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Deloitte believes the private equity industry may be entering a new phase of growth. To shed more light on how this shifting environment may affect the industry, Deloitte created a tri-scenario asset-based growth model that spans the next five years. Deloitte’s estimates for industry growth, which include its perspective on both valuation levels and how we see dry powder increasing, will be detailed in their upcoming report entitled “Private equity growth in transition: Evolve to meet tomorrow’s challenges”
Rising asset levels are only one part of private equity growth, however. In a slower market environment, firms will want to focus on growing profitability through restructuring and operational efficiencies as opposed to front office deal-making. To support this transition, Deloitte recommends in its report that managers consider the rising importance of three broad areas that relate to the growth and profitability of the private equity firm and its portfolio: the need to create robust internal controls and processes; a growing focus on value creation and operational excellence of portfolio companies; and the use of technology to enable tax transformation.
Of these three areas, which the report covers in greater depth, the processes around internal controls are receiving the most external attention. Transparency requirements by regulators and investors alike are creating the need for firms to take a closer look at how internal controls are set up, documented, and communicated to members of the firm and its portfolio companies. Well-documented controls, coupled with a strong training program, are key to having operational issues appropriately handled, while preventing deal-makers from being distracted by them.
The heightened focus on transparency also extends to fund marketing and valuation. In recent years the Securities and Exchange Commission has shown more interest in the marketing of private equity funds and the valuations used in the performance calculations, and advises that marketing will continue to be a risk area. To help manage this potential conflict of interest—and pass regulatory reviews—private equity firms need to establish clear controls, and ensure separation from any potential valuation conflict related to marketing or performance reporting.
These types of challenges illustrate the growing complexity of the private equity marketplace, a trend to be seen escalating over the next few years. While Deloitte anticipates private equity to remain attractive to investors, based on its outperformance versus standard benchmarks as calculated by Preqin, Ltd., balancing a firm’s objectives of funding growth and lowering costs may become a focal point of the new normal. In this light, initial outlays may be required to support technology, infrastructure, and operational improvements, even amid rising cost pressures. Yet, private equity firms that actively embrace this opportunity may be more effectively positioned for the future.
Full report (subscription required)