PE players seek opportunities in minority deals, differentiated strategies

Differentiation and flexibility have been of increasing importance for sponsors in winning deals and deploying capital in a crowded market in recent years. Sponsors that are able to offer a variety of deal structures and investment strategies, be it making minority investments or providing alternative liquidity solutions, have been able to diversify their origination streams and expand beyond traditional majority buyout processes, as documented by Unquote in the past.

But the array of complex opportunities currently arising from the coronavirus pandemic could bolster these managers further. One example of creative deal strategies is minority investing, which has proved popular in recent years. In 2020, 115 minority buyout deals were completed totalling almost €29.7bn, according to Unquote Data. This aggregate value is almost triple that of 2019, in which 125 such deals were recorded, and also surpassed both the deal volume and value recorded in 2018.

"Covid has made people feel a little more mortal, taking less for granted – they don't want all their eggs in one basket and are increasingly looking to diversify their wealth," says David Whileman, partner and head of Partnership Capital at Inflexion, of the current considerations on the minds of many entrepreneurs. "And we are seeing more interest from family businesses, where one generation may not want to pick things up from the last and the company can have greater opportunities to resolve this with an investor on board as a partner than not."

Inflexion makes minority investments via both its Partnership Capital and Enterprise strategies; the second vehicle in the Partnership Capital line, which focuses solely on minority deals, held a final close in May 2018 on £1bn, while Inflexion Enterprise Fund V held a final close in April 2019 on its hard-cap of £400m. In March alone, the GP inked three minority deals, for The Goat Agency, CMS Payments Intelligence and Systal.

In addition to boosting the appeal of minority transactions, the crisis arising from the pandemic has presented unique challenges for GPs, as well as their existing and potential future portfolio companies, in turn creating opportunities for differentiated players able to offer tailored liquidity solutions to these situations, says Paul Newsome, partner and head of investment solutions for private equity at Unigestion. "GPs are willing to discuss different solutions to create a win-win situation: their companies get growth capital or support, and we can come in on attractive terms."

Unigestion manages a range of private equity strategies, but its Direct Opportunities strategy (that sees the GP currently deploying from Unigestion Direct II, which is on the road with a target of €600m) makes investments in small-cap and mid-market businesses alongside fund managers with which it has an existing relationship.

"It is a reflection of the maturity of the market that there are a lot of innovative tools and ways of investing in attractive companies now, be it secondaries, co-investment or direct," says Newsome. "That is a big difference between this crisis and the global financial crash (GFC) – in the GFC, the market was relatively traditional, and there were fewer options."

Specialising and network-building
Sponsors are likely to need specific vehicles and networks in order to gain access to these less straightforward deals, says Newsome, since GPs in need of additional investor input would generally rather not bring in parties whom they regard as external investors. "We are seen as friendly investors – external investors might be strategically misaligned with them, whereas we can be very much aligned with our GPs. As long as we have sufficient oversight, and sufficient minority controls in place, these can be very attractive deals."

Minority investing also requires specialist skills, especially when it comes to the relationships with the businesses themselves, since these deals tend to be proprietary and not structured as a typical sale process, says Whileman. "These are businesses that are not for sale, so there is a whole menu of characteristics from an investor that owners are looking for. They want to know what value you can bring, how you support in both the good times as well as the bad, including throughout Covid-19. Are you a true minority investor or is there going to be fine print? It's not all about being the highest bidder, there are a whole range of aspects including reputation, value add and, most importantly, chemistry. This will always be a process that is more discrete and interactive than selling a business."

Inflexion is not alone in that, of course – a number of other sponsors also have specialist funds that enable them to take advantage of opportunities that might not fit with typical fund structures or the remit of their flagship funds. Blackstone, for instance, is currently investing from the third-generation vehicle in its Tactical Opportunities strategy. The fund held a final close in June 2019 on more than $4bn. The vehicle provides opportunistic capital with the aim of making timely investment decisions when such opportunities arise, unconstrained by geography or asset class, with the aim of providing a diversified strategy for its LPs.

Qasim Abbas, senior managing director with Blackstone's Tactical Opportunities Group, sees significant opportunities for the strategy in the current market. "The changed circumstances brought about by the pandemic have had a significant impact on the investment environment. Tactical Opportunities' scale and flexibility mean that we can offer creative deal structures that are in demand now."

"These flexible solutions, which we've deployed in Europe since 2013, are today relevant to an even broader range of businesses," adds Abbas. "Our recent investments in NIBC, Ki-Insurance and HH Global are just some examples of where our structural creativity and flexible capital are differentiated in the market."

Win-win
Another area that is expected to continue creating interesting investment opportunities for some GPs – and LPs too, when looking at the ongoing success of continuation vehicles and single-asset secondaries – is private equity's appetite for supporting businesses beyond the traditional five-year horizon. As reported, 36% of GPs who told Dechert's 2021 Global Private Equity Outlook survey that they generally retain a minority stake when exiting an investment, 50% said that their targeting of minority investments, including retaining a stake on exit, had increased in 2020. Making lower-risk investments or diversifying risk was cited as a motivation for this by 32% of these GPs, while 24% said such arrangements can be attractive to founders who are resisting a control investment.

One firm that has a strategy centred on this is TA Associates. The GP launched its first TA Select Opportunities Fund in October 2019. The vehicle is designed to allow the GP to invest in companies that it already owns but is partially exiting, allowing TA to continue to benefit from the growth of its portfolio companies while also reaping returns for LPs backing its its flagship strategy.

However, many GPs do not have strategies through which they can retain a stake on exit or provide additional capital, creating situations that bring opportunities for Unigestion's Direct strategy. "One line of opportunities coming out of this environment is the increasing number of situations where companies that are already in the portfolios of GPs we know require more capital, to benefit from growth opportunities, add-ons or expansion into new markets," says Newsome. "The GPs are sometimes tapped out in terms of fund dry powder or portfolio concentration. So we see minority opportunities where we can almost put in preferred equity on attractive terms to support the growth."

Whileman says this has been a source of dealflow for Inflexion's minority team, especially given the appetite for extra input from a like-minded GP: "Another source of opportunities has been other PE houses who want to continue with their successful companies but take some money off the table and bring in an investor with a complementary skill set."

Looking ahead, Whileman expects that dealflow for Inflexion's minority strategy will continue to increase, as will the strength of the minority investing market as a whole. "I believe minority deal activity will increase – partly due to people being more aware of them, partly since Covid-19 has made us all feel differently, and also because a number of institutions such as ours have developed a good reputation as a minority investor. People are willing to get references and test people around their value-add. The more collaborative success stories we and others have, the more it will encourage that momentum."

As established managers increasingly look for ways to diversify fee income streams with additional funds, and newcomers are urged to offer differentiated strategies to stand out from more generalist buyout funds in the eye of LPs, it stands to reason that such opportunities will increasingly be met by capital ready to be deployed.

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