The private equity industry has long been the preserve of institutional and high-net-worth investors, but new legislation in the US could open it up to the wider investment community
As the private equity industry emerges from a tricky couple of years, new opportunities are starting to emerge. As regulations are being formulated, the industry is set to go through a period of reinvention that could see it significantly opened up to the wider investment community. With 2012 drawing to a close and managers looking toward the coming year, lawyer and industry specialist Kirk Radke, of US law firm Kirkland and Ellis, looks at some of the issues facing the industry and what opportunities are emerging.
The regulatory environment
Although the summer months and the election season ramping up has meant a limit to legislation being passed in the US that will impact the private equity industry, Radke does think that one piece of policy which will is the recently-passed so-called JOBS Act (Jumpstart Our Business Startups). “This is the one item of interest which will potentially impact on both the private equity world and the hedge fund world. In the US, up until now, you could not have a firm engage in general public advertising or solicitation. If that rule does come in, you could see the hedge fund industry and the private equity industry doing more in the public eye, talking about their funds and fundraising.”
This could be significant, as it may go some way to addressing the concerns of the general public about what they deem a relatively secretive industry. “It could be just another step in the evolution of the asset class. I think that one of the issues which is really important is how private equity is able to go to the general public and make the case for a sophisticated investor in the general public to become an investor within private equity. I think that is something which, going forward, could see an opening of the asset class to more and more investors.”
Radke is enthusiastic about the potential opportunities that the industry could present to the general public. “The high-quality private equity firms are recognised as delivering consistent value-added returns. It should be something that the broader public is permitted, in some fashion, to invest in. I think that’s an area of very significant potential, post the election.” It is not just in the US that the industry is evolving, however. Radke says that countries across the globe are developing the regulatory environment for their private equity firms. “Each jurisdiction around the world understands that private equity is an important asset class, and they are thinking about how they want to understand that asset class.”
The fundraising process
Radke says that, certainly in the US, activity in the industry has increased as funds are attempting to raise capital. “What we are seeing here in the US is a very strong amount of activity around private equity. In the US, the private equity firms are going through a fundraising process. While that is a difficult process and time consuming, most of the high quality firms are going to come through the fundraising process in very good shape. They will perhaps have a fund that is not of the same size as they had in the boom years of 2007 and 2008, but it will still be a significant amount of capital.”
The enthusiasm for the industry from institutional investors is clear, and this is down to the amount of work private equity firms put into ensuring value didn’t drop too much during the crisis. “Most observers feel that the limited partners in private equity are mainly committed to the asset class. They like the returns that high-quality general partners are delivering to them. They like the way that the private equity really worked very hard between 2007 and 2010. They saw these firms worked hard to preserve value, to create value, to protect investments.”
The industry has also attracted interest as a result of other sectors performing poorly. “Compared to the alternatives,” says Radke, “there are not a lot of investment opportunities being presented to investors where they can commit significant capital to a venture, an investment, or an asset class, and have expectations for returns that succeed their target.”
Radke expects this round of fundraising to continue beyond the next year, and believes it will likely show which firms are going to be successful in the long run. “The fundraising will continue over the next year, or 18 months. At the end of that period, we will clearly see which firms have come through it in very good health, which firms have come through it in okay shape, and which firms have come through it with less capital than their organisation needs.”
The environment, however, is considerably more positive than before the global downturn. “The fundraising environment is very different. It’s much more positive and people are thinking about two years ago, three years ago, where there was a real question of how many firms were going to be able to raise a fund. That confidence on the fundraising side really leads to investment committees and general partners looking for the investment opportunities. Even though our economy is better than it has been, and it’s certainly better than what Europe or the continent is facing, it’s still a challenged environment. One of the things many of my colleagues have learnt from past cycles is that you don’t invest when everyone thinks the economy is going great. The investments that they make at a lower point in the cycle have proven to be terrific investments.”
This confidence has resulted in greater enthusiasm for new opportunities, says Radke. “The confidence from fundraising has led firms to look for new opportunities. In the US, the capital markets are very vibrant. In August, we saw the amount of high-yield debt that was issued set a record for all Augusts. There was a huge volume of new loans made. The majority of that was refinancing of existing debt, but there were many new issuances in there as well. So capital markets and the debt markets are open for new business, and that translates into a lot of activity.”
There are opportunities for the industry from the plethora of companies available for sale or requiring some form of restructuring. Another factor, says Radke, is many private equity firms are look to dispose of portfolio companies they’ve held for a long time. “Firms have a very significant amount of portfolio companies that they’ve held for a long period of time. They are looking for dispositions. Here in the US things are pointing towards significant activity for the next coming months.”
Of all the sectors that private equity firms are looking at, Radke says the most amount of activity has occurred in energy. “You just look at the transactions that have been completed this year. There’s a significant amount of investment, and a significant amount of capital being committed to firms. They’re focused on the energy sector, which has been a very important part of the investment story this year. I think you’ll continue to see that over the next little while.
Deals happen very quickly these days. You need to be able to respond in a consistent fashion
“There have been some transactions in the energy space around the world, but the story that I’m seeing is really more of a US flavour to the fundraising, and more of a US flavour to the transactions. I do believe that there are opportunities all around the world that this sector is encountering.” The expansion of the private equity industry into emerging markets continues, says Radke. “That’s clearly been part of the story over the last four or five years that we are witnessing play out right now.
Firms are looking at opportunities in Latin America, Asia, Eastern Europe, Turkey and South Africa. They like the private equity model of investing and of creating what I call value-added corporate governance. I think the private equity model has resonance in each of these regions, and you are seeing capital being deployed in each of these regions by private equity players.
“People are very optimistic on interim investments. I think that you can say private equity is now very much a global business. You can say that each region has its own issues, each region has its own challenges, each region has its own strong players, but the industry is not solely a developed country industry anymore. It really stands up in emerging markets as well as the developed markets.”
Dealing with legal issues
Kirkland and Ellis is a firm that is perfectly placed to offer clients the sort of services required to operate within the private equity space. Radke says that his company’s global reach and experience has helped to ensure continued success. “What we do is work very closely with private equity clients around the world in their fundraising and their work with our portfolio companies. Yes, the industry is always looking for good advice, and is looking for problem solvers. We pride ourselves on working with them to add value into their investment decisions, and working with them to deliver the best legal advice possible. They are a challenging, demanding group of clients, and we like that.”
It is a challenging and fast-paced industry that Radke serves, but this does not deter him. “We like the challenge, we understand what we need to deliver; that is, high-quality advice in a compressed time frame. Deals happen quickly these days. You need to be able to respond around the world in a consistent fashion.”