Navigating PE Success in a New M&A Landscape
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2024年5月23日
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2024’s sluggish deal tally should not obscure the growing role that private equity (“PE”) is now playing in M&A. It now seems accepted wisdom among informed observers that as goes PE, so goes M&A. But PE firms will experience a new set of challenges as they bring their liquidity — as well as their innovation — into the market. Not everything will change, of course. These firms are adroit in handling deal details and navigating the risks of private markets for themselves and their portfolio companies. Some things will be new, however, and two among them are worth consideration. Unfamiliar and increasingly complex regulatory, compliance and reporting issues add to strategic considerations firms will now have to make. Furthermore, managing different kinds of communications with stakeholders — both required and voluntary — and attending to government affairs at both the federal and the state level may place added focus on the strategic role of General Counsel (“GC”) and in-house legal teams that have traditionally managed these details for PE firms as they seek further advantage and returns in the M&A market.
Current State
Although cautiously optimistic about 2024 after the doldrums of the previous year, there is a continued sense of urgency and pent-up energy in PE looking for an outlet in M&A. A key driver is global private equity dry powder, which, at the end of 2023, was a record $2.59 trillion — a nearly 8% increase from the previous year’s.1 Add to that a backlog of 2023 transactions that were paused due to misalignment of valuation expectations from buyers and sellers and the pressure to return capital to limited partners (“LP”) seems only to be increasing as 2024 goes on.2 With a record number of funds — 4,000 in total aiming to raise $1.2 trillion by some reckoning — looking to close deals,3 it’s a ripe environment for the kind of innovation that PE will bring to the market, along with much needed liquidity.
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Private equity also brings a more aggressive approach with a higher risk tolerance that offers new and creative avenues for investment into a market that, after a down year, is eager for momentum, increased deal flow and the promise of returns. When compared to more traditional strategic dealmaking, PE has an advantage in that firms can focus on cash generation, as opposed to profit or revenue growth. This advantage allows PE to be more aggressive in their valuations, synergy assessments and value creation theses. PE firms also have greater flexibility in deal structure and deal financing, including the ability to tap into private credit markets. A further advantage of PE in the M&A sphere is the ability to add secondary or tertiary equity investors (“co-investors”), which can provide additional capital resources for larger deals and portfolio company follow-on investments, as well as offer ways to share risks and potential rewards.
Recalibrating the Risk Profile
The risk calculations that have served private equity well, however, will need to be recalibrated in the face of changing market dynamics in order to secure the necessary returns. The M&A arena that PE is moving into is itself changing — not least due to a global trend in increased regulatory scrutiny in 2024 and beyond — with a notable focus on technology and healthcare.4 Deals will get done, no doubt, but firms will now face heavier compliance burdens, increased amounts of reporting and lengthier approval processes. PE firms may find themselves having to adapt to greater attention from regulators than they have previously experienced. GCs in PE firms and current or potential portfolio companies may find themselves busier and in need of additional resources as they confront recently proposed changes to the Hart-Scott-Rodino Act, increased state regulatory focus on competition — especially in healthcare and technology — and the recent action by the Federal Trade Commission (“FTC”) banning non-competes.5 The key to success will be the ability to respond quickly and thoroughly and adjust risk calculations accordingly.
The FTC recently proposed amendments to the pre-merger notification rules under the Hart-Scott-Rodino Antitrust Improvements Act will likely get adopted soon.6 Under that new rule, Firms will face new notification processes and increased scope of information required at filing and in post-filing second requests, which, by some estimates, will result in a fourfold increase in the overall cost and time required to prepare the initial finding. Identifying and retaining required data, as well as meeting discovery requests, may stretch the technological skills of many companies. Indeed, the use of second requests — additional information required after the initial filing — will most likely increase, and the compressed time frame for these requests will add additional pressure on closing deals and providing returns to private equity limited partners.7 Similarly, evaluating the antitrust risk with buyers and sellers outside the private markets, for example, will become even more important. Lock-up and exclusivity periods will require closer scrutiny. Internal operational and morale risk will take on greater weight, as will relations among competitors, including the sharing of information that might not have excited attention in the past, but will certainly do so soon.
Added to these expected increasing burdens on filing, reporting and compliance is an intensified focus by the FTC, DOJ and U.S. State Attorneys General on Private Equity, especially on deals in healthcare and technology. Practices that have served PE firms well — information exchanges among firms, investors and portfolio companies or roll-ups, for example, where a firm acquires several companies in one industry and builds them into a larger entity — have received special attention by the FTC and state regulators.8 Indeed, in 2023, 24 states enacted laws related to health system consolidation and competition, according to the National Conference of State Legislatures.9
Managing Multiple Strategic Conversations
Telling the private equity story to the right audience at the right time with the right information will become increasingly important in this environment as innovations are applied and challenges are met. GCs and in-house counsel will take on some of this work, but new talent may need to be acquired as strategic communications plays a greater role. Engaging with governments in a proactive and ongoing manner at both the state and federal level to highlight the value private equity brings to investors and portfolio companies will be critical. The push by the DOJ and FTC for increased self-reporting will require more active management by in-house legal teams to scan for potential violations, which, when discovered, will require additional engagement with regulators.
Additional communications challenges will come with managing LP expectations, engaging with the growing secondaries market and addressing the concerns of new classes of investors as PE expands its presence in the M&A market and seeks additional liquidity and flexibility. Increased transparency and active engagement with stakeholders and regulators will require parallel communications with LPs already concerned about the slowdown in dealmaking, the decline in PE exists and the continued uncertainty surrounding the cost of capital amidst stagnant high interest rates. While adding secondaries to the mix brings additional liquidity, they too will need to be more actively communicated with as the year unfolds. Finally, tapping into and educating retail investors will carry a host of new communications challenges for PE firms, often more versed in working with institutional investors.
Conclusion
Seeing private equity merely as an alternate source of liquidity for dealmaking misses key elements of its contribution potential, as it plays an increasingly important role in M&A. The higher risk tolerance that has led to large returns has also allowed PE to innovate. The move into a more public market will require already nimble private equity firms to shift their risk profiles as they adjust to greater visibility, weightier regulation and compliance and a broader range of stakeholder expectations.
The complex and multidimensional challenges facing PE as it takes on this greater role should not distract from the tremendous benefits private capital brings to the M&A market and to investors. Evolution is necessary, but not necessarily easy. The private equity firms that have an accurate map of this evolving landscape, as well as an accurate assessment of how they and their teams align to meet the challenges and seize the opportunities on it, will be best prepared to know where they can move forward on their own, where they will need strategic support and which areas they will need to avoid. GCs and in-house counsel at PE firms and portfolio companies, in particular, may find themselves thrust into a greater strategic role as they adjust to new and more complex regulatory responsibilities and the growing need to communicate with a broader range of stakeholders.
Footnotes:
1: Muhammed Hammad Asif and Annie Sabater, “Private equity firms face pressure as dry powder hits record $2.59 trillion,” S&P Global Market Intelligence (13 December 2023).
2: William Clogg and Justin M. McCarty, “M&A Market Status and Deal Outlook: March 2024,” FTI Consulting Insights (16 April 2024).
3: Chris Cumming, “Private Equity Faces a Gloomy Fundraising Forecast,” WSJ Pro Private Equity: Special Report on the Year Ahead” (February 2024), 11.
4: Victor Goldfeld, Mark Stagliano, and Mark Andriola, “Mergers and Acquisitions – 2024,” Harvard Law School Forum on Corporate Governance (19 January 2024).
5: “FTC Announces Rule Banning Noncompetes,” US Federal Trade Commission Press Release (23 April 2024).
6: “Premerger Notification; Reporting And Waiting Period Requirements: A Rule by the Federal Trade Commission on 02/05/2024,” Federal Register (2 February 2024).
7: Ashley Brickles and Colleen Voshell, “Global Regulators Squeeze Merger Control as FTC Proposes Strict Revisions to Guidelines,” FTI Consulting Technology Blog, n.d.
8: On DOJ and FTC concern about PE strategies in healthcare see David C. Kully and Kenneth Racowski, “Private Equity Under the Microscope: Taking Stock of the Antitrust Enforcement Environment,” Holland and Knight Alert, 18 January 2023.
9: Anna Claire Vollers, “‘Shell game’: When private equity comes to town, hospitals can see cutbacks, closures,” Stateline, 18 January 2024.
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2024年5月23日
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Senior Managing Director, Global Leader Private Equity