How Private Equity Plans to Cash in on the Covid-19 Recovery

With exit activity surging back from last year’s slump, private equity leaders are looking to maximize valuations.

Michael Nagle/Bloomberg

Michael Nagle/Bloomberg

Private equity is making a comeback from its pandemic lows — and firms have big plans to capitalize on the booming exit environment.

In the second quarter of 2020, private equity exit activity dropped to decade lows, according to the 2021 global private equity divestment study from Ernst & Young. Then, it sprung back, as private equity leaders saw opportunities to produce stronger valuations. From March 2020 to March 2021, PE exits jumped nearly 40 percent to $600 billion, higher than it had been since before 2010.

Firms hope to ride this wave of increased capital access and maximize deal valuations along the way. In the next 18 to 24 months, about half of surveyed PE executives said they are planning exits to public markets through initial public offerings or special-purpose acquisition companies.

“I think there are a few dynamics here,” said Pete Witte, EY’s lead analyst for global private equity. “You’ve still got your traditional trade buyers; you’ve got secondaries where PE firms have all this dry powder that they’re looking to put to work. Those buyers are still out there, and they’re still very active. The IPO markets have clearly rebounded, and now you’ve got SPAC buyers in the mix as well.”

Digitalization is “Key” to Valuations

The annual survey results were based on answers from 106 global PE executives from firms with $10 billion or more in assets under management. From February to March 2021, respondents were asked questions on exit strategy, preparation, and execution via an online survey.


Asked about exit strategies, respondents ranked digitalization as a “critical component” in the success of their last major exit. In the hierarchy of importance, respondents placed digitalization of the business above acquisitive growth, strength of the management team, and product innovation. Over half of respondents also saw artificial intelligence as an “important value lever” for portfolio companies moving forward.

“Arguably accelerated by the pandemic, digitalization is a key value driver that impacts the operating model, cost base, and break-even point for a business, enables revenue growth through better customer service, pricing, and margin, and allows new routes to market that expand the addressable customer base,” EY said in a repot on the findings.

The pandemic was difficult for portfolio companies: 58 percent of respondents said their firms required fast action — including bridge loans and temporary credit facilities — to access capital, while 44 percent of firms reported a “visibility gap” between profits and cash flow, according to EY.

“Everybody models for declines of 25 to 30 percent in revenues,” Witte said. “Nobody models for 50 percent declines or 100 percent declines in cash flow. We worked with a lot of firms to help them understand what their working capital situation was. And it’s something that carried over into the exits.”

Over the last 12 months, 31 percent of respondents said that working capital and operating cash improvements generated the most value out of any pre-sale initiative to improve business performance. Capital and operating cash improvements outranked organic growth through product and service innovation or channel expansion, formation of new alliances and partnerships, and manufacturing cost improvement, EY said.

Tax and Cash “Remain Kings”

Survey respondents were also asked about exit strategies that didn’t work out well in their last exit. Forty percent cited a lack of fully developed diligence materials — which led buyers to reduce prices — as the primary cause of value erosion in their last exit. Respondents also pointed to high levels of debt in the target, deteriorating business performance during the exit process, and lack of time to manage an effective process with buyers as sources of value erosion.

In the future, private equity professionals said they plan to incorporate environmental, social, and corporate governance strategies into exits. For the businesses they are considering exiting, 72 percent of respondents said they expect to capture ESG premiums.

Under the ESG umbrella, respondents on a global scale are focusing most of their efforts on social impact policy, including diversity and equality commitments. Regionally, priorities look a bit different. In the Americas, 50 percent of respondents said their firms are focused on brand management and reputation.

EY also noted a growing focus on taxes as 65 percent of respondents said they expect changes in tax policy to impact the timing of their exits. Respondents said that out of all potential tax items, transfer pricing exposure on inter-company transactions have had the greatest impact on exit value.

“The pandemic effect is still playing out — both short and long term,” EY said in the report. “It has accelerated changes in attitudes to factors that are now affecting the attractiveness and valuation of businesses — notably digitalization and ESG metrics. But traditional factors remain important, including tax and cash — they remain kings.”