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PE investment strategies prepare for eventuality of US economic downturn


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According to Market Intelligence, April 2023

PE investment strategies prepare for eventuality of US economic downturn

With the U.S. economy in its ninth year of recovery, private equity companies are preparing for an eventual downturn domestically and elsewhere in the next few years.

Speaking during a panel discussion at the SuperReturn US East conference June 18, Chris Egan, managing director of Advent International Corp., said his firm is already leaning on several strategies to counter the downturn impacting the next four- to seven-year investment period. Among those strategies is Advent's focus on "quick wins," which means for example making operational and pricing improvements as soon as it closes an acquisition.

Mergers also have a role to play at Advent. "M&A continues to be a good driver of opportunity in our portfolio, and again we're trying to pull that forward and think about, 'Can we combine a couple of businesses off the bat?'" To that end, Advent acquired and swiftly merged two payment companies earlier this year.

A partner at another private equity firm said his firm's preparation for a downturn is to invest in defensive industries — including consumer durables, healthcare services and certain segments of financial services — at low purchase prices and use less leverage. Further, it is buying businesses that are slightly smaller than its typical target and avoiding auctions, giving it the opportunity to create businesses that otherwise would require a higher multiple to acquire.

In terms of lessons learned from the recent global financial crisis, Advent's Egan said it is important for private equity firms to maintain exit discipline. It is easy, he said, to become attached to the companies and management teams in which a firm has invested, but circumstances can change and the need to move on intensifies.

"When we hit our expected returns and we see an opportunity to exit, we make sure we take it," he said. "And I think that's even more true in this environment with the exit market as frothy as it is."

Exits also give a private equity firm capacity to put money to work and find new opportunities. Advent raised a fund in April 2009 and was able to pursue some of its best deals as a result, Egan said, highlighting its investment in Fifth Third Bank in March 2009, enabling it to form a new joint venture.

The private equity partner on the panel said the last downturn taught him that management teams must be capable of working through a tough time. While he does not see the next downturn having the same magnitude as the financial crisis, he said there is a lot of "froth that can come out" of the market.

Daniel LeMoine, principal with Brooke Private Equity Associates, predicted that a downturn will come between 18 and 36 months from now, though he said he does not think it will be as severe as the 2009 recession. Among factors to monitor for signs of a coming downturn, he said a severe fluctuation in credit markets would probably precede the event by about six months.

The other panelists also said they are keeping an eye on rising interest rates, particularly with regard to how more-expensive debt will affect the balance sheets of their portfolio companies.