I moderated at a private equity conference in London last week on the subject of what private equity firms are doing with respect to exiting in the current business environment. Even if the reader is not from the private equity industry, I believe the subject is still of general interest, as it provides trends on what sophisticated market participants are doing in an often difficult market.
The accompanying chart gives an overview of exits for the European private equity industry.
The main points made at the conference about private equity exits were as follows:
Not all sectors and countries are experiencing downturns. Poland has been the most robust market, thanks to its strong macroeconomic performance vis-a-vis other countries. There have also been certain sectors, such as IT and technology, that have performed quite well. So there were still 160 private equity exits Europe-wide, according to statistics provided courtesy of the European Private Equity Association, in Q3 2011, the most recent figure available – just to strategic investors.
The number of firms written off by private equity investors is also surprisingly common – also 160 firms in Q3 2011, Europe-wide.
Most private equity owners have postponed exits on a number of their investments. So for example, whereas in the first half of the previous decade, the average hold was only about four years, that number has now crept up to seven or eight years for many private equity firms.
As it is harder to grow top-line revenues in many sectors of the economy, private equity firms may hope that multiples improve over time; but hope, in itself, is not a strategy. Many private equity firms are putting much more emphasis on operational improvements to build value.
One of the reasons for which it is so hard to exit in the current market is the difficulty of giving performance forecasts. In many sectors, it is very difficult to predict what will happen even in a three to six month horizon – the time it takes to move from a Letter of Intent (LOI) to closing.
In this type of environment, a seller can either give a conservative forecast (which will greatly diminish valuation), or provide a more optimistic forecast. If this more optimistic forecast is missed, it will devastate the value of the firm even more than under the former scenario, because it destroys the credibility of management in forecasting performance, even over the short-term.
One strategy for avoiding the risk of missing budgets is to diminish, as much as possible, the period between LOI and closing. For mid-sized companies, this might be accomplished in 10-12 weeks, provided that there is an extremely thorough advance preparation, which would include having everything ready that an investor would want to have at their fingertips, including a completed data room, perhaps even with a completed vendor due diligence.
Some competition in the process, to keep bidders moving according to a preset timeline, can also help prevent the process from lagging.
In a nutshell, while the environment is not easy for most private equity firms, there are some excellent strategies to deal with the current situation. For those private equity firms with capital available, it is generally a buyers’ market, and the diminished credit available from banks in most countries means that companies generally seek more equity.
While there is something of a shakeout happening in the Central European private equity industry, this is not happening as quickly as some pundits were forecasting in the months immediately after the Lehman Brothers crisis.
It is primarily those private equity firms that show a good track record, even during the tough times, that will be more successful at raising funds. There is something of a flight to quality among those institutions and individuals who invest in private equity funds. It will be even more difficult for new entrants to compete against 10-15 years of positive track record.
My prediction, therefore, is that over the coming five years, there will be fewer but larger private equity firms active in Central Europe.* Les Nemethy is the CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on mergers and acquisitions. He is the author of Business Exit Planning, published by John Wiley & Sons and available on Amazon.