Maybe private equity firms live in a parallel universe. If recent headlines relating to their fundraising exploits are anything to go by, the liquidity crisis has done nothing to reduce investors' appetite for the asset class. Never mind that banks are still reeling, and that large sections of the financial markets such as structured finance remain closed: private equity firms have carried on raising fresh capital as if the crunch had never happened.
Indeed, some of the largest buyout funds ever organised have closed in recent weeks. Before press time, we received word that Apax Partners had wrapped up its Fund VII at a staggering €11 billion. A similar result from CVC Capital Partners was thought imminent. A flurry of smaller, though still sizeable vehicles have also made progress these past few weeks: Think Advent International's €6.6 billion close in April, and Brigdepoint's pending close on a €4 billion-plus mid-market pool later this spring.
These numbers may seem perplexing, given that LBOs generally and large LBOs in particular are a tough proposition nowadays since there isn't enough “L” available to get them financed. There is, however, a rather simple explanation: The funds closing now have been marketed for some time, and in committing to them, limited partners are sticking to allocation plans drawn up before the financial world went mad. Private equity is a slow-moving asset class, and the real impact of the credit crunch on fund formation will only become visible later this year.
In the meantime, however, one has to ask: Can all the new money be invested sensibly despite the ongoing trouble in the loan markets? And what are the prospects for new deals done today if, as many predict, future purchase price multiples will contract under the twin impact of financial and economic fundamentals deteriorating simultaneously?
Inevitably, different types of private equity investors give different answers to these questions, but one increasingly popular theme is the notion of “investing in growth”.
This is not a new idea: Growth capital funds, making investments in rapidly expanding businesses using little or no leverage, have always existed. During the heady days of the buyout boom, they populated a segment of private equity that many investors often overlooked. As a result, “growth capital” is not the most widely understood investment strategy within the asset class – witness Bill Ford, chief executive of Boston-based growth capital specialist General Atlantic, in April feeling obliged to write a letter to the Financial Times to explain what his firm does, and why it matters. “Growth equity” is how General Atlantic labels the form of finance it provides, and Ford and his partners are confident that in today's straitened times, more and more companies struggling to tap other sources of expansion capital will find it appealing.
To make private equity-style returns without using much leverage, investors like General Atlantic need portfolio company earnings to increase big time. Helping management boost EBITDA (rather than optimising the capital structure or cutting costs) requires sector expertise and operational understanding, which is why in your average growth capital firm, former management consultants and operational types tend to be in the majority. In a traditional buyout team, it is usually the bankers and accountants who dominate.
This is not to say that buyout firms by definition can't be expected to play the growth capital game as well. Some are in fact designed to purchase rapidly expanding businesses, and have staffed their investment teams with people capable of managing growth. Apax for instance says its non-banker to banker ratio is a telling 4:1. With the bulk of its new mega-fund still to be deployed in a credit-starved environment, this is a line-up that is going to come in handy.
Other, more traditionally staffed LBO houses will also step up their deal sourcing efforts among growth businesses, just like Permira did last year when it placed a big, equity-only bet on a stake in Macao-based gambling group Galaxy. For conventional buyout funds, such excursions into growth deals constitute an opportunity to answer those who claim that smart finance is the only thing they know about.
Whether there will be enough such opportunities is a moot point. From an LBO perspective, the growth capital world really is a parallel universe that sponsors can explore. But investing well in it won't be straightforward, because a different skill-set will be needed. And, given the many billions of private equity money still being raised, it is hardly going to be big enough for everyone.