Adam Griffiths: Expect flexibility and a flight to quality in private equity deals this year

Last week saw Silver Lake, the US private equity group, acquire the Utah-based software company Qualtrics for $12.5 billion in what is the biggest private equity buyout of the year to date. Qualtrics has a prominent presence in the Irish tech ecosystem, and employs hundreds of people in its EMEA HQ in Dublin.

Economic indicators remain difficult to read, and developments at Credit Suisse have sent further jitters through the market, but the deal signifies the growing confidence on the part of private equity investors in "pricing in" the negative macroeconomic factors that have characterised the last twelve to eighteen months.

Some feel that new opportunities created by market volatility, as well as an estimated $3.7 trillion of "dry powder", will sooner or later translate into a renewed pipeline of private equity transactions across the globe. If so, how does the Irish market stand to benefit, and what trends can we expect in 2023 and beyond?

To answer these questions, it is necessary to understand the mindset with which Irish entrepreneurs have approached private equity to date, and how that might be shifting. In Ireland, attitudes have been shaped by the post-2008 banking crisis, and the bursting of the property bubble. Among certain audiences, there is still a wariness surrounding private equity and its role during that period.

However, within private equity, funds can sit at different ends of a broad spectrum. Their raison d'être is the same: to ensure maximum return on investment. But their methods can be very different.

Buyout or growth funds are essentially trying to super-charge investee company growth in a defined timespan, typically three to five years. Growth for a private company isn't achieved by asset stripping. It is achieved by supporting a business plan created by a management team and agreed at the time of investment.

At its simplest level it is about enabling talented people to maximise the potential of their business, like giving Jürgen Klopp a suitable transfer budget and letting him invest in gegenpress gurus.

To accelerate growth, many Irish business owners have taken on expensive debt rather than parting with equity. This has often been rooted in fears about dilution and control. Many of these businesses are "close companies”, controlled by five or fewer participators, often from the same family, with an inherent desire to maintain influence. By their nature, private equity investors pore over the details and ask challenging questions.

However, there are signs that perceptions are shifting. Notably, professional advisers are starting to the see an increasing number of “secondary” buyouts, a practice that is very well-established in the US and British markets. This is when one private equity fund sells to another, with the management team typically reinvesting a material proportion of their stake and taking the balance off the table.

Ireland has invested heavily in attracting investment from Big Tech, and we have seen a new generation of indigenous tech companies grow alongside them. It is, however, no secret that their young management teams are today facing unprecedented challenges.

Nonetheless, last year some 30 per cent of all global private equity deals were in tech and, if management teams can come to terms with reduced valuations, tech companies remain well-placed to receive serious attention.

Fundamentally, deal-making is about alignment of expectation. Private equity investors have already adapted their modelling for the macro-economic factors outlined above. Unfortunately, sellers tend to be slower to have their Damascene conversion.

A boon for prospective sellers might be the increasing flexibility and diversification of private equity funds. Traditionally, private equity investors were looking for businesses to fit a very particular mould. They wanted majority ownership, and all the control and comfort that comes with it.

However there has been a material shift in recent years, with minority and "partnership" options appearing. The larger fund managers are essentially designing different products for their investors and prospective management teams to select from.

Another clear trend is a flight to quality. Marginal deals that might have been rubber-stamped by a Zoom investment committee during the pandemic are being shelved or at best subjected to heavier due diligence. Unfortunately, this does not favour some smaller companies where financial discipline does not always match entrepreneurial spirit.

The upper mid-market - the €250 million to €500 million valuation range - is also challenged, given that debt, which is a key component of most private equity deals, is now more expensive or harder to access.

In the immediate term, that combination means that deals in the lower mid-market, in respect of businesses with a valuation of €10 million to €250 million, should see the most pronounced levels of activity. Ireland offers many opportunities in that range for the shrewd investor.

There were over 300 private equity deals completed in Ireland in 2021 and again in 2022, representing a significantly higher volume than in any of the years 2018, 2019 or 2020.

Last week saw Qualtrics grab the headlines and, with a "wall of capital" still looking to find a home, notable Irish transactions will be executed. However, in 2023 dealmakers might have to fight harder, and for longer, to get the job done.

Adam Griffiths is an M&A partner at Taylor Wessing, the global law firm, and head of its Dublin office