Top 5 Private Equity Trends In 2022

Sean Mooney:
Welcome to the Karma School of Business podcast. This episode is brought to you today by BluWave. I'm Sean Mooney, BluWave's founder and CEO. BluWave is the go-to expert of those with expertise. BluWave connects proactive business builders, including more than 500 of the world's leading private equity firms to the very best service providers for their critical, variable, on point and on time business needs. In this episode, we're going to discuss the top five trends in private equity in 2022. Enjoy.

Today we're talking about the top five trends that impacted the private equity industry in 2022. Let's jump straight to it. The first big trend in 2022 is what I'm calling running towards the storm. The private equity industry does its best when times are worst. The data on this is very clear. The reason they do well is that, unlike the VC industry that structurally almost plans on losing money seven out of 10 times, because they make a ton of money on a few deals, the PE industry makes relatively less money on each deal. So pretty much every deal has to be successful. So when times are tough, the PE industry runs towards their companies with resources because they can't afford to lose money on any single deal because they won't be able to make it up.

BluWave has been equipping the PE firms with a wide variety of resources all year as they've been running towards their companies in this economic storm that's been underway all year. So we got a pretty good sense for what's going on in the PE industry with front row seats. The PE industry has been taking on inflation with pricing strategy groups and procurement advisors. They've been addressing labor supply issues with organizational effectiveness advisors, recruiters, and interim executives. They've been proactively resetting their debt agreements and maximizing liquidity at their portfolio companies. They're getting data to make agile decisions. As we talk with our clients, pretty much all of them will tell you that they've already battened down the hatches of their businesses, and they're ready to go if when a full blown recession occurs. Every single company, whether you're PE backed or not, can and should do the same. But you need to start now with urgency if you haven't already.

The next trend in 2022 in the PE world is the rise of human capital. Given that the private equity industry is so competitive now, they have to transform their companies versus optimize them like my earlier days as a private equity investor. Transforming requires lots of new and enhanced skill sets. So the historically linear logical PE industry has been immersing itself in the art of humanity. The hottest hire in all of private equity industry right now is the head of human capital at a PE firm. Usage of human capital in the BluWave Activity Index, which tracks PE firm activity of VR proprietary project data has increased from 17% of all activity in Q1 2018 to approximately 40% of all projects today. During the last 60 days, 45% of all PE projects in the BluWave activity index were related to human capital. That's a staggering amount, and contrary to what most people think is going on in the real world.

The third big trend in the private equity world in 2022 is digitization and data. Digital transformation has always been like the nation of Brazil. The next big thing, always has been, always will be. COVID has actually catalyzed digital transformation and gotten it over the top. This year we've seen surging demand for software strategy firms, system selection firms, and data and analytics resources. I'd say PE is probably somewhat in catch up mode as it relates to their tech peers, but the level of buy-in and PE is increasing exponentially. This year was in many ways about the basics of getting ready to do more. So we've seen a lot of work rent updating foundational systems like ERP systems, adding data visualization capabilities, et cetera. Next year I think we'll see movement towards AI and deeper analytics in PE. The tech focus firms are already on top of this. Now we're seeing the more traditional economy investors catching up.

The fourth big trend in the private equity world is ESG. Which stands for environmental, social and governance. Virtually every PE firm that hopes to fundraise, particularly from family offices and European LPs are expected to have ESG programs in place today. In full candor, I'd say this remains a somewhat polarizing topic in private equity. Namely because a number of people in PE, not entirely unfairly, view their jobs as being builders of businesses while being ethical and adhering to established law, but not necessarily that they need to put gardens on the top of all their buildings that haven't said much of. PE has actually been following ESG for quite some time. It's been much easier and more natural for large cap PE to embrace ESG, because their large companies were often already doing much of it under the umbrella of what was called CSR, or corporate social responsibility.

Large cap PE also has much larger companies that have greater infrastructure, that have been able to capture the data required to follow ESG. The data capture is reasonably complicated, quite nuanced, and labor intensive. What we're seeing this year is a somewhat fast and rapid adoption in the middle market. In lower middle market. We're seeing relatively broad adoption because my sense is that the middle and lower middle market firms are taking a look at what ESG is and realizing they're already doing a lot of it, but they haven't been capturing it under the scaffolding of this new framework. In particular, I think every PE firm can and is getting behind a number of the core tenants of ESG that are true win/wins, and so let's think about that.

First, within environmental, every PE firm, every company can and does get behind the idea that they need to reduce energy usage and reduced waste in production processes. That's a total win/win. From a social perspective, every PE firm truly gets the idea that an engaged employee is a productive employee. Low turnover is better for ROIs. Workplace safety is good business. All of these things are absolutely in line with the fundamental goals of PE in the first place.

Next, if you think about governance, every PE firm now and increasingly understands diversity at the board level is strategically valuable and creates ROI. There's been endless studies now, whether it's McKinsey or others that have demonstrated this. Private equity people are data people and the data is quite clear on this.

The next thing that every PE firm can get behind is the notion of having strong accounting standards. That's been PE 101 for the history of PE. First thing they do is check the numbers, and if they're not absolutely exceptional they take strong action to make sure that they are from day one.

Lastly, within the construct of governance is the concept of strong business ethics. The PE industry 100% understands that good business ethics is the long game. That's where you're going to drive value. If you don't have good business ethics, it's going to be a path disaster. Remember, PE firms can never afford to lose money, and so they're not going to take risks on things like business ethics, because it could cause damage to the entirety of their fund and their livelihoods. So ESG is here to stay. The key for it to be a real thing is to find the broccoli with cheese on it opportunities, where it's good tasting and good for the world and good for ROI. Those aren't mutually exclusive things for many, many things. ESG is going to be a fundamental piece of private equity for the days to come.

The last major trend impacting private equity in 2022 is fundraising. Fundraising in 2022 has been a land of haves and have nots, and a battle of the denominator effect this year. According to PitchBook, about 347 billion has been raised in PE through year to date September, which is slightly below the three year pre-COVID average. What's interesting is that just 13 funds accounted for 48% of this capital. The fund count as successful fundraisers this year as decreased by more than 50% from historic norms. What this means is that the mega funds are absorbing the bulk of LP dry powder. The middle market firms, which historically have been the generators of the best returns in PE, have really suffered in this fundraising market. The larger cap firms are benefiting from their scale, perceived relative safety in turbulent times and branding. Going forward, I think the winners in PE fundraising will be those that can demonstrate distinction in the marketplace. We think the winners in PE will be those who look at diligence through the lens of informing value creation. Those that take a proactive approach to building value after investments are made. PE firms that run their management companies like they would run a portfolio company, and maybe less like a partnership, and those that embrace ESG, which is here to stay and creates a lot of value.

In the spring, we issue an award called Top PE Innovators that recognizes PE firms that are on the cutting edges along these lines. Stay tuned for February 2023 to see which firms are leading the way.

That's all we have for today. In our next episode we'll be discussing our top five predictions for 2023. Always a dangerous proposition. Thank you for joining us. For more information, go to BluWave, B-L-U-W-A-V-E.net/podcast. Please continue to look for us anywhere you find your favorite podcasts, including Apple, Google, and Spotify. We truly appreciate your support. If you like what you hear, please subscribe, review, and share. In the meantime, let us know if there's anything we can do to support your success. Onward.

Private equity insights for and with top business builders, including investors, operators, executives and industry thought leaders. The Karma School of Business Podcast goes behind the scenes of PE, talking about business best practices and real-time industry trends. You'll learn from leading professionals and visionary business executives who will help you take action and enhance your life, whether you’re at a PE firm, a portco or a private or public company.

BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs.