Private equity firms must now accept that the party is over

Probably no sector or industry represents the boom of the past ten years better than private equity.

The industry’s multi billion- pound deals, dizzying returns and transactions that increasingly involved household names ensured that it often featured heavily in the media headlines.
Today the economic and market environment in which it operates is profoundly different.

In terms of financing, in recent years, most private equity houses have been able to make gains through financial engineering, significant leverage, cheap debt and multiple arbitrage.

Some private equity firms earned their outsized returns as a result, at least in part, of betting big with borrowed money. That is no longer achievable. More equity will be required to get deals funded, and the average length of ownership before exit will increase by several years.

The SME sector faces carnage during the next year unless new sources of capital present themselves. Bank debt is scarce and, where it is available, prohibitively expensive.

What’s more, lending does not often provide the long-term, patient equity capital than smaller companies require.

If our present Government wants to do something of real value, it should establish a 21st-century version of 3i in partnership with firms that understand the SME marketplace.

A refocused private equity industry could also help here. Interest in SMEs from private equity firms is definitely likely to be restored since many institutions, private equity funds and venture capital houses have largely abandoned working with early- stage growth companies.

It is also likely to be the case that one of the key success factors in private equity will be the investment timing of entry within economic cycles. The next one to three years will therefore be critical in getting it right for the good returns and health of UK plc.

Private equity will return to its core competence – identifying undervalued companies and delivering improvements through better management, improved products and services and operational efficiencies.

Extracted from an article by David Giampaolo