Global Counsel’s practice director Tom King, discusses the role of PDD post-deal and how GPs are assessing the impact of macro factors on their portfolio.

What can Global Counsel offer GPs and how has the firm’s offering evolved?

We’re best known among GPs for political due diligence and that’s at the core of what we offer and what we talk to the industry about.

Over the last two years, we’ve expanded well beyond the deal process to a much more holistic, end-to-end offer, which combines both due diligence and strategic advisory services much more akin to what we would offer any corporate. Translating that into the world of private equity often means we’ll eventually be advising the management team. Just as often, we will be advising GPs on a whole market or a whole sector, where either funds are considering new investments, whether new platform investments or bolt-ons, or they’re considering how to best help their portfolio companies navigate change in those sectors and ultimately sell businesses. Our work has become much more geared towards the whole investment cycle, and indeed, the whole fund cycle.

How does PDD fit into the post-deal investment process and value chain? Why is this important?

PDD is now an important part of planning for growth. Today, our reports are not merely focused on risks and red flags - we also consider how to mitigate those risks, what actions need to be taken after the investment and then how the growth plan can be implemented or enhanced. This is also applicable to the PE house itself. Working from a political and regulatory starting point means you can identify not only commercial but reputational risks.

Areas we consider include the new national investment and screening regime for example, where companies and funds need to be more aware of notifying the government formally about takeovers of certain businesses. There’s more scrutiny around certain industries, particularly in the tech and defence industry, but even areas like public health are now covered by that regime. At the same time, there is increasing media scrutiny of the social impact of companies and their owners, especially in sensitive sectors like childcare and social care.

What has led to the rising importance placed on PDD over the last few years?

I think it goes all the way back to the financial crisis. When I started working in PDD in 2012, it was still a time when banks were not eager to lend, so there was still quite a tight credit situation. As a result, PDD became a way of evidencing the fact that you were doing more work as a GP around a deal - that was the initial starting point for its rising importance.

Four years later, we were faced with Brexit and Trump, massively increased economic volatility across Europe and then more recently the Covid-19 pandemic and the Russian war in Ukraine. As a result of all of this, governments have become more interventionist and the rise of right wing populism has also made governments much more interventionist by nature. It is no longer a simple left-right divide where investment and business are either frowned upon or given a relatively free hand. We’re seeing that in lots of other countries as well across Europe, Asia and North America, and so it has become a much more complex area to navigate.

Why should PE firms consider national, as well as international change when assessing an asset?

In the early days of PDD, there was a focus on companies that have what I would call primary risks around politics and regulation, which are mostly national level. This included businesses that were private providers within the public sector, essentially those that are typically facing national level political and regulatory change and whose customers or commissioners are within that national jurisdiction. We can think of private health or social care here, or software providers to schools or local government, or electronic tagging of offenders.

Increasingly, we’re providing DD on assets that have secondary and tertiary risks. So, as well as facing some of those primary risks, they’re often also importing components or goods from a variety of other countries, or exporting products across the EU and further afield. They may have a plethora of different customs, tax, and regulatory regimes to deal with and they’re also facing a lot of change within those. This can include national or EU legislation on ownership structures, supply chain issues, labour conditions and human rights, new tariffs and so on. This consideration of secondary and tertiary risks is being driven by competition for more complex assets that are perhaps UK-headquartered, but also operating in different locations internationally. It’s now unusual that a company is only based in one country, and so this type of diligence is becoming more necessary.

How are GPs considering volatility and the impact of a recession on their assets?

The GPs I speak to have taken a couple of months to rethink what they’re going to do and how they will respond, should the economy continue to struggle, and what to prioritise in the context of a high inflation period, which is unusual by recent historical standards. But the reason they’ve been reappraising their strategy is because they still need to get money out of the door. There’s still a very strong onus on people to do deals. A lot of my clients are feeling pressure, both from deal teams, but also from LPs to get capital deployed. I think the type of assets people will look for will change. There will be more interest in businesses with guaranteed revenue – for example skills and training companies - and I think it’s possible that there could be more investment in sectors that have been underappreciated - e.g. logistics companies or specialist recruitment businesses. There will also just be more investment in distressed businesses as valuations fall, which is an opportunity, but can bring more difficult questions around reputation – for example if you need to ‘right-size’ the employment footprint.

The fact that the UK Government has now agreed its headline spending for the next three years to 2024/25 gives quite a lot of certainty if you’re a private provider into the public sector. I expect there to be a lot of competition around those assets.

In order to prepare for an increasingly likely recession, what are the key learnings from previous downturns that investors should be aware of?

It’s definitely a different situation to the 2010-20 decade in that politics has moved on from austerity being the consensus among policymakers. Investors should be looking out for perhaps a change in personnel, at the top of government, where more spending may be unlocked, and then they should be looking at how that chimes with their investment strategies. We are also in a very different political landscape now than in 2019, where Labour are a much more relevant opposition, and the prospect of a change of government at the next election is a real possibility.

There’s a general point to make about private equity which is that the industry as a whole will continue to come under scrutiny. We’ve just seen, for example, the McColl’s rescue, which was a very good outcome for a challenged business. There will be other examples of businesses that don’t have such a good outcome, where PE ownership will come under scrutiny from Parliament and the media. GPs will probably have to make some hard decisions. They did a good job in the pandemic of protecting their portfolios and making sure jobs were saved. I think there’s a continuing challenge for the industry and for individual funds around how they position themselves and present that story. Reacting to negative stories will not sufficiently address both a highly competitive fundraising environment and a political economy that is increasingly characterised by quite shrill ethical judgements.