Perspectives From Private Equity Leaders…Who Just Happen To Be Women

March 5, 2020 | By: Jon Jackson

The CVCA will be publishing its 2019 year-end report next week and the preliminary numbers show Canadian venture capital heading towards another record year for investment and private equity continuing its momentum.

However, there’s volatility at seemingly every turn. In Canada, we’ve been experiencing spin-off consequences from the federal natural gas pipeline project and the slow economic recovery in the province of Alberta. Over the last year globally, trade uncertainty, yield-curve models and an escalation of political relations between the US and Iran have caused significant strain on performance.

More recently, all eyes have been on the coronavirus and the resulting economic damage. Not only did global public markets post their biggest one-week decline since 2008, companies like Mastercard, United Airlines and Apple and dozens of others have warned that the virus will hurt profits.

What are the strategies available to limit portfolio losses and even log some gains during a downturn?

There are women in Canada that wield significant influence in our industry that oversee millions and billions in assets. These expert opinions are needed now more than ever. Strategies are looking to adjust for where markets are heading and to focus on the many variables that will spell future investment success or failure.

This year, to mark International Women’s Day, we’re uncovering the valuable insights from leading women in our industry. Separated by asset class in the CVCA membership, we’re profiling the wisdom from women in private equity first.

What is the most exciting trend right now in Canadian private equity?
We see three exciting trends in mid-market private equity.

First, entrepreneurs are now clearly interested in partnering with an active minority shareholder to drive company growth together post-closing, whereas founders used to seek passive investors when looking for a minority partner. As Clearspring Capital offers both active minority investments and control positions, our pipeline benefits solidly from this trend.

Second, sponsor-to-sponsor exits in mid-market PE has significantly increased in the past 5 years, thus providing an additional path to exit for our current portfolio companies and also replenishing our pipeline with attractive opportunities and high-quality management teams.

Lastly, if you look at PE fund management, gender diversity has become a “real” subject, finally. LPs are focusing on it actively and consequently GPs are focusing on it as well. Efforts are made to collect relevant data and the results are very positive. Data shows that gender diversity makes a material difference. Investments with women as the deal leader outperformed male-only deal teams by 12 percentage points on an internal rate of return (IRR) basis and by 0.52 times in terms of gross multiple of invested capital (MOIC). Deals led by diverse teams also have failure rates (defined as gross MOIC less than 1) that are 9 percentage points lower than deals led only by men.*
*Source: Bain Global Private Equity Report 2020

What is the biggest challenge facing private equity right now?
The biggest challenge facing PE right now is that valuations are at a tremendous high. In Q3 of 2019 the average US LBO multiple was at an all-time high of 11.5X and in Europe it was just below 11X. This is driven by the amount of dry powder and also by the very high leverage that are now common as we see more than 70% of US LBOs having greater than 6 times leverage. This means that we are having to assume multiple contraction in our models for when we exit in 5-8 years which dramatically impacts returns. And, 71% of deals fall short of EBITDA margin projections (this in a very benign economic era).  The only solution is a very clear and differentiated value creation plan.

Which economic factors do you feel have the most impact on your fund’s strategy?
There are four economic factors which we consider relevant to our Fund strategy. First is the very high likelihood of a recession in North America. We are in the 12th year of economic growth and it is a near certainty that there will be a downturn during our 5-8 year holding period. This is especially relevant given the very high multiples that are being paid for mid-market companies. The second factor we consider is the rising global trade tensions. This has already impacted a number of our portfolio companies and we expect continued volatility. We believe that there is a housing bubble in Canada which makes us very careful with respect to home related investing and reinforces our concern about a recession and a downturn in consumer spending. Finally, we are bearish on auto production related investments as we believe we may be at “peak auto” and the impact of trade tensions may be significant.

What is the most exciting trend right now in Canadian private equity?
We’re seeing many alternative ownership structures for business owners to consider – royalties, minority growth capital, preferred shares, longer term or permanent capital, pools targeting diverse or underrepresented entrepreneurs – all in addition to traditional private equity. There have never been so many options for founders to consider, so it’s a very exciting time right now.

What is the biggest challenge facing private equity?
Human capital is a significant challenge across our portfolio and the private equity industry more broadly. Attracting, engaging and retaining great people at every level of our organizations is a constant theme, in both services and manufacturing environments. In addition, calibrating our senior leadership teams and setting them up for high performance is a key area of focus for our boards.

Which economic factors do you feel have the most impact on your fund’s strategy?
For our portfolio companies, the USD/CAD exchange rate, interest rates and credit availability are all critical on a short-term basis, but fiscal responsibility at all levels of government feeds those inputs over the long term. In general, an investment friendly climate is critical for the success of all of our businesses over time.

What is the most exciting trend right now in Canadian private equity?
It’s very exciting to see the growth in Canada’s technology industry.  This activity is producing exciting new companies that are maturing and creating numerous attractive investment opportunities at scale.

What is the biggest challenge facing private equity?
We are in the late stage of a long-term economic cycle. Investors need to be thoughtful about how they invest and actively build resilience into their portfolio. Given the length of this bull run, a large number of industry players have never worked through a market correction or economic downturn, so I’d say the biggest challenge is preparedness and experience in the face of adversity.

Which economic factors do you feel have the most impact on your fund’s strategy?
Vertu invests in growing enterprise software companies. While the general business cycle will have an impact on our end market, the secular trends around demand for software are in our favour, which will off-set risk on the downside. Vertu’s investable universe is expanding relative to other industries and that is a trend that will continue to play out for decades.

 

This article is part one of a two-part series providing insights from leading women in Canadian private capital in celebration of International Women’s Day.

 

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