Private equity in the mid-market: reshaping strategies for 2021

With deals coming back to market, four private equity specialists shed light on current deal flow, where opportunities for private equity firms will lie in the future and how they can adapt to realise them.

When the global COVID-19 pandemic stormed across the globe in early 2020, the private equity sector was hit hard. Almost overnight, deal flow fell through the floor, as mid-market funds and advisors from Berlin to Brisbane battened down the hatches and tethered portfolio companies to safety through active portfolio management.

Carlos Ferreira, US national managing partner for Private Equity, recounts his experience at the onset of the US lockdown: “It was St. Patrick’s Day, we were at the peak of our M&A deal count and literally seven days later 90% of those transactions paused, halted or died. It was pencils down.”

“From there,” says Mo Merali, Partner and Head of TAS and Private Equity UK, “other than the deals that were on the cusp of being closed, since they still made sense, portfolios were divided into three categories: the seriously impacted, such as those in travel, bricks and mortar retail, consumer and leisure; those that had a boost from COVID and were in need of more working capital or cash because trade was moving so fast; and those that fell in the middle, where the full impact was still unknown.”

Similar actions took place in every market. In Germany, according to Wilhelm Mickerts, Partner and Head of Private Equity, at Warth & Klein Grant Thornton, “mid-market private equity funds used the first weeks of the crisis to not only secure financing, including government-backed loans, but also to improve the operations of their portfolio companies.”

Mickerts likens the pandemic’s impact on the private equity market to that of the 2009 global financial crisis, adding that the industry’s response was decisive in both instances: “Funds were wise back then, as they are now, to take care of their portfolios, so they emerge stronger when market conditions become clearer.”

Where next for deal opportunities?

The initial laser focus on portfolio management was common across the globe, but now that markets are beginning to recover, funds and advisors are assessing the landscape for deal opportunities on the sell and buy side.

Private equity houses are, unsurprisingly, drawn to tech-enabled businesses that can sustain growth through the current – and any future – regional or global disruption. In markets as diverse as Israel and Brazil, deals are being explored and closed in online training and education, telehealth, e-commerce, pharmaceuticals, food-tech, and distribution and delivery, to name a few, says Ferreira. As a result, he says, the US team is also seeing a lot of debt financings for these sectors.

“These businesses are thriving and, alongside their private equity backers, they’re looking for opportunities to reinvest through leverage while interest rates are low,” adds Ferreira.

Paul Gooley, Partner and National Head of Corporate Finance Grant Thornton Australia, says that most mid-market funds there had already “pivoted in their later structures to more tech-enabled businesses” prior to the pandemic. Given that most funds having a solely domestic remit, he adds, Australia is in pretty good stead, with just one to two companies per portfolio – possibly in the travel or hospitality sectors – in poor shape.

For others, the pandemic has boosted performance. “Some e-commerce businesses have seen volumes double,” he says, adding that other segments, such as online education platforms, which have low integration in Australia, are also seeing more deal flow.

Jared Grima, TAS Partner, Australia, says Software-as-a-Service (SaaS) and IT managed services companies that can land recurring contracts are particularly attractive. “Cloud implementation is really being pushed,” he says. “We’re seeing roll-ups from domestic private equity-backed businesses and interest from US players.”

Gooley believes that infrastructure – which is earmarked for Australian government spending in 2021 – could also be targeted for technology integration services, opening up even more new opportunities. The same could be true of the UK, where private markets will have a larger role to play in funding infrastructure projects and the related supply chains due to depleted public coffers.

There are other questions relating to the UK, however – notably whether capital gains and corporation tax will be raised substantially in November’s Budget. This could prompt businesses and shareholders to “transact by the end of October and realise their value, so they can bank it at a low capital gains rate,” suggests Merali.

In the US, meanwhile, the Paycheck Protection Program is proving to have a sting in its tail. “PPP money is potentially being recorded as a liability, then subsequently recognised as income,” says Ferreira. “Current deal closing negotiations entail deciding which party will pay for that PPP loan and to what extent the company qualifies for forgiveness. The guidelines for that are continuously changing, and buyers aren't willing to take the risk of assuming those liabilities to the extent they're not forgiven.”