NextWave Private Equity

In this episode, Karim Anani and Alex Zuluaga, EY Global SPAC Practice Co-Leaders, explore why SPACs attract PE investors and advise how they should manage SPAC transactions.

Contact Karim: [email protected] Contact Alex: [email protected]

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Special Purpose Acquisition Companies (SPACs) are rapidly evolving from an interesting option to a desired path of taking a company public. This malleable vehicle is becoming better understood, more widely accepted and is proving to be a highly adaptable way to meet the needs of both operating companies and investors. A key factor in this flexibility is because a SPAC transaction is a merger, not an IPO.

Unlike a traditional PE fund vehicle in which a fund invests in multiple companies, a SPAC will instead effectuate a single transaction. As a result, a PE fund's investment philosophy, strategy and approach for a SPAC differs from its traditional investment model.

A SPAC appeals to private equity (PE) investors for several reasons:

• Speed at which capital can be raised
• Opportunity to expedite entry to public market
• Ability to tell the story with the aid of future projected earnings of the company
• Opportunity to explore a different investment thesis
• Potential for significant upside as SPAC sponsor
• Definition of minimum cash and financing structuring options on the front end create a lower risk of deals falling apart

PE funds interested in utilizing a SPAC as an exit vehicle should consider the following recommendations:

• Define transaction goals and value drivers
• Choose a SPAC that aligns with the industry of operating company
• "Get your house in order" to be more attractive for a SPAC exit
• Attend to backward-looking compliance procedures
• Ensure company is able to function like a public company from an operational and talent standpoint
• Anticipate the regulatory and compliance landscape to continue evolving

Sally Jones, EY UK Trade Strategy and Brexit Leader, recaps the current state of Brexit and advises PE executives how to navigate the transition.

Contact Sally: [email protected]

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The Brexit deal released at the eleventh hour of 2020 caught many businesses off-guard. According to research by UK in a Changing Europe, the economic impact of Brexit is projected to have twice the impact of the COVID-19 pandemic on the UK economy.

The path forward for service-based business remains especially uncertain. Services have become potentially unlawful to provide, as member state regulation, movements of people, and dataflows between the UK and Europe are either unclear or restricted. Questions service providers must now ask themselves include:

• Am I lawfully allowed to provide my services?
• Can I travel to my client to deliver my services?
• Can I legally deliver my services remotely?

Many private equity (PE) investors had already assumed a no-deal Brexit, choosing to pre-emptively migrate business operations from the UK to Europe so they could avoid disruption as Brexit negotiations progressed.

Foreign direct investment (FDI) into the UK fell to near zero in 2020, as wary investors allocated capital to other markets in which they had more confidence. It is possible the retrospective elements of the UK National Securities and Investments Bill and the resulting uncertainty and risk it creates for investors could be damaging to UK attractiveness. The US has now eclipsed the UK as the #1 most attractive G7 nation for investment.

Over the coming months, as the immediate disruption ends, PE investors will have a better idea of how to resize and reshape investments and operations as the "lay of the land" emerges in the UK.

PE firms must monitor how their portfolio companies are trading, as value can erode quickly.

Portfolio companies can employ five tactics to navigate post-Brexit uncertainty:

1. Create a response team that includes senior decision-makers
2. Communicate transparently and frequently to all stakeholders
3. Monitor rapid changes to legalities around dataflow between the UK and EU
4. Anticipate cost increases and decide whether to absorb them or pass them to customers or suppliers
5. Understand new regulations as quickly as possible

Andres Saenz, EY Global Private Equity Leader, explores three hypothetical future scenarios and how they impact PE's right-to-win in 5-10 years.

Visit ey.com to read our NextWave Private Equity report.

The future for private equity (PE) is going to look very different in the coming years. New technology, tighter regulation, retail investor empowerment, growing digitalization and increased competition are set to impact heavily on how the PE industry functions. To bring these impacts to life, we explore three hypothetical scenarios for PE in this new landscape.

"Democratization of investing"

Retail investors (investing relatively small sums) can participate in the PE universe in a way they have never been able to before. New PE fund structures combine with online trading apps and brokerage platforms to allow ordinary investors access to the same functionality previously reserved for pensions, endowments and foundations.

