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The stage is set for private investment to drive recovery

By Jeffrey Stevenson, managing partner at private investment firm VSS – There are several reasons to be optimistic about 2021. Vaccines are starting to be made available and are expected to save lives, raising hopes that the US economy is poised to re-open next year. The US presidential election has largely been decided which has taken some uncertainty out of the markets. 

These positive developments have already helped stimulate the resurgence of private equity in the third quarter of 2020, when USD148 billion in transactions occurred that surpasses last year’s third quarter total by 10 percent, according to a new survey by Mergermarket and Dechert.

As investors in structured, “flexible,” capital, partnering with growing small and mid-sized businesses, we see the lower middle market as a primary source of new job creation meaningfully contributing to re-building the growth engine of the US economy at a challenging and critical time.

That said, America’s vast number of businesses are continuing to contend with the fallout from the pandemic. Many companies face challenging circumstances as the new year approaches, dealing with the inability to project revenue and earnings performance given disruptive market forces and brutal industry transformations. 

Riding out volatility

As we near the onset of a new year, there are signs that some of the volatility and uncertainty that shadowed much of the investment world in 2020 has leveled off. Equity markets, for example, rallied in November on news of the Coronavirus vaccines, helping to lift the Dow Jones Industrial Average by 11.8 percent, the S&P 500 to 10.8 percent and Nasdaq Composite to 11.8 percent for the month.

As for the credit markets, debt financing is back to pre-Covid-19 levels and frenzied competition between the banks and private credit providers in the deal market continues, positioning debt markets to become as frothy again as before the onset of the pandemic.

Meanwhile, those companies that have met the challenge from the pandemic head on have been those in the fortunate position to adapt quickly to new market demands, successfully converting their in-person business processes to virtual ones and leveraging new technology to their advantage.

We have seen similar adaptations during the Global Financial Crisis (2009-2011), although at different scales and in different ways. Helping growing companies in high-potential industries make that leap forward with the support of “flexible” private capital is where our focus will be again in 2021.

What markets, what solutions?

As public market capital dried up for many businesses over 2020, interest in flexible, private market solutions has dramatically increased and become a more prevalent financing option.  What we have found is that businesses, including those in the lower middle market, have been more willing to explore different private capital strategies to pursue growth. That is a trend we expect to see continue next year.

The year 2020 is perhaps the year that structured capital has gone mainstream, mainly due to the flexibility and growth it offers to shareholders and companies alike. That is compared to over a decade ago when few were familiar with its benefits, such as the flexibility and downside protection and equity upside structured capital can provide.  Today, many pension plans have structured capital as an allocation in their portfolios.

Founders and managers of small businesses have been naturally concerned about continuing to own and run their businesses throughout the pandemic. Rather than selling out in a low valuation environment, they have demonstrated strong interest in minority-stake preferred equity and non-control investments to maintain ownership and even accelerate growth.  These options allow business owners to participate in company growth and remain actively involved in management.

Looking ahead

To be certain, it will not all be smooth sailing in 2021 for businesses in certain sectors such as energy, retail, hospitality/tourism and airlines, with mounting pressure for industries to transform themselves, within a short time. But we expect companies in growth sectors such as healthcare services/IT, digital education, technology-enabled business services (Cloud, IoT, AI) and information (cybersecurity, business process outsourcing) to continue to demonstrate growth characteristics in 2021.

The need for almost everything remote – learning, working, managing, coupled with accessibility to online services from any location – is here to stay and will constantly evolve.

With USD1.7 trillion in dry powder, private equity is well capitalised to take advantage of new investment and realisation opportunities. While economic uncertainty will no doubt continue to influence public markets and M&A deal-making in the coming months, the stage is set for private investment to drive recovery and support corporate growth in 2021.

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