The outlook of the year has dramatically been impacted by the COVID-19 Pandemic, with investment strategies, portfolio companies and private equity firms being severely tested. But even without the pandemic, many factors that complicated matters in the last year continue to plague PE markets in 2020, defying general partners (GPs) and their time-tested protocols, but they also present opportunities for those daring enough to strike when least expected.
In terms of challenges, the presence of excessive dry powder in the markets continues to haunt firms, mostly occasioned by diminishing opportunities in the wake of an increase in the number of PE firms.
According to Preqin’s Global Alternative Report for 2020, there are more than 8,400 PE firms globally with the US accounting for up a substantial chunk of that number, leading to a sharp spike in firm-to-firm competition. This has left thousands of PE firms with billions in unspent capital.
And even as the number of firms and dry powder continues to rise, the amount of companies and ventures that may be available for sale has almost remained the same. Firms are avoiding auction processes because they believe it rapidly raises the multiple. In turn, the intensity rises as price tags go up.
With multiple funds participating in deals, firms are avoiding attracting cash only to strike deals two or three years later as it would make them appear incapable of employing capital or simply inferior.
But amid the challenges of being able to strike deals, firms have no choice but to somehow scout for deals – to enable them to put the contributed capital to work.
Challenges sire opportunities
With the COVID-19 Crisis, the Environmental, Social and Governance (ESG) considerations will bear far greater importance than before, with a focus on how PE firms will run and the enterprises they invest in. The current global pandemic will play a big role in catalyzing a shift to ‘green investing’.
Additionally, a need for greater transparency remains a top priority for firms and stakeholders, especially in portfolio management and performance. The growing importance of transparency and investor reporting is now reinventing opportunities for firms. At the heart of greater transparency and accountability lies technology, with digital solutions seen as the ultimate remedies.
In the past, PE firms tended to avoid tech-based companies as they were infamous for their high valuations. But these companies have demonstrated the ability to maintain strong revenue growths, resilience and solid fundamentals as most enterprises are now looking to digitize to stay in business amid the new normal that requires wide adoption of the ‘work-from-home’ approach.
Capital impairment is also relatively low in the tech field since applications are crucial and generally difficult to dislodge upon installation.
In closing, deals in this sector have more than tripled over the last five years alone with the year-on-year growth rising to 26%. Considering how tough last year was for tech unicorns such as Uber and WeWork, there is certainly something to write home about in 2020.