The agile regulatory landscape: A guarantor of growth

The implementation in Europe of the Alternative Investment Fund Managers Directive (AIFMD) in 2013 was certainly one of the triggers of such success. First considered as a threat and a costly upgrade to operational processes, it finally paved the way for tremendous expansion. It helped to define and clarify some common standards, which although not entirely perfect still provided enough options and benefits to professional and specialized Private Equity fund managers, the famous GPs (General Partners).

Some countries, like Luxembourg for instance, went the extra-mile and used this occasion to supplement some special features which also became accelerators of this growth. These included the refurbishment of the Limited Partnership law (SCS) and the creation of the Special Limited Partnership (SCSp), which currently represents the most used legal form, at least in our industry, and is a true bestseller with more than 6,400 active SCSps. This crucial addition to the Luxembourg toolbox was also accompanied by two emerging business models, which grafted themselves into the ecosystem. It allowed specialized fund administrators (PSFs) to emerge under certain conditions as depositaries of “assets other than financial ones” (i.e. non-listed assets and so englobing the PE funds) and the rise of the third party AIFM model. Instead of instantly creating an in-house AIFM, such robust providers proposed the required services, substance, and manpower—a real starter pack—in order to accelerate the launch of such activities, which also became another local specialty.

In 2016, Luxembourg continued its innovative pathway with the implementation of another winner: the Reserved Alternative Investment Fund (RAIF). This offered an interesting structuring model, which included add-ons such as the possibility to use sub-funds, the pan- European ‘passporting’, and a fast time-to-market as supervision is handled at AIFM-level and not at product level. It proved so successful that there are currently more than 1,680 such vehicles in the marketplace. And it isn’t only Luxembourg that showed its creative chops: other EU countries also took the opportunity to innovate and refurbish their existing vehicles. Together, the EU has become a busy hub for Private Equity structures, targeting EU capital and doing local and international investments.
 

The performance, trust, and expertise

The flexible toolbox, the recognition of the track record by institutional, professional investors, and the profound experience of the different asset servicers are surely guarantors of the success of the Private Equity asset class, but the main reasons are its core values and intrinsic strengths.

Globally, the long-term goal of PE is to invest into unlisted small, medium, or larger companies in order to make them better, stronger, and more profitable before selling these firms on (or exiting) after a successful transformational process. In the past, this was heavily centered around financial restructuring—the use of leverage, cost reduction/savings and, in some cases, even consolidation. This model evolved over time and today the emphasis is placed upon concrete contributions to the real economy and the ecosystem of enterprises, which require capital, external expertise, and succession planning solutions in order to leverage and pursue their growth. These target companies, once aligned with the GP’s interests, are now able to embrace a new age of evolution with one of the following:

• A complete digitalization of their operations;
• The launch of new products;
• The expansion to new markets; and/or
• A fully-fledged buy and build strategy (buying up competitors and becoming a national, EU, or worldwide champion).

The same applies to venture capital (VC) which allows start-up companies to be backed, quite often, by former successful entrepreneurs in order to get their companies off the ground and grow. VC, in its noblest sense, is injecting money (in a way, ‘passing on’ money to new founders) and helping innovation, research and development, and a new generation of giants to emerge. These investments do have a capitalistic goal of improving the value of the companies themselves, which also triggers further positive outcomes for the society via new jobs, career opportunities, and the creation of an agile workforce capable of handling multi-dimensional skills and fast-paced industries.

PE is the perfect combination of finance and entrepreneurship and is meant to create value and deliver performance. In this industry, everybody has or should integrate this entrepreneurial spirit, try to improve their performance, and remain curious and eager to learn. Hard work and very robust studies are surely part of the ‘must-have’ package, but it’s worth the effort because of the brilliant professionals and entrepreneurs you will meet, because of the diversity of the profiles that will be found in PE teams or investment committees. There is no ‘one size fits all’ mentality and you can work with engineers, industrialists, PhDs, merger and acquisition specialists, genius financiers, visionaries, smart marketers, and pragmatic back, middle, and front office specialists who are attracted by this mind-set and business attitude. The goal of PE is not to simply analyze markets and indicators or mechanically review firms while trying to do short-term bets or transactions. Rather it is to successfully transform (value creation) the portfolio companies into the winners of the next generation—thanks to these specialists with an intimate knowledge of launching, running, and selling companies.
 

The challenges and opportunities of the industry

Since the PE sector is growing in strength and size (Preqin PE forecast 2020-2026 from US$4.52 trillion to US$ 11.12 trillion with a CAGR of 15.6%), is it therefore exempt of any flaws? The realistic and pragmatic answer is no.

For example, the industry itself is and usually remains labor-intensive, heavily under-automated (especially the AML/KYC processes), and still embeds many manual processes despite emerging applications and digital platforms from FinTechs or legacy IT firms. It is also complex to value new assets or businesses which do not yet exist, especially when a comparison with current indexes, market data, or previous transactions is not feasible nor available. This hinders the use of classical valuation models and therefore requires a robust methodology, powerful tools, and sophisticated internal resources. This need for high-level experts and talent represents an interesting but also serious challenge, since these specialized profiles require well-trained candidates with the right level of technical, theoretical knowledge (as provided by recognized, but selective University programs) and, most importantly, direct exposure to the sector. This is a long process which calls for time, continued efforts, a good corporate culture (to extend the retention rate), and a degree of flexibility since energetic talents can sometimes be rather impatient, expect early and ‘tasty’ packages, need strong mentorship/leadership, claim direct access to executives, and require hands-on experiences with responsibilities.

Data is another rather difficult fish to catch and to consolidate. This should not come as a surprise since it is naturally embedded in the industry’s DNA and usually composed of private capital injected into private markets through non-public transactions and dedicated to selected categories of investors (e.g. institutional, professional investors, family offices, private high-net worth individuals). Thanks to industry efforts such as those by Invest Europe and the different national European PE/VC associations, some statistics have been collected and treated in order to provide a more holistic overview, next to some specialized financial information providers which also have invested a great deal of time in order to be work on global reports, estimates, and trends, in collaboration with the industry and the inevitable use of manual surveys.

Nevertheless and despite some of those characteristics, the industry’s success, performance, and resilience have been validated in recent years by the tremendous and continued investors’ appetite which has fully empowered its growth. It is important to underline that the value creation process, as described above, has softened the discussion around the limited liquidity of PE funds (classical PE structures being for a majority closed-ended with an expected lifetime of a decade). This was unfortunately and wrongfully perceived as a risk, while missing the exact rationale of patiently boosting companies and increasing their intrinsic value without any quarterly pressures as experienced in the publicly listed space.

The industry is also receiving many optimistic signals from tech innovators which have the ambition to digitalize the sector and accelerate its evolution.

Finally the opening up of practitioners to more transparency, increased reporting (financial and non-financial including the important ESG criteria), and prevalent success stories have also led to more interest from smaller investors who would like to access the PE asset class and benefit from its returns and strengths. This opens a new paradigm: the democratization of PE. This could represent a tremendous injection of additional capital, but only with the right set-ups and the availability of adequate solutions which could deliver strong returns and a great portion of diversification to many portfolios.

We have truly entered the golden age for the Private Equity industry.