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Where Private Equity Firms Need to Step It Up to Win Capital

Companies’ biggest concern about their private equity owners centers around financial controls, a Deloitte survey found.

Private equity firms may need to pay closer attention to their stakeholder relationships to get a piece of the capital expected to flood into alternative assets over the next five years.

Alternative assets will swell 61 percent to about $17.2 trillion globally by 2025, with about half of those assets in North America, according to a Preqin report. Private equity and private debt will be the biggest winners, Preqin predicts. 

Private equity firms vying for capital should strengthen their stakeholder relationships with limited partners, portfolio companies and their own talent, according to a recent report from Deloitte. The accounting firm found that some private equity-backed businesses — mostly those expecting a decline in revenues — have concerns about their owners in areas such as financial control and assistance during the pandemic.

“The industry is going to grow, but each of the PE firms needs to figure out a way to distinguish themselves,” Frank Fumai, who leads Deloitte’s private equity practice, said in a phone interview. “They’ll compete not only for capital,” he said, but for deals and talent as well.

Building diverse teams will be important as they show up at the negotiating table to potentially buy businesses, according to Fumai. Diverse leadership “ultimately leads to value for portfolio companies,” he said.

Fumai also pointed to Deloitte’s survey of 200 private equity-owned companies, saying they valued financial assistance and industry expertise during the pandemic. That’s important for private equity firms to keep in mind, he said, explaining that “word of mouth” matters to companies when choosing the right partner as an investor.

While most companies are satisfied with their private equity owners, around one third of the comments that the accounting firm received from portfolio companies were negative, the report shows.

The biggest concerns revolved around financial controls, including restrictions on investments and expenses and a lack of capital infusion. Tighter talent policies, including layoffs and compensation cuts, were the second biggest worry cited by portfolio companies, while “excessive operational scrutiny” ranked third, Deloitte found.

Larger businesses with more than $500 million of revenue had the highest portion of negative comments about their private equity owners. Smaller companies with revenues under $100 million were the most positive about the support they received from their private equity backers.

Some of the actions that private equity firms took across companies of all sizes may be necessary for their survival through the pandemic, according to Deloitte. 

It’s “tough medicine,” Doug Dannemiller, the firm’s head of investment research, said by phone. “You’re going to have to make some hard choices about how you’re operating the firm and conserving cash and working with your employees.”

[II Deep Dive: The World’s Dominant Investors in Private Equity]

Private equity funds have returned more than $2 trillion to investors over the past five years, according to Deloitte. The median net internal rate of return for private equity funds with vintage years 2008-2017 has continuously been at least 12 percent, firm’s report shows.

That helps explain why investors keep flocking to the industry.

Under its baseline estimate, Deloitte expects global private equity assets will rise to $5.8 trillion by 2025, as investors seek bigger gains than they expect to reap from stocks and bonds. Under its bull case, with growth in gross domestic product averaging 3.4 percent, the firm predicts private equity assets will expand to $6 trillion.

“Since bond yields are expected to stay low and public equity returns are likely to be below historical annualized returns over the next 10 years, institutional investors — pension funds, insurance companies, endowments, foundations, investment companies, banks, and family offices — are increasing allocation to private capital,” Deloitte said in the report. 

Preqin has forecast that private equity assets will double to $9.1 trillion globally by 2025, with private debt assets rising 72 percent to about $1.5 trillion over the same period. The data provider sees hedge funds assets increasing at a much slower rate of 20 percent to about $4.3 trillion, and real estate assets rising 18 percent to about $1.2 trillion.

Asia-Pacific will drive global growth in alternative investing, says Preqin, predicting the region will triple its assets in the category to about $5 trillion in the next five years.

“Private markets are a core part of the investment landscape, and have seen an incredible rate of growth in size and influence in recent years,” David Lowery, head of research insights at Preqin, in the firm’s statement this week on alternative assets. “Our model shows that growth will continue, buoyed by an uptick in private equity activity and booming in participation in Asia-Pacific.”

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