Private equity and extended holding periods

Economic headwinds and high interest rates have slowed investment activity, as buyers seek to drive prices down or simply hold off making offers. Meanwhile sellers are reluctant to sell, with the hope of achieving a better price later on if things improve.  

European private equity (PE) exit activity has slowed, with the number of sales to corporate investors and other PE backers (secondary buyouts) down 46%, from 355 in 2022 Q1 to 191 in 2023 Q1, according to data from PitchBook Data Inc. IPO related exits have been negligible, at three during 2023 Q1.

And for those portfolio companies that have been sold, the average length of time being backed by the seller has risen to 6.1 years from 5.3 a year ago, according to data from Arx. Considering that the typical investment holding period is three to five years, this highlights that, where possible, sellers are holding back and waiting for a better time to exit.

Exit delays impact the internal rate of return for investors and can put pressure on the narrative between PE backers and their investors. However, portfolio companies can still seek to create value during this period and ensure a smooth future exit by focusing on a few specific areas. 

1. Maximise the success of integrations of add-on acquisitions

Most portfolio companies make add-on acquisitions (on average 2.25 per UK portfolio company between 2018 and 2023 Q1) and should place effort on maximising the strategic and operational value of these acquisitions. Would-be buyers are unlikely to simply ascribe a higher EBITDA multiple to the enlarged business, the outcome of a valuation-increasing strategy called ‘multiple arbitrage’, but will look carefully, especially during times of uncertainty, at how well the combined operations and propositions tie together and if key functions like finance are working effectively across the enlarged entity. 

At a recent forum that was attended by CFOs of PE-backed mid-market companies, we asked the audience of 46 how well their integration process had faired. Encouragingly, none of them stated that the process had been ‘unsatisfactory’, but 78% stated that things had been ‘good but could have gone better’. Only 22% stated that the integration process had gone ‘very well’. 

Companies facing extensions should therefore take the opportunity to maximise the success of integrations where relevant.

2. Ensure cyber resilience

Companies should ensure that they have robust cybersecurity measures in place to safeguard their operations and data. With pending corporate activity, the potential for cyber criminals to exploit vulnerabilities increases. By investing in advanced security technologies, conducting exposure reviews, and educating employees about cyber threats ahead of a sale, companies can mitigate risks and bolster buyer confidence in their systems. 

3. Establish effective reporting mechanisms 

Companies should establish transparent and granular measurement and reporting mechanisms using advanced data management and dashboarding tools, like Alteryx and PowerBi. Not only will this provide the information that prospective buyers seek, but companies can leverage the insights in the meantime to drive better decision making and activity.  

4.  Fully leverage the expertise of your PE backer

Most PE backers now employ specialist operating partner teams to support their portfolio companies. To some companies, this expertise is a significant asset, with 24% of the CFO Forum attendees saying that this support was ‘wow - more than expected’.

However, it seems like there is a way to go, with 52% stating that the support was ‘good but could have been better’, and 12% saying the support was ‘unsatisfactory’. This suggests that more attention could be placed on this relationship to fully leverage the benefits.

5. Commission sell-side vendor due diligence

By conducting a comprehensive evaluation of their own business, private equity-backed companies can identify and rectify any potential issues before engaging with cautious investors. This proactive approach demonstrates the company's commitment to transparency and reduces the perceived risks for potential buyers.

In summary, private equity-backed companies are likely to face extended holding periods during the rest of 2023 and possibly beyond. During this time, and in fact right across the private equity investment lifecycle, they should remain focused on value creation, resilience, and maximising buyer assurance when an exit eventually comes. By integrating add-on acquisitions, reducing cyber risks, setting up effective reporting, undertaking sell-side due diligence and working closely with their backers throughout, these companies can enhance their market appeal, reduce uncertainties for buyers and increase their chances of a successful exit.