The private equity industry has expanded significantly in recent years as new capital has flowed into the market, arguably because big LP’s don’t really know where else to deploy it. Private equity is no longer just an ‘alternative asset’, it is very much the mainstream. There is no end to this on the short term horizon.
Two specific issues flow from this. First, whilst capital allocations are up massively, deal flow isn’t – and more money chasing constant deals can only mean higher prices and lower returns. Vendors and management teams can choose from a long list of keen investors, all bidding similarly aggressive numbers and structures, and often with little to distinguish between them: capital is now a commodity, so the only real points of difference are personal / cultural. Firms have moved to justify higher valuations by investing in their own operational skills, many developing dedicated portfolio teams to drive value capture, but unless you have won the deal in the first phase, these expensive new assets are redundant, so there is an ever-greater focus on research and origination – good old relationship building is back in fashion, with an emphasis on humility, not something that comes naturally to many industry participants.
Second, managing a portfolio has become more resource-intensive as the stakes have risen higher. This burden, linked to having to deploy more capital in ever more competitive processes means firms have had to grow their team sizes in recent years. It has been a boom time for headhunters, but at risk of biting the hand that feeds us, the pool of talent has probably shrunk in this period. Many senior people have left their positions, some to establish their own independent smaller platforms, some into other careers. At the junior end, the lure of the start-up world has absorbed a lot of talent that traditionally moved into banking and consulting, the classic training grounds for the industry, and Generation Y factors have made many question if this is a career they really wish to pursue; as one UK commentator has noted, ‘It’s not as much fun as it used to be.’ So where is all this new talent supposed to come from? It is not at all uncommon to see one really strong person receive four or five offers in the space of a week, and clearly they can only accept one, leaving the other firms unsatisfied. Investors will not wish to compromise on quality but may need to show greater flexibility on issues such as training commitments to integrate people from other backgrounds, flexible working arrangements, or compensation level and structure to bring in talent in the volumes required; when you layer on top of this the need to improve gender diversity as well, it starts to look challenging.