Rising to the challenge: private equity’s role in the downturn ahead

The BVCA has published three pieces capturing some of the discussion points at the recent Summit. In the third and final instalment we reflect on speakers’ comments on the role the industry will play in challenging times. Speakers at the BVCA Summit in October were positive as to the industry’s role in the more challenging economic environment ahead.

No-one was playing down the seriousness of the macro-economic situation or the challenges it poses to investors at the BVCA Summit in October. However, there was a widely shared belief that private equity is well positioned for a downturn, and that it can play a positive role in UK growth and levelling up.

In the immediate-term, the financing markets are challenging. The ‘giant sucking sound’ of liquidity being withdrawn from the market as central banks run out of monetary ammunition is presenting a generation of dealmakers with novel challenges, along with how to operate in a high inflation environment.

Debt finance is constrained, particularly for larger new deals. This may be ameliorated by a swift return to the market by private credit funds and venture debt. It will also take time for price expectations to be re-established. For this, interest rates do not need to be ‘low’, but they do need to be relatively stable.

As Stephen Quinn, (Co-Head of Credit at 17Capital) put it, the current economic volatility is as “an opportunity to demonstrate the resilience of the asset-class through another crisis.”

The private equity skillset is in demand

BVCA Chair, Charlie Troup, commented that large elements of the existing aggregated private equity portfolio “have been constructed with a downturn in mind” — something the industry had been anticipating since 2019, even if nobody foresaw the precise drivers.

More fundamentally, there is a widely held belief that the private equity model of careful asset selection and active management, while not always understood outside of the industry, is a powerful one for nurturing growth, even in the face of wider economic upheaval. Not every investment will work out as planned, but managing change and growth is what private equity is built for.

Today more than ever, private equity is able to make a palpable contribution to any growth agenda. The growth in aggregate funds under management gives the industry real firepower, and its current combined portfolio in the UK employees some two million workers, or 6% of the UK’s workforce. More than half of these are outside of London and the Southeast. To learn more, read our latest reports ‘Growing Great British Businesses’ and ‘Measuring the contribution of private equity and venture capital to the UK economy in 2021’.

Changes to industry practice

A downturn is also an opportunity to focus on the basics: good deal-sourcing, active management, and the eternal quest for operational outperformance and productivity improvement.

For instance, on the financing side, one such innovation might be the collateralisation of intellectual property to better reflect the intangible nature of modern economic assets. On the operational side, this could see the emergence of more funds structured, not just by sector, but by sub-sector.

All the while, secular and technological shifts in private equity’s investor base means that continued rapid growth in aggregate assets under management is set to continue through the cycles, putting more pressure on the ingenuity of dealmakers and portfolio managers to maintain returns.

As one speaker put it, if private equity is a function of buying low and selling high, the opportunity set would have quickly run out. But private equity is not zero sum, no more than it is a mere reflection of the macro. It relies on the creation of value that is grounded in specific business realities. Such value quickly adds up.