Coronavirus to reshape mid-market private equity dynamics in year ahead

December 31, 2020

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King And Queen Wooden Chess Pieces With Letter M And A Wooden Blocks © Andriy Popov /123RF Stock PhotosThe year 2020 tested the mettle of entrepreneurs and small business owners like none other in recent history. And private equity firms operating in the small- and medium-sized business space were called upon like never before to help manage through the pandemic.

For many business owners, 2020 has been about survival and making it through the next day, week or month. With few exceptions, entrepreneurs everywhere are nursing coronavirus scars – whether it’s a recent layoff of employees, an aborted expansion plan or the loss of key customers – and that has given them food for thought about whether to keep going or perhaps engineer an exit from their business.

Many are also ageing, which is influencing how they’re viewing the pandemic, as well as 2021 and beyond. According to recent research by the Business Development Bank of Canada, most Canadian entrepreneurs are 50 or older and most of those 65 and up plan to retire in the next three years. Importantly, close to half of all middle-aged entrepreneurs indicate that the pandemic is accelerating their decision to retire.

At the same time, the appetite for private equity is increasing among institutional investors, family offices and high net worth individuals, as record levels of dry powder capital continue to look for attractive deals – pandemic or no pandemic.

Against this backdrop, 2021 will likely mark an important inflection point for middle-market private equity.

Factors like coronavirus, ageing entrepreneurs and strong investor appetite for private equity make for a perfect merger and acquisition climate. My team reviews hundreds of companies every year with owners that are thinking about acquisitions or asset sales and that number has grown by about 25 per cent through the pandemic.

Competitors are looking for entrepreneurs and founders who might prefer to sell rather than slog it out for the next several years while managing the reverberations of the coronavirus crisis. In an environment like this, smart M&A can bring scale and greater operating efficiency — and greater market share — so it makes good sense that many owners are actively exploring inorganic growth opportunities.

I also expect that in the next 12 months, the private equity advantage will take the spotlight. Compared to private equity investors, those who invest in public companies have relatively fewer options for recourse if they disagree with the management team’s decisions.

When a private equity firm is invested directly in a business, it can reduce capital expenditures, trim costs, renegotiate supplier agreements and pull a number of other different levers to preserve capital.

Another factor for consideration when thinking about success in the next 12 months is a business’s clientele. Throughout the pandemic, businesses that keep the government operating have performed very well. After all, governments at all levels couldn’t simply stop operating because of the pandemic.

I expect the government will keep on giving, primarily by spending heavily on infrastructure and health care, as well as supporting services related to those two fields. Businesses with exposure to those sectors and with strong public-sector relationships should perform well in 2021 and beyond.

I’d also like to raise one issue that probably won’t change, but should. Most chief executive officers probably haven’t had a real day off in nine months. Many aren’t taking care of themselves as well as they should. Fighting multiple fires every day often nudges out other priorities, like getting well-deserved down time, exercising and sleeping well. That’s not sustainable – but leaders need to make sure it changes.

I expect 2021 will be just as demanding as 2020 was for entrepreneurs, just in a different way. Whereas 2020 was all about crisis readiness and owners’ ability to quickly pivot in the face of massive uncertainty, 2021 will for many be a tough climb back to stability and (hopefully) growth. This will make businesses stronger, tougher and nimbler, but it will take hard work and many long days to get there. If we want to be able to get up and fight each and every day while nurturing and caring for employees, business partners and our families, we have to give ourselves permission to rest – at least a little.

Even though 2021 will be no cake walk for many small businesses, I couldn’t be more optimistic about what lies ahead.

The pandemic has taught most investors and business owners decades’ worth of business lessons in just nine months. In fact, I believe the pandemic will create a generation of truly resilient, creative and agile leaders who embrace change, live comfortably with uncertainty and can take an emerging crisis in stride. That, in turn, makes for an extremely compelling investing environment for private equity and a more vibrant economy over the long term.

Tracey McVicar is a partner at CAI Capital Partners. These views are those of the author and not necessarily those of the Canadian Investment Review.

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