EquityFC Blog

Why good financial management matters to PE | 27 July 2010

Great article in the FT this Sunday by Tony Jackson on some analysis of private equity returns. This is the good bit: "One study he cites unpicked the returns on 110 completed deals in the UK and Europe between 1995 and 2005. The average internal rate of return was 39 per cent, of which debt accounted for 22 per cent and a rising stock market 9 per cent. That left just 8 per cent as the contribution of the private equity managers."

It goes on: "Considering that Mr Morris puts the average annual fees in private equity at 8 per cent – some put it higher – this is thought-provoking. It means, in effect, that the pension funds which provide the bulk of the money would have been as well off investing in the market directly and borrowing the leverage from the bank."

At a time when fundraisings are under pressure and the PE model is in danger of over-regulation, firms are going to be looking hard at deals where there is a strong "management" component and where growth contributes a higher level of the overall return. (Of course, this kind of analysis usually focuses in on the big LBOs - in the mid-market, leverage has never played such a major role...)

Growth and development means having financial management in situ that goes beyond box-ticking, solid reporting and cost control. Great news if you're a forward thinking, value-adding FC or FD, then.

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Some weekend reading | 23 July 2010

Every week, I gather lots of interesting snippets about financial management, private equity and entrepreneurialism from around the web. So what's news this week?

Let's start with the Carbon Reduction Commitment. I recently did an article on the FDs of PE firms, and this is a biggie for them. As far as the Environment Agency is concerned, PE funds are conglomerates, so every "subsidiary" (i.e. portfolio business) stands to get caught by the new rules on September 30th. Worth boning up on carbon credits if you're going for a job... especially since CO2 is now the CFO's responsibility, apparently.

Then I'm recommending the Wall Street Journal PE blog. For example, this entry has a link to a PBS report on the PE takeover (and subsequent bankruptcy) of Readers' Digest. If you're getting involved with PE for the first time - don't panic. It's an extreme example. But the WSJ (and other) PE blogs are good at explaining sentiment for the industry.

Third up, more video - this time coverage of a recent Grant Thornton survey that has positive news for the UK where the firm predicts "billions" will be invested over the next 12 months. Deal churn is good - especially for FCs and FDs looking to get into a new position. And the year is looking better for MBOs in the UK, too. So keep 'em peeled...

Looking for something a bit more technical? How about a scholarly paper on why buy-outs are leveraged? This PDF download posits a model for the capital structure in MBOs and might be worth a read if you plan on getting down and dirty on the technicalities with your bakers.

Finally, stat of the week, courtesy of Reuters: "Private equity-backed M&A in the second quarter was up 125% from a year earlier to $40bn, and up by a third from the first quarter. For 2010 [H1], it totaled $70bn, more than double a year earlier." BUT... "The $70bn of PE-backed deals this year through June 22 compares with the record $542bn in the first half of 2007."

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The equity gap: don't call it a comeback | 21 July 2010

Remember the equity gap? In more buoyant times, it was the chief malaise for companies seeking PE backing. Too small to get a nice big slug of debt and equity from the serious PE players, too big to be viable on the backing of early-stage funders and angels. What to do?

Well, it's back. I was chatting to a lawyer specialising in VC deals this week, and he says it's worse than ever. The problem is that less debt is ratcheting up the risk for equity providers - and a sluggish economy means that they know they need a watertight business case if they're to get the confidence they need to take the plunge and buy a company still in development. It's a contributory factor to the Dearth of Deals™ - and to the slow recovery.

One way to address the central problem - perceived risk for equity providers - is to show the business is clearly out of start-up phase and has the chops to move forward decisively. And that means hiring a decent finance exec.

For many business suffering from the equity gap, that might not be a fully-fledged, six-figure FD. But at the least, they need a decent controller to nail the cash-flow and related processes and put in place working budgeting and forecasting systems. And they need FD-like advice - from a part-time or interim FD, or perhaps a finance-minded non-exec.

