high multiples, fund clients are thinking through how they can optimize what they do across the life of the deal cycle. This includes asking questions, such as:

• What’s the best way to think of origination and deal sourcing?
• What’s the best way to differentially diligence assets to position ourselves to win?
• How should we think of operational value creation to make deals work?
• How can we be more thoughtful and deliberate about exiting?

Private equity firms are rethinking how much they need to innovate and optimize across the deal lifecycle as they look across the whole thing. This starts with learning from operating partners when they own the business, making sure companies are performing, and being smart about how and when to exit. With competition heating up as much as it is, firms have no choice but to focus on improving the cycle. This includes differentiating yourself from the 40 other people courting a selling CEO. How can one firm differentiate themselves from the rest? This differentiation is going to be a key theme and it requires a focus on sourcing, operational excellence and partnership with the team through the ownership cycle.

If you missed the earlier installments of this series, you can review part one here and part two here.

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