Acclaro Growth Partners' M&A and Strategy Weblog

What Will Be the Impact of the Financial Crisis on Private Equity?

Private equity investments are down sharply.  That’s no surpise.  But they are down in proportion to overall M&A activity, which means that strategic acquisitions are increasing.  Strategics can often offer stock, and public companies may now be better able to secure debt than private equity groups.  So, what is the longer term forecast for private equity?

The deepening credit crisis obviously makes it more difficult and potentially more expensive to borrow capital.  But it may also make it harder to pay back borrowed money.  The worsening general economic conditions are reducing the values of portfolio companies.  As private equity groups spend more time and energy on these portfolio companies, they will be likely need to hold onto these companies longer to generate reasonable returns.  Restructuring the portfolio companies, combining them with other companies, pursuing add-ons, and generally being more hands-on with management takes time.  Expect fewer new platform investments and longer holding periods.

Yet, despite the doom and gloom, there are new funds being formed on a daily basis.  Investors all over the world still have an appetite for US private equity investing.  Some private equity groups are positioning themselves as special situations funds and others are deciding to focus more on distressed debt investing. 

Private equity is certainly not going away.  But the landscape is changing.  The expectations are evolving.  The types of investments are morphing.  The next year, scratch that, the next couple of months should be interesting.

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Add-On Acquisition Trend is Growing

While many private equity groups are having a difficult time pulling the trigger on new platform acquisitions, they are making hay with add-on investments for their portfolio companies.  In some cases, the financing for add-ons is easier to line up because the original loan agreements documented the terms for add-on contingencies.  There is generally less risk associated with strategic acquisitions of competitors than investments into entirely new, unfamiliar niches.  LPs, especially in these uncertain financial times, expect PEGs to do something -- and portfolio add-ons qualifies as a worthwhile use of PEG resources.  And, at the same time, add-ons certainly place some of the burden of returns on the management teams.  So the trend is currently toward an inward focus on portfolio comapnies and their add-on investments.

These add-on acquisitions do not require full-blown market/business strategy due diligence, but they do benefit from some aspects of business strategy diligence.  Customer calls reveal the degree of satisfaction, the unmet needs of customers, the reasons for lost accounts, and the fit between customer purchase decision criteria and the company's key strengths.  Management assessments uncover a wide range of issues related to individuals, the team, and most importantly, the cultural fit between the acquirer and the company being acquired.  Operations assessments are important diagnostics of the efficiency of the processes being carried out in the business model of the acquisition target.  They can reveal the low-hanging fruit that can be picked to improve profit margins, and the costs of these changes.

In conclusion, as private equity groups carry out add-on acquisitions, they should consider elements of the business strategy diligence process.  For more information, visit our website Acclaro Growth Partners.