"First artificial intelligence fund raises over US$20b"

A PE firm competes with top Silicon Valley names for talent and resources to build the first fund driven entirely by artificial intelligence (AI) and data analytics. Pulling data from thousands of disparate sources, the fund algorithmically originates deal ideas, monitors portfolio companies and charts an optimal path for exit.

"A private equity firm becomes the world's largest employer"

While this represents great success for the PE sector, it also increases levels of responsibility. Regulatory bodies scrutinize more heavily the duty of care that PE firms have to their employees, portfolio companies and the general public.

PE firms must begin to think now about how they will thrive in a future in which these scenarios are playing out in real time. Acquiescing to a lagging position is not an option for PE if they want to remain competitive in 5-10 years as the industry landscape and right-to-win continues to evolve.

Andres Saenz, EY Global Private Equity Leader, explains why PE must aspire to a long-term value (LTV) strategy if they want to thrive in the NextWave of private equity.

Visit ey.com to read our NextWave Private Equity report

EY NextWave is a global strategy and ambition to deliver long-term value to EY clients, EY people and society at large. The NextWave Private Equity vision represents the EY organization's perspective on the most powerful trends and forces shaping the private equity industry's future. It explores how drivers such as value creation, purpose and transparency, digital and talent are driving magnanimous change across the global PE landscape

While PE is a relatively young industry, it has grown quickly, matured immensely and is now at an inflection point. Preqin is anticipating an impressive 15% CAGR in AUM over the next five years, a trajectory that requires PE to remain competitive while simultaneously experiencing tremendous growth.

The long-term value (LTV) narrative in PE is shifting from "we contribute to society because we are successful and then give back" to "we are successful because we create shared value with society." While LTV remains an aspirational goal, leading firms have already started moving in this direction because they view it as both inevitable and non-optional.

Four key drivers of the shift to LTV include:

• Demand from investors and resulting competition for capital
• Regulatory scrutiny threatening PE's license to operate
• Competition for deals involving discerning entrepreneurs
• Talent landscape that seeks alignment of values

There are five stages of an LTV journey for PE firms:

1. Compliance: establish compliance with initiatives, regulations and LP agreements
2. Risk management: ESG is used as a tool to manage non-financial risks during the investment life cycle
3. Opportunity-seeking: use ESG and LTV to identify opportunities for value creation during the entire investment life cycle
4. Impact-focused: selected portfolio companies create value to increase the bottom line. Active ownership seeks to adapt or transform the portfolio and deliver superior returns
5. Long-term value: find comparable and meaningful ways to measure and articulate strategic value creation for stakeholders

Jeff Vogel, EY-Parthenon US Managing Director and Head of the Software Strategy Group, joins Winna Brown to explore the complexities and key trends shaping the software deal landscape.

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The "software economy" is comprised of companies that sell or license software as well as software-enabled business services companies that differentiate themselves on the basis of their software.

Because a software asset is especially complex to valuate and diligence, PE firms and the advisors who serve them have transformed their talent strategy to attract a wide spectrum of operational experts ranging from serial CTOs to young entrepreneurs. A passion for technology combined with partnering experienced executives with curious young talent helps teams remain agile and responsive to rapid change.

A software asset is different from a traditional asset for three important reasons:

• Markets are amorphous and difficult to size.
• Revenue potential and gross margins are high; however, R&D expenditure is also high because the product is must constantly evolve to stay competitive.
• Technical debt, unlike traditional debt, is difficult to quantify and does not appear on a balance sheet, so a PE investor may unwittingly sign up for obligations requiring significant capex.

Five trends shaping the PE/software deal landscape:

• Role of PE: PE is shaping the software landscape by providing access to capital and focusing on building companies.
• Long-term value: PE is increasingly prepared to hold software assets for longer and are therefore optimizing for LTV.
• Growth: high valuations require PE to underwrite for growth, not solely for cash flow.
• Hybrid deals: PE firms that were traditionally majority stakeholders are now considering minority stakes.
• PIPE deals: private investment in public equity (PIPE) deals are leading to cross-fertilization in management and strategy between public and privately held companies.

