In a highly competitive market — but with more money in the system than ever — private equity activity has been booming, especially as it’s more difficult to get the same valuations in the public markets. Lawyers are highly involved in these private equity deals, with an estimated 400 lawyers in Toronto alone supporting this market.
Family participation and the formation of more formal family offices is also increasing. And both family offices and private equity funds are giving public markets a run for their money.
“What we’re seeing . . . today is that the private equity firms are growing — there's more of them than there have been — and they have a lot of money,” says Denise Bright, a partner in Bennett Jones LLP’s Calgary office with a banking, financial transactions and securities practice.
“The public markets are not getting the same attention these days from the investors,” Bright says, especially the institutional ones such as pension funds and university charitable trusts, “as are the private equity funds.”
The private equity market is also “highly competitive compared to even five to 10 years ago,” says John-Paul Bogden of Blake Cassels & Graydon LLP’s Vancouver office, whose practice focuses on M&A and private equity transactions. “There are very, very few proprietary deals where a fund would find a business and buy it without having competing bids from other parties. That used to happen occasionally; it’s very rare that it happens now.”
Even the smallest deals have a sell-side or other type of financial agent involved who is helping the PE fund with an auction or sales process, he says. “So, the days of just finding a diamond in the rough seem to be over. That’s across all [size] brackets.”
‘Dry powder’ and the merger market
Part of the reason for the boom in private equity investing may be the money out there to spend. There’s currently an estimated $2 trillion of “dry powder” (capital looking for deals) in the PE market, says Curtis Cusinato of Bennett Jones LLP in Toronto, who practises corporate and securities law with an emphasis on cross-border M&A, private equity and capital markets transactions.
“I think private equity will continue to be very active in this upcoming year, and certainly that activity will keep pressure on pricing,” Cusinato says.
“There is still lots of dry powder,” agrees Samantha Horn, a partner in the mergers & acquisitions and private equity groups at Stikeman Elliott LLP in Toronto. At the halfway point of 2018, she says, the merger market had reported that the global value of M&A was US$1.8 trillion, based on more than 8,000 transactions, and about 1,500 of those transactions were worth about $245.1 billion.
There are higher transaction multiples on M&A deals today “because there’s a lot more money chasing deals than there are people selling,” says Alan Litwack, a partner at Dickinson Wright LLP in Toronto.
Private equity investors also find Canadian companies attractive, say Litwack. That’s because of Canada’s strong domestic market, its reliable legal system, its attractive foreign exchange and lending from Canadian banks and its desirable industrial sectors such as manufacturing and food production.
A shift from public markets to private equity . . .
With a few high-profile public deals either not going forward or struggling in the past year, such as those of GFL Environmental Inc. and WeWork, and public markets performing in an “underwhelming” manner, more deals have shifted to private equity funds, says Horn. Deterrents to going public include a lack of access to capital and the expense of launching an IPO, with the regulatory oversight and compliance that entails, she says. “People tend to want to — if they can access capital — stay private longer.”
Lower, mid-market companies are not able to go public as they are too small, and public markets can be leerier of debt and less tolerant of risk, Horn adds.
Particularly in the U.S., “it’s getting harder to get valuations” in the public market, says Litwack, noting that Uber’s market valuation is down “billions,” and Lyft’s as well. “Investors are far more critical in their analysis of companies doing IPOs” now, he says. And, it’s “far cheaper to do a deal with a private equity fund or another buyer then it is to do an IPO,” including in underwriting fees.
Some perspective sellers will follow a dual track process; at the same time, they’re negotiating with prospective buyers, such as private equity funds or “synergistic” buyers, they will also be preparing for an IPO. “And they'll see which one is going to yield the best results,” says Litwack. If a PE fund or a synergistic buyer really wants a company, they may make a bully bid to get it “without you going to the IPO market and figuring out what you could get there.”
Bright sees valuations in the private equity market now that aren’t generally seen in the public market. Citing Visa’s announced acquisition of financial technology start-up Plaid in January, she notes that the end-of-2019 valuation of Plaid was almost two times what it was at the end of 2018.
Some PE firms, such as Blackstone Group LP, have grown to the extent that they’ve gone public. “The nice thing about private equity guys coming in is they can be more flexible than the public markets can be,” Bright says. “Sometimes you’ll see debt-and-equity, or an equity line of credit; the private equity company will offer a large loan with specifications.”
… and to smaller markets, industrials, resources
The mid-market is the most active sector now, says Horn, representing 91 per cent of deal activity and 19 per cent of deal value in the last recorded quarter, and making it a good place for private equity to look. Cross-border deals are still strong, notably with the United States, as is the industrial sector.
As for rising stars like cannabis, artificial intelligence and technologies and cryptocurrencies, “a lot of that attractiveness to those segments has certainly decreased,” says Cusinato.
In Canadian capital markets the two traditional resource sectors are mining and oil and gas, and while the market in those sectors has been less robust in recent years, Cusinato has “a more positive outlook going into 2020” for alternative minerals, such as lithium, and for rare earth. He also sees a favourable forecast for real estate/REITs.
The rise of family offices and institutional investors
The family office — meaning a devoted investment office for a very wealthy family — has also come into its own. In family offices, a family will hire investment professionals to run their investments, ranging from a single person to fully staffed offices with formal boards of directors and investment managers.
Family offices are now choosing to put some of their wealth to work in funds that invest in private equity and venture capital, says Horn, and are participating directly in mid-market M&A activity, she says. That these families have made their money owning and running successful businesses is “a good story for the business owner that’s trying to sell” a business, she adds, as they’re looking for a partner with experience. “Sometimes a business owner would prefer to work with another business owner.”
Family offices are also looking “for more of a Warren Buffett-type of investment,” says Liwack: strong cash flow and continuing income for generations. And for the seller who wants to stay in the game after the sale of his company, and a patient investor with a timeframe of three to seven years, he “is better off with a family office buying” his business.
For entrepreneurs who find the next generation of their family is not interested in taking over the business, an exit through private equity may be the answer. But many successful “boomers” are still sitting on their companies, Litwack says, owing to the revenue those companies still generate. After a business is sold, “What can you invest in that gives you that $2 million” per year?
And the growth and reach of Canadian pension funds has expanded on a global basis. The Ontario Teachers’ Pension Plan Board now has offices in New York and London, Bogden notes, and the Canada Pension Plan Investment Board has set up an office in the Bay Area. Boots on the ground and higher visibility assist in assessing and participating in the higher deal activity in those areas, he says.
Uncle Sam’s sunset?
In the past year or so, Bogden says “some [PE] funds are finding the exit process harder” as new buyers drive harder bargains. As well, eeach of the four leading Democratic candidates in the U.S. election have pledged to eliminate beneficial tax treatment for capital gains among top earners, and private equity investors are talking about locking in profits under the current taxation scheme.
“You’ll see, perhaps in response to that, the large funds diversifying,” he says, into infrastructure, public funds and non-listed funds.
In the United States, at least, “there’s a sense that the private equity party has to end sometime, and it’s been an awfully good run.”