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Private Equity Races to Close Deals, Eyes Risk – BDO’s Fall 2021 Private Capital Pulse Survey

·8-min read
  • Fund managers are prioritizing new deals over add-ons

  • 34% are paying higher multiples

  • Nearly 60% of large funds are evaluating de-SPACs and IPOs as exits

CHICAGO, October 26, 2021--(BUSINESS WIRE)--Private equity fund managers are accelerating deal timelines in an effort to win bids, and more than half say uncovering risk during due diligence is a main challenge to closing deals, according to BDO’s Fall 2021 Private Capital Pulse Survey.

The findings of the survey, which polled 200 U.S. private equity fund managers, underscore the frenzied state of deal making. Forty-two percent of fund managers say they are directing the most capital to new deals (up from 19% a year ago and 26% in the spring) and deal flow drivers are up across the board. Meanwhile, their pursuit of add-on acquisitions has fallen to 16% from 24% a year ago and 29% in the spring.

"To compensate for the slowdown in deal activity at the beginning of the pandemic, fund managers are racing to put committed capital to work and get deals done," said Scott Hendon, Co-Leader of BDO’s National Private Equity practice. "Everything from private company sales to corporate divestitures is driving more deal flow. Add to that a healthy dose of external influences, such as a potential capital gains tax rate increase and a limited number of attractive targets to absorb all the dry powder on the sidelines, and you have a healthy amount of M&A deal activity—and competition—to contend with."

Among the fund managers who identified a capital gains tax increase as the tax change they’re most concerned about, 59% said that in this competitive climate, they were accelerating the deal process to get to deal close more quickly. Moving faster to deal close is a top strategy among all fund managers to win bids, tying at 49% with highlighting industry or sector specialization, a differentiation tactic that has been on the upswing.

Concurrently, while they are positioning themselves to accelerate deal timing, 53% of fund managers say risk exposure uncovered during due diligence remains the top challenge to closing deals, followed by increased competition from other buyers (48%) and gaps between buyer/seller expectations (46%).

"Risk is top of mind for fund managers—not just during due diligence but throughout the holding period," said Verenda Graham, Co-Leader of BDO’s National Private Equity Practice. "More funds are prioritizing cyber security concerns, for example, to remove risk that can discount the value of an asset at exit. Given the intensity of competition and high multiples, risk mitigation will be crucial to ensuring an investment’s value proposition."

Top challenges to closing deals

Risk exposure uncovered during due diligence

53%

Increased competition from other buyers

48%

Gaps between buyer/seller valuation expectations

46%

Lack of transparency, including access to management team or complete financial information

39%

Supply chain disruption

38%

Market consolidation

29%

Lack of bandwidth among legacy and other vendors

28%

Lack of internal resources/bandwidth/talent

26%

Key drivers of deal flow

Private company sales and capital raises retained the top spot as the key driver of deal flow (56%) and has shown a steady increase since last fall (45%) and earlier this spring (50%). Succession planning took the number two spot this fall (50%), followed by public to private transactions (45%).

Post-M&A Challenges

To be competitive in this deal market, fund managers are also laying out more capital: 34% say they are paying higher multiples to win bids. Higher multiples, in turn, are putting pressure on the ability to generate returns.

As a result, fund managers are using a combination of strategies to extract value from their investments, with the top tactics being:

  • Implementing new technology and digital capabilities (57%)

  • Adopting more sophisticated pricing strategies/identifying and launching more sales growth initiatives earlier in the holding period (50%)

  • Creatively managing cash flow across the portfolio to unlock cash from working capital (49%)

Identifying and implementing supply chain efficiencies (41%) is another lever they are pulling.

"In this competitive climate, fund managers have become increasingly focused on deploying a combination of operational initiatives strategically to generate value post-acquisition, and many are revolving around supply chain efficiencies," said John Krupar, Partner and National Leader of BDO’s Operational Value Creation practice. "This attention to creating value will ultimately drive better results related to EBIDTA, cash flow and assurance in the exit of a portfolio company."

Fund managers from large firms* are more likely to say they are identifying and implementing supply chain efficiencies (52% vs. 30% for small firms 44% for mid-sized firms). They are also more focused on cost efficiencies than their smaller counterparts: 56% say they are creatively managing cash flow, tying with 56% who say they are adopting more sophisticated pricing strategies.