Jerry Whelan, EY Private Equity Tax Technical Leader, and Ray Beeman, Co-head of the EY Washington Council, join Winna Brown to discuss the top five critical areas to which PE executives must pay attention:

1. Tax and regulatory
2. Incentives
3. Deal activity
4. Opportunity landscape (domestic and cross-border)
5. Sector big bets

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This podcast was recorded on 20 November, 2020 and assumes there will be a divided government scenario in the US with a Biden Administration and Republican-controlled Senate.

The results of the US election have enormous implications for all industries, and private equity (PE) is no exception. While there is anticipation of a return to a conventional approach to governing, it's critical for PE to remain agile and anticipate pendulum swings in government policy that will require agility and robust scenario planning.

It's critical for PE executives to track the following dynamics:

• Whether legislative issues such as stimulus, onshoring supply chains and infrastructure will gain bipartisan momentum
• Whether and how priority initiatives will be funded with proposed tax changes
• Impact of regulatory and enforcement changes on sector and deal flow
• Modeling tax variables, including sunsetting provisions that may increase cash tax
• A gradual shift in tone toward global trade and multilateral agreements and initiatives

Our speakers call on PE to adopt ESG and buy in to a broader long-term value strategy.

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A company's primary purpose is no longer simply enhancing and protecting value for shareholders through short-term profits, it is also delivering long-term value (LTV) to all stakeholders. Private equity (PE) has taken a keen interest in this expanded definition of value in the face of investor, employee and societal interest in conscious capitalism and ESG. The outdated "do no harm" mantra is rapidly being replaced with a business imperative to "do good."

In this shift from shareholder to stakeholder capitalism, the biggest challenge is moving beyond public relations talking points and truly integrating ESG into an organization. Organizations that anchor themselves to a meaningful purpose are better positioned to benefit from, demonstrate and measure the value they create and reap both financial and non-financial rewards.

For PE, developing and executing against a compelling purpose-driven, stakeholder-focused strategy incorporates employee experience, customer value proposition, supply chain management, capital allocation decisions and leadership incentives.

ESG skeptics need only look at the facts to be convinced to act:

• One in four investment dollars is now flowing into ESG funds: not only is that number growing exponentially, there is competition for those investment dollars.
• There is a massive transfer of wealth occurring from boomers to millennials, who have very different values and expectations.
• There is frequently a lower cost of capital for companies with better ESG scores.
• During the initial market selloff after the COVID-19 pandemic, funds that had an ESG focus experienced lower volatility and faster recovery than non-ESG funds.

PE firms starting their ESG journey can use the following framework:

• Now – understand the core ESG issues that are important to your firm and your key stakeholders.
• Next – report transparently on ESG issues, metrics, goals, and management tactics.
• Beyond – leverage what you learned and gained by integrating ESG into your business and articulating how it creates LTV for you and your stakeholders.

Josh Lewsey, EY-Parthenon Strategy & Transactions Partner, and John Levack, Vice Chairman, Hong Kong Venture Capital and Private Equity Association, join Winna Brown to help private equity investors understand how new regulations will impact the current and future private equity ecosystem in APAC.

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The global trade environment has increased geopolitical uncertainty, making forecasting difficult. The Organisation for Economic Co-operation and Development (OECD) is predicting 2020 will see a 4% global contraction in GDP with only one G20 country having a positive GDP: China.

It is possible that a bifurcation between US/Europe and Asia of both markets and products will occur as a result of politics rather than consumer requirements. This combined with the region's growth potential and faster post-pandemic recovery can potentially result in Asia as a more promising market in which to deploy private capital.

Hong Kong is the biggest cross-border center for private equity (PE) in Asia. While the National Securities Law in Hong Kong has caused significant discussion, the impact on Hong Kong-based PE firms has been nominal: this is because China is already a major investment market for these firms and anyone investing in China is already subject to the Chinese national security law, which is quite similar.

The Hong Kong Government recently passed the following three landmark laws that solidify Hong Kong as an ideal base for private equity operations:

1. Unified Fund Exemption Regime: extends the profits tax exemption to all funds, whether or not the fund's central management and control is exercised in Hong Kong.
2. New Limited Partnership Fund Law: allows a limited partnership to be set up in Hong Kong so a PE fund vehicle can be based there.
3. New concessionary tax rate on carried interest starting in 2020.

