A combination of bureaucracy and biased banking could lead to the end of private equity as we know it.
The most experienced and successful minds in the industry are threatening to turn their backs on the asset class, as lenders continue to penalise buyouts and a mountain of regulation is poised to bury the model in red tape.
Speaking at a breakfast to launch “Managing risk in private equity”, a survey carried out by Real Deals and global insurer Marsh, Andrew Hayden of lower mid-market house Sovereign Capital pointed to the care home sector, where private individuals can bolster their firepower with up to five times Ebitda. Private equity firms, meanwhile, are seeing their competitive edge – and returns – crushed as banks refuse to offer more than two times earnings.
At the same time, the administrative and financial burden of mounting legislation – not just the pending AIFM directive, of course, but health and safety fanaticism, the Bribery Act and countless other petty, yet potentially business-threatening irritations – have some starting to think: “why bother?” Particularly as, in an increasingly litigious world – where a malign media is just waiting to pounce on any perceived private equity indiscretions – the fallout from failure can so easily spread from portfolio company, to buyout house, to individual investor.
“It begs the question, why be a private equity firm?” says Andrew Hartley of Chamonix Private Equity, a direct secondaries specialist which, with its deal-by-deal model, is already treading a less familiar path. “Why not be an entrepreneurial outfit that does deals outside of the regulated regime?”
The limited partnership model has become the default structure for private investment – and for very good reason. Ignoring anomalies at the top end of the market, where vast management fees have distorted good sense, the two, eight and 20 model provides inherent alignment and the real luxury of a five-year licence to “go hunting”. But it is not the only option.
“A management team that wants to do a buyout does not need a private equity firm – that is what we, as an industry, need to remember,” says Mark Hammond of UK house Caird Capital.
“What they need is money and incentivisation to go with it. They may get sold added value when they get there, but what they are buying is cold hard cash. Private equity is unbelievably homogenised around structure and there is no reason why it should be.”
Of course, alternative models, including evergreen funds and listed vehicles, are nothing new. And emerging managers have frequently sought to cut their teeth in the asset class with a deal-by-deal approach as they prove their worth.
Meanwhile, more recently, well-established limited partnership managers – most notably Duke Street – have been forced to abandon the fallback model as blind fundraising efforts prove fruitless.
But as restricted banking and onerous legislation, not to mention a painfully slow fundraising market, combine to take the shine off traditional private equity, it is looking increasingly likely that some of the industry’s best and brightest will abandon the traditional route – not from a position of weakness, but from a position of strength.
Using the vast personal wealth many have amassed and exploiting the growing number of institutional investors looking to shore up dwindling returns by cutting out the middleman, we can expect to see an increasing number “opting out” of mainstream private equity, embarking instead on creative partnerships with each other, and with former LPs.
While senior partners using angel investment to ease their way into retirement may be par for the course, I suspect something more fundamental may now be at play.
Punitive regulation and changes in banking culture designed to stamp out risk could ultimately drive those best able to manage that risk out of the asset class.
