In 2015, the private equity industry continued to return significant capital to investors as they took advantage of a strong seller’s environment. Private equity managers completed 2,309 exits, generating $569.3 billion of proceeds and J.P. Morgan Global Wealth Management’s private investments platform participated in this trend. Putting aside distributions, the total capital raised globally in 2015 is estimated to be $527 billion, so not only do private equity firms have capital to deploy, but given recent portfolio exits, managers may have an even larger capacity to find new investments. Some of the largest private equity managers are renewing their focus in smaller businesses, partly because there are less crowded waters from the sea of corporate cash that continues to buy and provide capital to larger businesses. Private equity managers also invest in SME because they can often add value to operations and governance, which can have a significant cost and impact on small and middle market companies. Ultimately, private equity managers and SMEs can have a mutually beneficial relationship, provided the tools available to find growth. Given that turns in an economic cycle are inevitable and recession risk continues to mount, small- and medium-sized businesses could consider if a private equity partner can help weather a potential storm.
A private equity fund tends not to be influenced by short-term inputs. A longer-term (generally three-to-five-year) investment horizon makes private equity managers more willing to invest in long-term growth, with an eye toward maximising value. Private equity funds tend to average a 10-year lifespan. Many private equity managers have had success when investing alongside SMEs by investing when a company is at an inflection point. Sometimes that comes in the form of providing access to needed capital, or taking a hands-on approach to successfully guide a business through a new product life cycle. Private equity managers can also help drive efficiencies, or help better support core business processes. In working with an experienced private equity manager, they can also share successful strategies from prior portfolio company investments. It is important that a business finds the right private equity manager to leverage that partners’ experience and relationships.
Another reason SMEs are partnering with private equity managers is because they are finding it increasingly difficult to secure debt financing and are turning to direct providers of capital for their financing needs. Structural shifts, driven by regulatory reforms, have led banks to curtail lending efforts. Moreover, increased volatility in public credit markets has negatively impacted demand for high-yield issuance, particularly for companies with lower or no credit ratings. In this environment, SMEs could partner with a manager who can source, underwrite and structure bespoke financing. The managers often perform substantial upfront due diligence, but ultimately can create customised credit packages. As a result, these customised credit strategies are typically a combination of contractual cash coupons with other accretive features such as accrued interest, original issue discounts, prepayment penalties and/or equity warrants that might make sense for SMEs.
In a world with increased regulation and scrutiny, having a focus on navigating the complex issues related to regulation is another area that private equity can be successful in partnering with an SME. Private firms, especially those with a global presence, can often provide analysis and insights about geopolitical, demographic, technological, macroeconomic or long-term trends that inform business growth and investing. Private investing is not without risks, so it is important for businesses to find a partner with specialists with deep domain expertise, long track records, experienced teams and an all encompassing approach to investing. As a business owner, thinking through the anatomy of a private equity deal, it is extremely important to understand the fund’s original investment thesis as well as their experience investing in similar businesses.
In small-and medium-enterprises, specialisation often matters so we generally suggest partnering with a private equity firm that has well-resourced teams, a long track record and strong operational capabilities to help drive outperformance without relying on leverage or multiple expansion. Due to private equity firms taking a longer term approach to investing, having the capital to provide to those in need, and helping navigating an increasingly complex regulatory environment, it is expected that private equity managers can continue to have success when investing alongside small- and medium-sized enterprises.
The writer is Head of Alternative Investments — J.P. Morgan Private Bank, EMEA
