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PE’s powder won’t stay dry for much longer

A reordering of the post-pandemic economy will occur over the next year. It’s hard to see the economic downside of life returning to an old – but hopefully wiser – normal.

By Elaine Chim

There was an estimated $2 trillion globally of dry powder held by private equity funds in February.

In 2020, as firms restructured their portfolios to weather the covid-19 outbreak, managers expected a post-pandemic economic recovery would allow them to deploy capital by now. Today, however, they are still waiting to see how things shake out. Some believe excess capital, federal support and the resumption of business and travel will overheat the economy. Others foresee the pandemic’s ripple effects causing a downturn in the near future and challenges in the years ahead.

Inflation risks should be taken seriously. Some asset prices have room to increase while value of the dollar has some room to decrease. That said, after a tough year, it’s hard to see the economic downside of life returning to an old – but hopefully wiser – normal. Either way, a reordering of the post-pandemic economy will occur over the next year – which means that private equity’s powder won’t remain dry for much longer.

A new vintage of PE funds is going to arise out of covid-19. Sector specific and forward looking – focusing on companies set to shape the post-pandemic world – they will be faster and more adaptable than public markets in targeting capital deployment. If they put the $2 trillion of dry powder to good use, these funds will be able to initiate major deals, play a crucial role in rebuilding the economy and see stellar returns for joining the upturn. PE will be key in salvaging and turning around distressed companies, too, as valuations fall.

There’s a lot of pent-up deal demand. Mergers and acquisitions fell 50 percent in the first half of last year as firms built work-from-home infrastructure, transitioned to virtual meetings and worked to avoid liquidity shortfalls. They turned to new business and financing, like net-asset-value facilities, preferred equity and bolt-on deals to maintain momentum. But capital came “roaring back” at the end of 2020, illustrating how PE’s resilience enables it to rebound from a slowdown, resume acquisitions with quick turnarounds and still have dry powder to invest.

IPOs are too cumbersome at present because companies and investors don’t feel secure enough to complete the follow-through requirements for the pitching, roadshows, reporting and compliance that is necessary when taking a company public. That is precisely why SPACs are back in favor and their resurgence have captured investors’ imaginations. They promise a quicker and safer, though typically less lucrative route to the exchange. PE bypasses those obstacles entirely.

Public finances will remain under strain due to the pandemic and its consequences. Demand for private capital, meanwhile, will remain high even after we make up for lost ground. It’s true that the end of federal stimulus efforts could engender headwinds and expose structural problems. Some sectors and individuals will likely face tough times when that support is withdrawn. Private equity may be able to provide the lifelines these businesses need.

However, PE firms shouldn’t move so fast that they don’t take stock of the moment and ask themselves whether they need to make any internal changes to better seize the opportunities that will come along with the recovery. Many PE firms still email spreadsheets and rely on antiquated systems to record transactions. These processes innately slow down firms’ abilities to move quickly on opportunities.

New fund administration technologies could improve their performance significantly. Consider how deals slumped in 2020 in part because dealmakers were accustomed to flying across the country and meeting in person. We’ve demonstrated that nearly everyone can be equally productive using virtual tools. The same can be said of incorporating new technologies and services into general workflows.

Investors have new priorities, too, that require more attention and new thinking. Notably, the pandemic has heightened investors’, employees’ and consumers’ interest in social, environmental and governance issues. Aligning ESG-related goals with investments and returns requires PE firms to develop and apply new criteria to determine whether they are achieving their targets. The former requires vision, the latter requires the expertise to review the data that can deliver answers. Similar to firms that have recognized the need to update their internal processes, keeping up with these new priorities requires the development of systems that streamline things like compliance and reporting obligations.

The pandemic has shown PE that large-scale, rapid internal changes are doable, and that those who navigate them the most efficiently and effectively are positioned to see the greatest benefits. Time and resources are freed up to focus on the new priorities and economic shifts underway. It’s this spark which might ignite some dry powder.

Elaine Chim is the Head of Private Equity, Americas and APAC at Apex Group Ltd.