The eurozone financial crisis is the greatest threat to European private equity, trumping more industry-specific concerns such as the availability of debt, the ability to fundraise, negative press coverage, reputational concerns and increased regulation. In a survey of more than 50 European GPs by Real Deals and Marsh, a global leader in insurance broking and risk management, 43 per cent of respondents said that the eurozone financial crisis was their biggest cause for concern (see chart, right).
“The eurozone financial crisis affects absolutely everything,” says Ross Marshall, senior partner at Dunedin. “Yes, we are concerned by the fundraising climate, debt markets and all those other things, but if the eurozone crisis deepens and you start having things like runs on banks and/or escalation of social discontent leading to civil disorder, then the whole risk appetite of the financial community changes and businesses will not want to invest for growth. It could be like Lehmans times ten.”
Private equity investors must face up to a new reality. “There are several risks on the horizon,” says Juan Barnechea Aldatz, managing director at Riverside Europe for Iberia and Southern Europe. “Regulatory risk and reduced fundraising are certainly issues, but the macroeconomies of Southern Europe and the lack of market growth is the biggest threat to the whole private equity industry. The industry as a whole will lose participants because they are not geared towards the new reality – low growth, low debt.”
The second-biggest concern, for 19 per cent of respondents, is the ability to raise funds. This can be seen on both the macro and micro level. “For those at the end of their investment period, the challenging fundraising environment is probably one of the biggest concerns,” says Philip Shuttleworth, finance director at ECI Partners. “With respect to deals, debt is available at sensible levels in the mid-market, even if pricing has been adjusted, but if the European financial crisis turns into a wider credit crisis, then fund flows into the industry may dry up.”
The lack of debt was the top concern for nine per cent of respondents because without leverage at the right price, the whole buyout model will cease to work. “The greatest threat to European private equity is the continued weakening of returns, which is a reflection of the lower availability of leverage and lower growth prospects in European economies,” says Markus Golser, senior partner at Graphite Capital. “It means that the industry as a whole ultimately has to choose between making higher-risk investments or accepting lower returns.”
The lack of debt finance is compounded by competition amongst private equity firms, which are sitting on substantial war chests, for assets. “An oversupply of capital is a risk,” says Philip Shapiro, managing partner at Synova Capital. “The amount of capital available to deploy is greater than the number of deals available. It drives up prices and that is a threat to returns.”
Andrew Hayden, managing partner at Sovereign Capital, sees fundraising as the biggest threat in terms of the volume of money coming into the industry and where that money will go. “The biggest threat is to the asset class itself, in that availability of funding is going to be tougher and there is a need for greater differentiation of funds, which I am not sure is there in the UK. If you are an investor, particularly in the US, you have to ask yourself a number of questions. Do you want to put money into Europe? Do you want to put money into the UK? Who do I want to invest with? There are a lot of me-too offerings and it is hard to see them all surviving.”
Some would argue that this is Darwinian and rather than leading to the death of the industry, will lead to a more efficient, vibrant – if smaller – marketplace. “Fundraising is very challenging, but in some ways you can look at that as a cleaning out of the closet,” says a risk manager.
Lower returns would obviously hit the ability of firms to raise funds and survive. “At the heart of the private equity business is long-term performance and ultimately performance, or otherwise, catches up with you,” says Mark Wignall, managing partner of Mobeus Private Equity. “That directly affects the ability to fundraise. If you can’t fundraise then eventually – and it takes a long time – you die.”
The private equity industry has been battered by negative press comment in recent years and some see this, or the industry’s reputation in general, as a significant threat. “Reputational concerns are the greatest threat to European private equity,” says the managing partner of a European private equity firm. “Increased regulation we can
and will have to deal with. Ditto negative press coverage. The ability to fundraise is in question but if you have the returns you will be able to raise money. Debt we know will come back. The financial crisis will be resolved one way or another.
“The biggest risk is reputational concerns because it impacts on everything. If we are seen as being a bad place to invest because at one end of the spectrum we as individuals are shysters who are trying to glean as much money as possible and pay no tax, and at the other are fighting any regulation and controls over us, then in the middle, where we are buying businesses, stripping them dry and making tons of money – which by the way we are not paying any tax on – that will have bigger long-term implications than any individual factor. It means we will get more regulation, it will be harder to raise money from all sources and it will be harder to make investments. It will make private equity a bad place to be.”