Leveraging technology as part of post-M&A integration is also increasing in importance. Organizations of different sizes are looking to technology as one of the core ways to boost performance improvement, which fund managers say is their top post-M&A challenge (43%), followed by technology/ERP integration and optimization (39%) and operational improvements (38%).

Exit strategies: More fund managers weighing IPOs and SPACs

In private equity deals, dispositions historically have favored strategic buyers and other funds. However, given the performance of the public markets, 58% of large fund managers say their exit strategies over the last 18 months have shifted to include greater consideration of a special purpose acquisition company (SPAC) or initial public offering (IPO), compared to 33% among mid-size funds and 28% among small funds.

On average, nearly half (49%) of respondents say they’re placing more scrutiny on paths to exit during consideration of a potential target. This is followed closely by fine-tuning their exit strategies throughout the holding period (45%). Broken down by assets under management (AUM), these two strategies are a top priority for both mid-sized funds and small funds.

Private equity’s challenges to adopting ESG

Integrating environmental, social, and governance (ESG) criteria was at the top of limited partners’ list of priorities in the spring, and as funds seek to follow through to meet investors’ expectations, they are finding challenges across the board.

On average, fund managers are finding that adopting ESG goals and objectives that drive value creation is the greatest challenge, though the fact that the range of all responses is somewhat narrow (24% to 35%) indicates the ESG/investor landscape is still emerging. Fund managers recognize the need to incorporate ESG criteria at the portfolio company level as doing so may mitigate challenges at exit that could arise from the lack of a standard reporting framework—having the proper data, systems and reporting mechanisms to successfully integrate ESG criteria and report on it to regulatory bodies and shareholders/stakeholders.

Funds' Biggest Challenges to Integrating ESG

Adopting ESG goals and objectives that drive value creation

35%

Identifying and mitigating material ESG risks

34%

Developing short- and longer-term ESG actions tied to business strategy

34%

Determining a consistent approach and framework for reporting on ESG across our portfolios

34%

Implementing continuous ESG enhancements

33%

Producing transparent and measurable outcomes for LPs/investors

32%

Lack of actionable data and/or resources at the fund level

31%

Ensuring integrity of data and systems for reporting on ESG

30%

Adopting relevant reporting processes, procedures and report formats

27%

Lack of uniformity in standards, reporting and ratings

24%

Additional survey findings:

  • A potential capital gains tax rate increase was the top tax concern, displacing fears about increased taxation of digital products and services, which took the No. 1 spot among biggest tax change concerns in the spring

  • Outsourcing is the least-pulled value creation lever but is a rising trend in the industry as fund managers seek to bring down portfolio costs.

*Fund size is defined as having assets under management (AUM) of <$1 billion (small), $1-$3 billion (mid-sized), >$3 billion (large)

BDO’s Fall 2021 Private Capital Pulse Survey is a survey of 200 private equity fund managers at firms in the United States. The survey was conducted by Rabin Research Company, an independent marketing research firm, in August 2021. Download the full survey findings here.

About BDO's Private Equity Practice

Strategically focused and remarkably responsive, the experienced, multi-disciplinary partners and directors of BDO's Private Equity practice provide value-added assurance, tax and consulting services for all aspects of a fund's cycle, wherever private equity firms are investing.

About BDO USA

BDO is the brand name for BDO USA, LLP, a U.S. professional services firm providing assurance, tax, and advisory services to a wide range of publicly traded and privately held companies. For more than 100 years, BDO has provided quality service through the active involvement of experienced and committed professionals. The firm serves clients through more than 65 offices and over 740 independent alliance firm locations nationwide. As an independent Member Firm of BDO International Limited, BDO serves multi-national clients through a global network of more than 88,000 people working out of over 1,600 offices across 167 countries.

BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. For more information please visit: www.bdo.com.

Restructuring and turnaround services within the United States are offered through BDO Consulting Group, LLC, a separate legal entity and affiliated company of BDO USA, LLP, a Delaware limited liability partnership and national professional services firm. Certain restructuring and turnaround services may not be available to attest clients of BDO USA under the rules and regulations of public accounting.

View source version on businesswire.com: https://www.businesswire.com/news/home/20211026005820/en/

Contacts

Rosy Lum
The Bliss Group
(646) 846-0809
rlum@theblissgrp.com

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