Claiming you can't afford "back office" talent in a growth phase is false economy - and that applies whether you're an entrepreneur or an early-stage investor wondering whether you'll ever exit...

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Piles of cash seek finance brains | 14 July 2010

Every finance director knows the value of cash. But there something odd going on the business world right now. There's lots of it about - and no-one knows what to do with it. So what does that mean for PE-backed finance executives?

My data is largely from the US. OK, most of you are looking at UK opportunities - but I think the lessons still hold. For example, this chart shows the amount of liquid assets held by US corporates (and I know from anecdotal evidence that the picture is similar over here):

That's a lot of cash without a home. The picture gets worse: private equity funds around the world have been wrestling with "overhang" (funds committed by investors or "LPs", limited partners) for some time. The best recent estimate of PE's undeployed cash? Check out this PwC article on the subject. It says: "The current private equity overhang at nearly $850 billion (three and a half times the overhang in 2000) represents 54% of all capital commitments made between 2004 and 2009. Over 85% of the $850 billion is in funds larger than $1 billion, including 48% in funds larger than $5 billion, according to Cambridge Associates."

Result? LPs are reluctant to commit new cash, and while the big LBO players aren't that fussed - that unspent pile of cash is the bigger concern - the mid-market and VC end of the scene is taking a hit. Witness the recent drop in US VC fund allocations.

So what does this all mean for you? First, brush up your capital allocation skills. Investors (and corporates - although the fact you're here suggests you'd rather not work for a plc!) need to deploy money. But they're petrified that they won't make a return on it. That's a pretty damning indictment of the economy when interest rates are so low. And I think it means there aren't enough creative finance execs with good communication skills out there, standing up the business case for investments. Great entrepreneurs and marketing people are one thing; but without a proper investment appraisal, properly communicated, that cash is going to remain dormant.

Second, pick your markets. PE firms - particular in the mid-market and at the VC level, but across the board now that financial engineering is a dead duck - need growth right now to turn a penny. And with the economy flirting with a double dip, that means plumping for companies that have a compelling case whatever the climate. In short, some sectors are more resilient than others. Choose wisely.

(By the way, here's a link to a rather goo, rather long article on PE at the moment - worth a read if you have a few minutes spare.)

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PE watch: will summer sizzle or burn out? | 12 July 2010

Finance execs looking for PE-backed opportunities need to keep a weather eye on the private equity world. But after two years of mixed messages, are we any clearer about whether the industry is recovering? And what might that mean for opportunities?

Well, the bad news is that messages from both sides of the Atlantic - and in both the large buy-out houses and the (more interesting) mid-tier firms - continue to confuse. So on the one hand, we have some mega-deals in the secondary buy-out market in the US; on the other, fundraising continues to fall there, especially for the mega-funds. (That might have something to do with the fact that investors around the world are starting to ask tough questions about PE returns...)

What about this side of the pond - and what about those mid-tier players whose deal-flow creates openings for smart finance execs? The news is, again, mixed. At the bottom end - where many of you might reasonably spy exciting start-up and development opportunities working with creative entrepreneurs - VC funding is approaching record lows. A NESTA report says fewer funds are raising less capital for smaller early-stage investments. The one glimmer of hope for FDs and FCs is that VCs are taking a longer view of investments - giving you more time to get it right.

The good news? I'm still hearing lots of PE players talking about a flight to quality. Sure, they're nervous about overpaying for businesses - especially when competitive auctions result in very rapid and sometimes hasty due diligence. But if the business looks good and shows opportunities for strong organic growth (i.e. generating more cash without needing a ton of debt to do aquisitions), they want to buy.

That's doubly good for you because it means PE firms looking to sell - and boy, do some of these funds need to churn investments - need both great financial management in place and the kind of broad finance functions skills that will help them dress a business for sale. Time, perhaps, to brush off those financial reporting and investor relations skills.

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