The room was full of men and women wearing expensive suits, carrying brand-name leather briefcases and purses. You could land from Mars and guess you were at a conference of private equity professionals. I was invited, along with about fifty other investment bankers/business brokers, to meet with dozens of private equity firms from around the country to brainstorm and network over pending and future deals. Over the course of many brief meetings in one long day, I learned a lot about the present and likely future state of private equity (PE).
Learning #1, PE will be paying higher prices, but not recklessly. There are about one trillion dollars of committed capital waiting to be invested by PE. While I do not see PE doing marginal deals just to get their money active, I do see investor return expectations coming down a bit, which means prices paid will go up. It’s a simple case of an imbalance between supply (money) and demand (good businesses). In the early, good-old-days of PE (i.e., the 1990-2000s), PE funds could generate 25-35% returns for their investors, but in the past ten or so years, return expectations have come down to the range of 18-25%. These lowered returns do not mean the PE industry is in trouble. In fact, the returns PE generates for their investors are still quite favorable compared to alternative investment channels. However, it is inevitable that at least some of that one trillion dollars will be deployed around lower return expectations, perhaps 15-20%. Simply said, the prices PE will pay are going up (PS, they’ll never admit this).
Learning #2, PE will be more proactive about buying carve-outs from publicly traded companies. An example of this is Clayton Dubilier & Rice’s recent purchase of a majority stake in Brentwood-based NaviHealth from their publicly traded parent company, Cardinal Health. The theory of this deal illustrates a core tenant of PE: we have the fuel to fund rapid growth and can do it more efficiently outside the reporting restrictions of a publicly traded company. The net effect will be public companies looking to PE as a source of capital. This will take some market share from traditional corporate capital channels, such as commercial banks.
Learning #3, PE professionals increasingly see the public equity markets as their savior. I recently heard some seemingly insane multiples paid by PE in the high teens. Those numbers don’t make sense when the PE firm is committed to returning to their investors cash-on-cash returns of 20-25%. But PE firms paying those kinds of insane multiples are doing so because they are getting to a size where they can consider taking their companies public (a.k.a, the IPO). This is rarified air, you have to have EBITDA of $100 million or more for this strategy to work. But when it does, the math makes sense and justifies high multiples. This will continue.
Most PE professionals are smart, though I admit I was exaggerating when I said they all wear expensive suits and carry leather handbags. But beyond intelligence, one thing that binds them, they are all nervously looking for ways to allocate their staggeringly large pools of capital. One undeniable conclusion: change is inevitable for PE. I’ll keep you posted!
JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. Jim is the author of Home Run, A Pro’s Guide to Selling a Business. https://www.amazon.com/Home-Pros-Guide-Selling-Business/dp/1599329239 . He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee. The names and fact patterns above have been changed to preserve the parties’ identities.
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