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Middle-Market PE Firms Successfully Weather the Pandemic Storm

Swift and decisive adjustments in a highly uncertain environment could result in a record-setting year.

Middle-market private equity sponsors have made a remarkably smooth transition during the pandemic, according to research by New York Life Investments Alternatives, an investment advisor, and Coalition Greenwich, a consulting and research firm. 

Their success is reflected in a stellar performance in deal volume this year, according to data from PitchBook. Middle-market PE sponsors have closed 1,721 deals in the first half of the year for a combined $264.6 billion, putting 2021 on track to break the prior annual record of $416.3 billion in 2019. 

“Companies that have shown resiliency through 2020 and into 2021 are tracking very, very high values,” said Chris Taylor, head of NYLIA.  “And I don’t see that changing anytime soon.”

From February to April, NYLIA conducted more than 100 interviews with managing directors and partners at middle-market PE sponsors. About 80 percent of participants have EBITDA between $10 million and $50 million, according to the NYLIA research.

In response to the pandemic, middle-market private equity managers have sharpened their investment skills, adapted to new modes of relationship-building, and paid more attention to ESG and DEI factors in the investment process, according to the research.

According to Taylor, 28 percent of respondents said they have tightened discipline on valuations, which means they’re focusing more on “structures, cash flows, and liquidity” in the investment process and “rethinking some of their hypotheses around different markets.”

“I think [our research] highlighted certain characteristics of businesses that sponsors didn’t focus on [as much] before the onset of the pandemic,” Taylor said. 

The middle-market private equity firms have also learned the ins and outs of maintaining business relationships in an increasingly virtual world, Taylor said. The quick adoption of technology has ensured that they can process due diligence transactions, monitor portfolios, and make investment decisions in a “very relationship-based business.”

The surveyed PE firms prize covenant flexibility and relationship history in financing partners, according to the research. Some continued to hold important in-person meetings, while others have found digital solutions to be cheaper and more effective. Either way, they’ve proven that they can be flexible and resilient during the recent market turbulence. 

Just like other players in the investment space, middle-market PE firms are attracted to environmental, social, and governance investment opportunities. Sixty-three percent of participants in the NYLIA study said they take ESG factors into consideration when making investment decisions, although only 37 percent have established a formal process for accessing ESG risks or opportunities. 

“Relative to other parts of the asset management industry, middle-market private equity sponsors are still in the early stages of adopting formal procedures for both ESG and DEI,” the research said. 

The social unrest following the pandemic has “shifted the focus from the ‘E’ to the ‘S’ in ESG,” the report said. Middle-market PE sponsors that meet the diversity, equity, and inclusion standards at their own firms and at portfolio companies can distinguish themselves from competitors, the research concluded. 

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