Last updated on June 23rd, 2023 at 09:59 am
Private Equity exit activity is returning with a renewed Vigor after the dramatic, pandemic-induced lull in the capital markets in the first half of 2020. In 2021, most private equity (PE) executives surveyed are planning exits to public markets through initial public offerings (IPOs) or special purpose acquisition companies (SPACs) in the next 18 to 24 months. PE exits jumped up during the 12 months ending March 2021, with strength in IPO markets and sales to SPACs contributing to a spike in deal value and volume not seen in a decade.
With the receding impact of the pandemic and as it’s long-term effects on markets, consumers and geopolitical trends become clearer, PE firms’ transactions are likely to remain robust given their access to capital. Digitalization of businesses’ operating models or routes to market have become a leading driver of higher deal valuation – more important than their proven organic growth. However, the improvement of working capital-the traditional value driver, still remained a key factor. Over the next year PE priorities are expected to be dominated by the need for accelerated exits.
These will all be affected by the impact of the pandemic on the portfolio businesses themselves, their markets, M&A processes and investor appetite. Other changes would include greater relevance of environmental, social and governance (ESG) factors and tax concerns. They expect to capture an ESG premium in businesses that they are considering exiting based on specific ESG qualities. Furthermore, PE firms are actively courting potential buyers with a strong ESG record to capture a premium.
Most feel digitalization of a business ranked as a critical component of the value story and divestment thesis. Digitization is a key value driver because it impacts the operating model, cost base and break-even point for a business, it enables revenue growth through better customer service, pricing and margin as well as allows new routes to the market that expands the addressable customer base.
PE firms also regard Artificial Intelligence as an important value driver for portfolio companies over the next 18 to 24 months. This is because in addition to increased automation of processes and controls, AI can also support forecasting and decision-making that directly impacts the businesses margin enhancement and cash conversion.
Most of the PE firms with a primary focus on digital growth, digital analytics are the top priority for their portfolio companies’ digital development. They are investing in centralized data repositories, including data lakes, that enable them to bring insightful opportunities to portfolio companies to improve KPIs or change operating models.
Tax is another big value driver on exit, and depending on an investor’s rate, tax can either contribute significantly to or diminish returns. Transfer pricing exposures on intercompany transactions, non-income tax exposures and income tax exposures also ranked among tax issues that can reduce value. Conversely, certain tax planning may enhance the value of a portfolio company on exit. But PE leaders are now expecting changes in tax policy to impact the timing of their exits.
PE firms say improvements in working capital management and EBITDA cash conversion also formed the basis for significant value on exit, ranking ahead of organic and inorganic growth and manufacturing cost improvements. Working capital optimization continued to take centre stage in successful exit preparation, with most PE firms ranking it among the top three factors of importance to their exit strategy.
When the right deal comes, moving fast may be as crucial as a well-developed and data-backed exit equity story for the business. Lack of fully developed diligence materials, including product/service road maps, high level of debt, deteriorating performance are a source of value erosion that leads buyers to reduce price.
Short-term uncertainty and market volatility have changed the divestment landscape for PE owners. But PE firms have reacted fast to the pandemic and are now well positioned to build strong valuations and achieve exits that take advantage of the market conditions.
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