We seem to be living in an age of constant disruption. The complex interconnections between forces pushing and pulling on business are causing countless challenges for executives and there seems to be little, if any, respite.
Are we at risk of becoming desensitised to disruption? Or are we – as we’ve done throughout history – learning from our experiences and adapting?
Private Equity is a sector I’ve worked in extensively. I’ve seen the ups and downs and have watched as the sector’s size, influence and importance to the economy has grown. I know it well and in response to the question in my headline – ‘Has the pandemic prepared Private Equity for recession?’ – I can categorically say… in the main, yes.
In my last piece I assessed the impact of the stalled deal environment, the challenges in financing, and the limited exit opportunities currently available to PE. The sector endured similar stasis at the beginning of the pandemic. We saw the consequences of that in the deal frenzy of the last 18 months, the results of which may cause some funds some portfolio headaches depending on the length and depth of the economic downturn. But, has the sector learned from its experiences and is it better prepared for the almost inevitable recession?
Back in March 2020 we shared ‘10 pillars for managing the COVID-19 response’ with clients. While some of the guidance was situational and based on what was then an uncertain and unsettling disruption, many of the principles formed the basis for the advice we gave, and continue to give, clients. The specifics of the situation may differ, but the fundamentals remain the same. More recently, our CEO Simon Freakley and Lisa Donahue, who co-leads our Americas and Asia business, published an article in Harvard Business Review. Entitled ‘Setting Your Annual Budget Amid Economic Uncertainty’, it is more focused on recessionary preparedness but, again, the same principles emerge.
What’s particularly interesting, as Simon and Lisa outline, is that actions and strategies typically deployed in times of distress and uncertainty are now the norm. Adopting a mindset where disruption is a constant is the model all businesses should embrace. And we’re seeing this emerge across PE.
PE strategies are shifting significantly in response to market conditions. Growth and value creation, the long-time staple and mark of PE success, are starting to take a back seat. Value preservation is taking greater precedence. With exit options appearing limited and multiples likely to be muted, operating partners are reviewing their portcos and trying to identify the levers they can pull to reduce cost without inhibiting performance or a return to growth; managing inflation, labour, and supply chain challenges; and, most importantly, revising forecasts and managing cash in light of continued uncertainty.
As a result, we can anticipate longer hold periods, particularly where a degree of patience and some thoughtful value preservation might revitalise a “zombie” portco.
This is the first valuable lesson from the pandemic. While extreme disruption remains a constant theme across the pandemic and the downturn that has followed, the world is very different. A swathe of government subsidies and supportive credit markets have been largely replaced with much more constrained conditions. Indeed, 44% of the respondents to our recent Turnaround and Transformation survey told us that the availability of capital has decreased in the past 12 months, with 52% also stating that financial terms had grown more restrictive.
Those prevailing conditions are quite rightly forcing a level of portfolio reassessment that mirrors the introspection and swift subsequent action that many businesses implemented in the recent COVID-fuelled past, despite the tidal wave of liquidity that became available.
The elevated premium of pace
Those that moved quickly and decisively during the pandemic will likely have entered 2022 in better shape overall than those who didn’t. A global event of that magnitude demanded levels of flexibility and agility that simply couldn’t have been prepared for. Most funds now have a thorough understanding of the potential exposures across their portfolio, and the disciplines developed during COVID are equally applicable in the current environment.
With a series of more recognisable economic headwinds to contend with now – albeit running concurrently to create something of a perfect storm – the mantra of prioritising pace over playbooks stands firm.
Arguably, PE-backed firms are in a better position than Corporates at this time. The laser-focused lens that PE brings leads to a more agile approach without the prying eye of public markets. This lens should be applied across cash, cost, and balance sheet management; operating model transformation in an effort to drive improved multiples; and any reimagining of market propositions and pricing strategies in response to a consumer cost-of-living crunch.
In addition, the acquisition or divestment opportunities that do present themselves in an increasingly distressed environment must be seized and progressed at the greatest possible speed, given recent history points to the likelihood of further disruption potentially derailing deals sooner rather than later.
Managing in an inflation-led downturn is not something that PE leaders and portco management teams have had to work through for many years. And, pre-2020, the thought that something as monumental as COVID-19 might actually serve as a strategic training ground for what would then come afterwards would have seemed highly improbable.
Flipping the old saying that “the definition of madness is doing the same thing and expecting a different result”, now might actually be the perfect time for Private Equity to resurface and redeploy its successful actions from the most extraordinary of recent times.