Aberdeen recently polled over 50 GPs about the medium-to-long-term impact of Brexit.
Most of them said it won’t have a huge effect but they would wait and see. Very few … said they expected a positive effect. That’s since been borne out by levels of activity post-Brexit. There’s been a slight slowdown in private equity deal-making but you’re still seeing deals getting done at all ends of the spectrum. It was more of an intake of breath after an unexpected result. Typically, when you’re in unknown territory the natural reaction is to pause, but now GPs are realizing that gradually things will muddle through. With Brexit, you have 40 years of relationships and treaties to unwind. … That process could afford both opportunities and threats for private equity.
You’re an LP. Which types of funds could capitalize on the dynamics in Europe?
We are focused on the lower middle market. We are seeing country-specific funds and region-specific funds. For example they’re looking at opportunities related to preparing companies for export activity. We see that as a real opportunity. In the last quarter, we invested in a Spanish fund and two French funds for that very reason. We’ve also seen a real explosion in the growth of credit funds and we are taking the time to assess that sector. … We are still assessing on what to do in the distressed-credit space. We’re also seeing growth in funds aimed at small-to-medium-size enterprises.
What growth opportunities do you see in PE in the next five years?
[We’re seeing] signs of economic recovery in certain EU countries where lower multiples for businesses are being paid. [There are] significant growth opportunities in a lot of these EU countries, as for example, fresh data on levels of growth in Italy and Holland would suggest. They’re doing mildly better than previously forecast.
What are the advantages and disadvantages of investing in larger or smaller funds?
We believe there’s greater optionality in smaller funds. Invariably, the prices paid for assets are less, and a lot of the smaller funds operate outside the auction process. Also, they aren’t using as much leverage, compared to larger funds. As a consequence of paying smaller multiples for assets … there’s greater upside potential in returns and better optionality in terms of exits. They may execute a buy-and-build strategy and then seek out a secondary exit to another private equity firm, or attract the attention of a trade purchaser. There’s always the option of an [IPO].
By contrast, most larger deals have no other alternative for an exit other than an IPO. Cambridge Associates data show that lower-middle-market funds of $750 million or less outperform private equity funds overall on a global basis by about 450 basis points. Overall, the U.S. is ahead of the market in the sense that you’re seeing … more growth in sector-specific funds – whether it’s healthcare or services, or creating a distinct area whether it’s by geography or sector.
What can PE investors glean from VC?
[There’s a lesson in the] power of brands and how quickly brands can be created. We’re also seeing in venture capital the pace of change taking hold — the disruptive elements and how quickly that can be established compared to a more traditional industry. The pace of change and the perceived barriers to entry can be changed dramatically and significantly. … There are huge parallels there for private equity.