Record fundraising and strong M&A activity point to the industry's resilience and confidence to address uncertainty caused by geopolitical factors. But effectively deploying capital in a high valuation and volatile environment remains the key challenge.
Record Breaking Fundraising
The last year has seen records broken for total funds raised and size of individual funds raised, and overall the amount of dry powder available is at a high.
There is an increase in both specialisation and divergence of strategies. Several new or spun-out fund managers are focusing on specialists strategies, industries or geographies. Meanwhile larger fund managers continue to set up specialist teams or funds focused on strategies not viable for their main funds, such as small-cap tech deals, infrastructure and alternative credit.
However, as GPs' performance is squeezed by high entry values and uncertain markets some have moved to 'deal by deal' fundraising or have handed over management of legacy portfolio companies to other managers. Others have merged to bring together strategic and volume benefits.
Strong M&A Activity
Since recovering from the aftermath of the Brexit vote M&A activity, including London IPOs, remains very strong. There was an expectation that activity levels would slow down at the end of 2018, in anticipation of Brexit, but we did not witness a significant general slowdown.
However, the uncertainty around Brexit, and other geopolitical factors, has had some influence on investment activity. The traditionally popular consumer, technology, real estate and healthcare sectors continue to drive deal volume, but there is an increasing focus towards defensive plays and away from discretionary spend businesses.
Fierce Competition for Assets
Competition for assets remains fierce, driven by the availability of dry powder, and by corporates with strong balance sheets, family offices, the IPO market and the availability of debt.
Valuations are generally high and buyers are working harder than ever to find proprietary deals, pre-empt auction processes or do transformative deals with a particular angle. Buy and build strategies are a prevalent example of this, allowing GPs to both deploy more capital and to create value.
Addressing the gap between sellers' high valuation expectations and buyers' caution over an uncertain future, and the need to model for sufficient exit returns, is another feature of the current environment. We have seen numerous examples of deferred consideration or earn-out structures, or sellers' reinvesting into the buyers' structure, as a way to bridge this gap.
Management Team Terms
In hotly contested auctions, management teams are increasingly even more of a factor in which way bids go, and we are seeing management teams being better advised and getting involved in processes earlier.
Higher valuations are putting pressure on the economic package buyers are able to offer management teams, so we have also seen an increase in ratchets and performance vesting to help balance the need for sufficient upside for management and for base case returns for investors.
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