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Is Private Equity Getting Overheated?

Adam Gale
Partner, BakerHostetler

Private equity has had a stellar run for the past 20 years. PE assets under management total more than $2.8 trillion, with nearly half of it in buyout funds, according to Consultancy.uk.

At the same time, deal multiples, leverage ratios and the amount of uninvested capital in the private equity industry is at historic highs, according to a report published by the Boston Consulting Group (BCG). All this may indicate an industry that is overheated, overcrowded and that there is too much capital chasing too few investment-worthy assets.

PitchBook’s latest U.S. PE Breakdown shows that the amount of new cash raised by PE firms in 2018 was “on pace for a six-year low.” The slowdown isn’t limited to the U.S. According to Livemint, PE investments in India fell by roughly 29% in the first six months of the year, while the number of deals was cut in half during the same period.

“I think we’re now in bubble territory,” Frode Strand-Nielsen, founder of Nordic private equity firm FSN Capital, told Reuters earlier this year. He said rising interest rates were the biggest concern at this point, as the industry has relied on cheap debt for much of the past decade. He believes a noticeable uptick in financial engineering indicates the industry should be bracing for a tough few years ahead.

However, not everyone is as pessimistic as Strand-Nielsen. Boston Consulting Group says there’s enough room for PE firms to continue growth. However, these firms will need to reinvent their value generation strategy to survive a market correction in the foreseeable future. According to the BCG team, PE firms must “rethink organization design, double down on digital technology, and revamp their approach to talent.”

Disruptive Technologies

For many family offices and private equity investors, doubling down on technology means chasing cutting-edge disruptive technologies. Perhaps the most disruptive of these in recent years has been blockchain technology. Interest in the nascent technology that powers Bitcoin is continuing to grow, although firms are increasingly looking at ways distributed ledger technology will disrupt fund raising and investments, rather than direct investments in cryptocurrencies.

The tokenization of assets will have an impact on the private equity industry, according to Adam Gale, a seasoned attorney who recently joined BakerHostetler as a partner and co-leader of the firm’s investment funds team. “I think there is a movement toward security token offerings, which unlike most initial coin offerings, are designed to give the holder an interest in the equity of the issuer, and are designed with an affirmative intent to be classified as securities under U.S. securities laws,” Gale told MarketCurrents. He believes there is still interest in cryptocurrency funds, though not at quite the same pace as earlier this year.

Initial coin offerings (ICOs), cryptocurrencies and tokenized assets were also a major part of the discussions at this year’s Aternative Investment Management (AIM) Summit in Dubai. The largest alternative asset investment event in the Middle East and North Africa region devoted half of its two-day schedule to blockchain technology and emerging crypto regulations.

The rise of a new asset class indicates an expanding market for private investment. With more assets, more wealth and more startups being created across the world, the outlook for PE firms and family offices remains bright. However, a near-term correction cannot be ruled out. Firms that want to survive the next cycle must invest in better technology for operational efficiency, attract the right talent, and be open to unconventional assets and investment opportunities.

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