As the novel coronavirus pandemic upended the way businesses operate, investors around the world have been able follow daily market gyrations in real time to see how public companies are being impacted and what the crisis is doing to valuations.
What has been perhaps less visible is how private equity firms have responded to the pandemic and its impact on portfolio companies, and what the future might hold for the private equity industry following the pandemic.
For many firms, the last few months have triggered a careful review of portfolio businesses to ensure that they have the liquidity and strength to withstand the immediate impact of the pandemic. It has also been a test of the partnership between firms and the businesses in which they invest.
True partners tend to step back when the wind is at a company’s back, but will eagerly roll up their sleeves in a crisis like this one. That can involve daily meetings, assistance negotiating deals to pay suppliers and helping owners control their cost base and develop return-to-work plans.
The coronavirus has provided important data about how portfolio companies perform in an extreme stress scenario. After all, few forecasts can predict what a pandemic will do to a business better than an actual pandemic can. The lessons private equity firms and portfolio companies have learned will help build more resilient companies in the future and also serve as a reminder about the importance of risk management and crisis planning.
But as more economies around the world begin to reopen, investors are rightly asking: where do we go from here?
The mid-market segment of the market may prove interesting. Here, deal flow has slowed somewhat versus pre-pandemic levels, as businesses react and adjust to the crisis. With that said, there is ample evidence to suggest this is a temporary phenomenon. The reality is that founders are still getting older, they will have to retire and will bring their businesses to market as a result.
It’s also important to remember that private equity valuation multiples were, and still are, quite reasonable in Canada relative to public market and U.S. private equity multiples. I don’t expect multiples to change much, although the denominators will likely change even for the strongest businesses.
Economic growth has slowed and as a result both private equity firms and their portfolio companies have moderated expectations about the future. That means forward earnings before interest, taxes, depreciation, and amortization will likely be less lofty in the next few years.
So while it’s doubtful many good businesses will sell at fire sale prices, those business owners approaching retirement age realize that the next several years will likely be difficult to navigate. This could prompt some of them to become motivated sellers sooner rather than later. On the flip side, private equity firms – now armed with pandemic performance data – will also likely become choosier with respect to the sorts of businesses they will be willing to buy.
There will likely be a premium placed in terms of both investor interest and valuation on companies that have high quality earnings, well-documented and relevant key performance indicators in place and a fulsome data room available to potential buyers.
When we look back on this pandemic several years from now, we will remark that it has made the private equity industry more resilient, nimble, value-driven and risk conscious than it was before 2020. That’s a good thing for investors, for portfolio companies and for the private equity firms themselves.
Tracey McVicar is a partner at CAI Capital Partners. These views are those of the author and not necessarily those of the Canadian Investment Review.