For private equity and venture capital, 2021 broke investment records, capped at a five-year run that equated to $1.8trn in new buyout capital. This was largely due to a pandemic technology boom that increased buyouts and valuations. Today, we are entering a new and volatile period, with inflation being pushed higher due to soaring energy prices and supply chain issues.
However, as we have seen in the past, private equity is well equipped to not only push through but thrive in times of economic recession – even outperforming public markets. Chris Biggs, CEO and founder of consultancy and accounting advisory, Theta Global Advisors, shares his commentary on how private equity is perfectly positioned to capitalise on this volatile market and effectively go on the offensive, taking advantage of new investment opportunities to avoid sitting on depreciating cash.
Private markets tend to be more resilient than public markets because of active ownership and insulation from public volatility due to their long-term focus. This protects them from the steep drops in valuations and prices which are currently being seen in the public markets. At one point last week the S&P 500 was down 20% from January, which is the worst it’s been since the dot-com bubble burst 20 years ago. This sets the stage for a valuation reset, allowing for a rebalancing for newer entrants into the market and creating attractive investment opportunities for private equity firms.
Private equity firms are well equipped to fare and profit in times of crisis. They outperform in heavy part due to private market funds deploying capital over a typical period of three to four years. Because of Covid and economic uncertainty, these investment tenures have become longer than usual, and PE houses are reaching the point where they are looking for new opportunities for investment. They also are in a position of having record amounts of capital to deploy as by the third quarter of 2021, PE houses were sitting on a record $1.4trn of ‘dry powder’. With a high inflation environment, the value of this cash they are holding is depleting day-by-day, further encouraging them to participate in the growth stage of new and potentially lucrative businesses.
Chris Biggs, CEO and founder of Theta Global Advisors – an accounting and consultancy disruptor – has commented:
“Companies financed by private equity are facing an interesting period at the moment – because of Covid and the current economic uncertainty their investment tenures are becoming uncommonly long. So as a private equity house, if you back something for three to four years, that’s about the term they want to be involved in. But now you’ve got a whole bunch of private equity investments that have been around for six or seven years. So those private equity backed companies have reached a point where they need to get out of these transactions.
“A lot of private equity houses still have a lot of cash – but the problem is in a high inflation and low interest rate environment, the value of that cash is depleting day-by-day. I think the PE houses are looking for opportunities to invest in new companies, because it’s that first phase where you can start to invest and grow it – that’s where you can add the most value and see your overall investment grow. So, the problem is, if it’s a company they have already invested in for three, four, or five years, they are past that point in the cycle. This means if they invest more in it, they are going to get smaller returns for their investment.
“Most of the PE houses would prefer to invest in companies where there is greater growth potential – i.e., that first round of funding that companies do. I think we are possibly moving into the environment where funding of private equity is going to become more common than funding through classic banks. This is largely because these private equity houses need to get the cash out.”