Over the next three to five years, PE in Asia-Pacific (APAC) will see:

• Fee pressures and low yields in developed markets will push more capital allocation to APAC.
• Funds that drive sustainable returns through operational value creation and prioritize ESG will emerge as market leaders.
• Bifurcation of funds into financial conglomerates and small specialist funds.
• Minority stakes in local SME companies coming to market as new generations explore exit opportunities.
• An influx of capital from pension (defined contribution) investors will increase dry powder and exacerbate the challenge of deploying it successfully and responsibly.

Josh Lewsey, EY-Parthenon Strategy & Transactions Partner, and John Levack, Vice Chairman, Hong Kong Venture Capital and Private Equity Association, join Winna Brown to help private equity investors understand how to navigate and set expectations in APAC.

Visit ey.com to read our latest private equity perspectives.

It's an exciting time for private equity (PE) in Asia-Pacific (APAC). According to Preqin, AUM for buyout funds focused on Asia have more than quadrupled over the last 10 years and firms now have more than USD $260b in AUM. They also have almost US$100b in dry powder available for deals. Taking a larger view, when we include some of the other private capital asset classes such as growth capital, venture, and infrastructure, PE firms focused on Asia have US$1.6t in AUM.

With 4.3 billion people and a blossoming middle class, the positive growth we are seeing in APAC is a contrast to slowdowns in the US and Europe. As a result, PE investors are eager to put capital to work in the region using the LBO strategies and playbooks that have proven successful in the US and Europe. This can be problematic for several reasons:

• Because the region is dominated by small and mid-size enterprises (SME), 70%-80% of PE deals are minority investments.
• PE is often in an influential (not controlling) position, with limited ability to dictate changes in management.
• It's difficult to find and execute a viable LBO deal due to a cultural perceptions that associate selling a business with a failure of its management.
• APAC is a fragmented market with multiple languages, cultures, legal jurisdictions and working customs.
• The region has not always been open to foreign capital, and while this is changing, legal and regulatory requirements in a fragmented market demand local expertise.

Six ways PE investors can adapt to APAC:

• Choose businesses with capable, collaborative management in addition to competitive advantage and growth potential.
• Realize your ability to use leverage is dramatically reduced.
• Prepare to influence and support rather than dictate by demonstrating how your expertise and operational value creation is accretive to the business.
• Consider walking away from attractive deals in which PE and management are fundamentally misaligned.
• Avoid an ethnocentric, "colonial" approach: instead, lead with empathy and confidence in local talent.
• Present operational value creation and ESG as positive value accretion methods that improve the quality of a business.

Jeff Woods, EY-Parthenon US Co-Head of Healthcare, joins Winna Brown to explain why PE should remain optimistic about investing in the healthcare sector despite the short-term detriment of COVID-19.

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The assumption that the healthcare sector is "recession proof" has been debunked as the pandemic usurped traditional assumptions among both patients and investors. Now, there is heightened awareness of how patients access (or don't access) the healthcare system after utilization plunged nearly 20%. According to EY-Parthenon research, 10% of Americans have decided not to access the healthcare system for the rest of 2020 or until a viable vaccine is available.

Despite the short-term impact of the pandemic, PE investors have been encouraged by recent return to volumes and are more optimistic now than they were in the spring.

The US payer mix is unique in a global landscape of government-sponsored healthcare systems. While there has not been a strong shift in favor of universal healthcare in the US, there has been a secular shift in healthcare expenditure from commercial to government that has accelerated due to rising unemployment caused by the pandemic. While the US healthcare market is ripe for efficiency gains, private equity (PE) can drive innovation in any healthcare market, regardless of the payer mix.

Shifting patient behaviors and preferences are accelerating experience-led transformation and inspiring an increasingly patient-centric approach, creating opportunities for PE to drive innovation and improve patient experiences.

The healthcare/technology deal environment continues to be very active. The pandemic has impacted the deal lifecycle in several ways, including valuations and timeline to exit. In addition, PE has looked to deploy digital across the portfolio to address access, engagement, navigation, care transitions, cost management and staffing.

Summary of the PE/healthcare landscape over the next three to five years:

• Deal landscape remains very strong and is expected to recover to pre-COVID levels
• 2020 deal volume will be down 15-20% from 2019 but the worst is over
• Providers will be the largest deal category and healthcare/technology deals will be the second largest
• Private capital remains the fastest way to innovate
• The healthcare sector will no longer be thought of as "recession proof"