Private equity in Spain: the challenges ahead

19 August 2003

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The Spanish private equity market has often been referred to as the â€˜eternal promiseâ€™, with industry insiders predicting an explosion of activity that never quite materialises. Recent times have indeed been challenging for the industry, with a number of salient factors accounting for the evolution of the Spanish market. Difficult economic conditions coupled with generalised geopolitical instability have brought widespread uncertainty; pressure on prices has created a situation where the whole process from fundraising through to transaction due diligence is taking far longer that was previously the case. GPs are more cautious and reluctant to invest unless they can see a clear route to exit - indeed several large pan-European houses are struggling to close their first deal in the country. Nevertheless the potential is clear: private equity currently represents only 0.18% of the countryâ€™s GDP, meaning that in order to be on a par with the UK, Spain would have to double its current level of investment. The Spanish market is as yet still relatively immature, having developed later than other European markets, and the industry remains fragmented and in need of consolidation. Whilst private equity is now better regarded than several years ago, it still suffers from something of a presentation problem. According to a senior partner at one of Madridâ€™s top law firms, private equity has no clearly defined image, and is still regarded with suspicion in some quarters. It is often seen as a â€˜last resortâ€™ to be considered when all other avenues of financing have been exhausted, as a third-rate option to be considered when the banks have said no. This lawyer is not alone in suggesting that Spainâ€™s private equity industry would benefit from a concerted public relations campaign, to educate both from the investor side and the business community at large.In addition to a lack of awareness about the industry, some cultural factors also come into play. Within the Spanish business community, there is a lingering element of prejudice against management buyouts. A senior dealdoer at a leading buyout firm comments that â€œmany Spanish managers consider themselves to be relatively well-off in comparison to their European counterparts, and are loath to jeopardise their top-of-the-range car, substantial house and swimming pool by taking what they see as a huge personal risk in the shape of private equity financingâ€. Furthermore, within the Spanish private equity world itself, there is also an element of ingrained prejudice against secondary buyouts. The secondary buyout market is small and incestuous, and remains less liquid than that of the UK. Often a private equity firm balks at buying from a competitor because it feels it may lose face in what it sees as a tacit admission that it should have spotted the original opportunity in the first place. A further factor to consider is Spainâ€™s economy, which has a largely industrial base and a high number of family-owned companies. There is a clear and long-standing reticence on the part of many family businesses to â€˜resortâ€™ to venture capital as a method of financing. This is in part explained by the tradition of succession, whereby businesses are automatically passed down from father to son, regardless of whether the next generation is either equipped for or willing to take on the task. The family can sometimes see the business as merely part of its heritage, and they can come to see growth as an option rather than a necessity. Long-established families may fear losing control of their company, which represents not only their material wealth but also their social status and self-worth. By allowing a private equity firm to â€˜interfereâ€™ in the business, their fear that these things will be taken away from them and all managerial decisions will be taken out of their hands. There is also a feeling that selling up is â€˜selling outâ€™. However, as small family-owned companies by their very nature have limited funds and limited access to capital, a buyout is often a good way to replace the second or third generation who actually has no interest in continuing the family business. Nevertheless, in spite of these economic and cultural factors, the outlook for the private equity industry in Spain is far from pessimistic, with many people talking of an early recovery. Despite the low percentage of the countryâ€™s GDP invested in the asset class, the industry is fast catching up with other European countries. The high number of family-run businesses creates a strong platform for the private equity houses. There are many opportunities for refinancing, to replace family members needing liquidity, as well as to dispose of non-core activities via a management buyout. In terms of the broader picture, macroeconomic indicators are strong and seem to be pointing towards a gradual recovery and continued growth. The economy is relatively dynamic, having been stabilised to comply with Euro integration, and inflation is controlled. Unemployment, which has traditionally been the countryâ€™s Achilles heel, is now down from 24% to 12% and the countryâ€™s economy is growing faster than its European peers. According to figures collated by the Spanish venture capital association, ASCRI, Spain was the seventh largest private equity market in Europe last year and saw a 23% rise in activity, which represents one of the fastest growth rates in Europe. It has grown by five times since the early 1990s, and since 1998, the Spanish market has increased by 50% compared to a figure of only 19% across the rest of Europe. During the first half of 2003, private equity has grown by 26% compared to the same period in 2002, with 183 investments carried out during this time. There has also been a notable increase in new firms, with a number of groups targeting the top end of the market. In addition, many foreign players and pan-European funds have set up office in Spain, including major debt players such as Bank of Scotland, which currently has the biggest leveraged team in the country. With many firms reporting healthy dealflow and no undue pressure to invest, there is a general feeling of optimism in the market that the worst is over and that good firms will continue to invest, with natural selection weeding out the weaker players in what is becoming an increasingly competitive market.