Private Equity: How Is The Industry Evolving?

Private equity is a form of alternative investment that includes capital that isn’t traded on a stock exchange. Private equity firms and investors invest directly in private companies or participate in publicly listed companies’ buyouts, resulting in the delisting of public equity.

Institutional and retail investors finance private equity. The funds can be used to finance new technologies, make acquisitions, increase working capital, and bolster and solidify a balance sheet.

How is the Private Equity Industry Changing?

The private equity sector is experiencing major changes as a result of fluctuating markets. Since 2019, exit and deal-making activities slowed down in the private markets whereas the public markets saw an uptick partly due to leveraged lending which resulted in growing investor confidence.

IT, Healthcare, and B2B Continue to Be Front-Runners

IT, healthcare, and B2B accounted for 63% of overall private equity deals in the United States during the first half of 2019. These sectors accounted for an even higher proportion of overall deal value. In the technology sector, their average deal size increased by 50%, while in the healthcare sector, it increased by 10%.

In 2019, investments in the energy sector dwindled. The number of deals closed in the third quarter was the lowest in a single quarter since 2010. In addition to low transaction sizes, the average deal size dropped to $13.7 million in the third quarter of 2019 compared to $30.3 million in the same quarter of 2018.

A significant percentage of deals are now coming from the IT, healthcare, and B2B sectors. It’s impossible to tell whether or not these patterns will continue. As markets continue to make fewer deals, capital is likely to flow towards the most well-established industries with potential for stable long-term returns.

General Partner Stakes Have Been Picking Up

Strong cash-on-cash profits were continuously demonstrated by the market. As a result, general partner investing and fundraising started to pick up. Limited partners are also likely to continue searching for ways to expand their exposure to private equity investments rather than general buyout funds.

Some of the money generated by this strategy is now going to investment funds, but most of it is going to late-stage or buyout firms, which have greater, more consistent sums of assets under control on which they can charge management fees.

Exit Activity Reached Historically Low Levels

Private exits are at an all-time low. Private equity exit operation was $62 billion over 168 exits in the second quarter of 2019, which was marginally lower than the first-quarter estimates.

More Private Equity Deals Are Getting Bigger

In previous years, most of the transactions under $25 million accounted for a significant portion of the overall transaction count in US private equity. The number of these deals has declined as the number of larger deals has increased.

What are some key trends?

Private equity now has ties to 401(k) accounts

The US Department of Labor, which oversees retirement plan legislation, released guidelines that cleared the way for PE funds to be included in certain retirement plans signalling increasing private equity exposure for the general public.

Banks are coming back to Private Equity with Volcker rule changes

Another piece of good news for the industry is the relaxing of the Volcker Law. Officials from the Federal Deposit Insurance Corporation (FDIC) announced that the Volcker Rule’s limitations are being eased, enabling banks to make larger investments in venture capital with greater ease. This is a big development since banks have been reluctant to invest directly in privately run funds since the Great Depression.

The Inconvenient Report

Although we see new sources of capital entering the private equity space, not all is rosy according to a widely contested thesis by French scholar Phalippou on private equity fees, returns, and the billionaire machine.

Despite being advertised as independent of public market whims; PE funds have been unable to beat public markets on several occasions after fees. The funds strongly disagreed with the report, and Phalippou included their objections in the paper.

How Can Private Equity Firms Leverage Blockchain?

As they currently operate with multiple fund managers, private equity fund investment models suffer from a variety of inefficiencies. 

Furthermore, such funds have a high entry barrier, meaning that only institutional investors can invest in them. Many investors are unable to gain access to attractive private equity fund investment opportunities because of the high minimums involved.

Liquidation deadlines are set, but they do not always guarantee that the underlying asset values are maximized. Consequently, in some situations, a downturn scenario could result in funds being liquidated, resulting in substantial losses for investors. Structural deadlines also restrict investment managers from producing the best returns for investors.

Blockchain’s immutable ledger system aids in the tying of real-world assets through tokens. This strategy can provide all of the benefits of Blockchain, including accessibility, liquidity and transparency.

Tokenization reduces the entry barrier, encouraging more investors to participate. The fund structure of private equity can be optimized with liquidity. There is no time limit for liquidating such assets, and they can be managed more effectively through an automated trading infrastructure as cap tables dynamically adjust without impacting the capitalization of the fund itself.

Fund managers will also benefit from lower redemption rates, and those funds would have fewer liquidity issues. Investment managers can boost asset prices with better alignment, and investors can choose how long they want to be a part of those portfolios.

In conclusion, private markets are likely to depict some of the same efficiencies seen in the public markets through the advent of security tokens and global private marketplaces.

Given the rapid changes we are seeing in the market coupled with the recent pandemic, MetaFinance is well-positioned to help private equity firms leverage the latest technology to raise capital digitally, manage investors & reporting while allowing for controlled liquidity. Contact us today to learn more.