The immediate challenge is that a seller’s market does not (with such low confidence) swing to being a buyer’s market, as neither party is able to quantify the moving risks being created. At the same time, we have a wall of money that needs deploying so ‘quality will out’ and this period will further differentiate those that stick to the knitting and performance manage their companies well. Equity is becoming more valuable – as we see the leverage multiples decline and therefore public market opportunities, trade and strategics are going to be more and more important participants in exit processes. Management teams will have to consider careers that see earn-outs in these formats as well as funds.
In terms of public markets, we will see a bit of a backlash from listings and companies currently that have listed, tapped, or merged on the markets, as there will no doubt be some big failures that were not totally unpredictable (for example, made.com) when real-world dependencies and supply chain realities are considered. Secondly, the ‘rate of change’ of inflation and interest rates – rather than an absolute level of these – is the challenge, as it means capital structures and equity volatility are hard to predict. In simple terms, when your financing comes up for renewal or you need to ‘amend and extend’, the rate at that point in time depicts costings for a lot longer period than the likely stability of the prevailing inflation and interest rates themselves.
Until we see the equity markets gain comfort with a longer-term prediction of a running level of global growth and relative interest rates to inflation in markets being traded in for companies, we are unlikely to see main market IPO and SPAC responsibly being the substitution/step-in answer. However, as this visibility and signs of stability occur, equity markets will, without doubt, be one of the first out of the door using their competitive position to get ahead of higher leverage funds and debt market rates. These will be real exit routes for companies and teams out of mid-cap and larger funds where a good track record and the end of a holding period is happening, and leadership teams will need to feel comfortable that their governance, reporting, and ESG credentials – as well as their skill sets and altitudes for what comes with this – are set up, motivated, and aligned.
I think some of your CEOs and indeed Chairs are, perhaps, going to experience a different journey to the one they signed up for. And it will be interesting to see how many of them find the agenda of the sponsors’ fund, house, and deal team individuals affects the context of decision-making and timing of things. We are managing the careers of these individuals as much as the company in many instances. Longer deal timeframes require appropriately shaped capital structures and we are unavoidably often setting off with existing ratcheting PIK notes and preference share hurdles that seep value to the houses at the expense of management terms, as well as seeing additional follow-up money increasingly dilute management returns when it cannot be funded with third party debt. The refinance ‘impact era’ has started.
Talent becomes the rare commodity that every company must capture, harness, and cultivate as we search for execution capability – motivation and culture being at the very heart of this. Working without a step repeat visibility of an outcome is going to be the new norm and we are going to have to grow the confidence of people at the centre/peak of their careers that this is acceptable. You can’t help but think from just a cross-section like the event attendees that this is going to see some people emotionally retire and others just miserable as it becomes harder and less certain. Refinancing is not going to be a value-creation driver in the next few years, but something that will unavoidably see perfectly good companies put under unanticipated stress. People are going to have to think through where the best use of their time and energies go and Chairs, CEOs, and funds are going to have to try and create structures that work for everyone without the transition inference or feeling they are being held hostage.
The wall of pension fund money that has been diverted into PE/LP funds takes a few years of momentum loss to shrink, so we are again irrationally going to see that there are too many PE houses chasing too few quality assets and risk rises in the chase of management fee deployment. We are unavoidably going to see Euro/Dollar based funds being opportune in the UK and must not conflate this with underlying valuation support – it’s a currency arbitrage over the investment term that none of them are allowed/have the authority to put into their investment papers ‘on a deal’, but they all know it potentially supports reported fund earnings (but not the management teams). Exits are inextricably linked to purchases – at the same time, we are going to see management teams stretched and, by consequence of all the above, structurally unavoidably less aligned with their sponsors than their last 5-10 years of experience. If you hear the leadership team ‘leading with conversation on exit’, and not on ‘building the best quality business’, you probably already have the wrong team in place.
Tom GrangerHead of CEO and Advisory Practice