NextWave Private Equity

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. Visit ey.com to read our latest private equity perspectives. 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: Tax and regulatory Incentives Deal activity Opportunity landscape (domestic and cross-border) Sector big bets Visit ey.com to read our latest private equity perspectives. 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. Visit ey.com to read our latest private equity perspectives. 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. Visit ey.com to read our latest private equity perspectives. 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: 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. 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. 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. Visit ey.com to read our latest private equity perspectives. 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”

Jon Shames, Senior Partner and Leader of the EY Geostrategic Business Group, joins Winna Brown to explore why PE must embed geostrategy in both deal lifecycle and organizational culture to recognize unique opportunities and drive investment decisions. Visit ey.com to read our latest private equity perspectives. The geopolitical landscape is shaped by four disruptive forces: globalization, technology, demographics and the environment. Private equity firms need geostrategy to manage a shifting political environment with the objective of finding opportunity amid geopolitical risk. It is necessary to develop a culture in which these considerations are explored, resourced and incorporated into all steps of deal flow, ESG and LP relationships. A geostrategy is a powerful way for private equity firms to differentiate themselves and win in the market. Some PE funds have a more sophisticated and proactive approach to geostrategy while others are more reactive and ad-hoc: whatever the chosen approach, there is ample room for PE to further embed geostrategy into investment committee decisions. Geopolitics shouldn’t just be about risk and worrying about the downside: it should be about driving the investment strategy from a proactive, informed perspective that yields unique opportunities that may not have otherwise been considered. It’s also about making sure a deal makes sense given the complexity of risk in the current geopolitical and broader ESG environment.  A successful geostrategic framework should follow: Scan: establish and maintain the ability to identify, monitor and assess political risk. Focus: evaluate the impact on key performance indicators, mapping the political environment to the company footprint. Act: develop a portfolio of robust geopolitical risk management instruments and build a growth-oriented geostrategy. Five key geostrategic practices PE executives can adopt: Political risk is here to stay and is increasingly more complex. Firms need to refine their philosophical and organizational perspective. PE firms must embed geostrategy into every stage of the deal lifecycle from origination to exit. Consider developing a geostrategic center of excellence (COE) that empowers executives to move beyond risk identification to opportunity assessment. Geostrategy is more than a “check the box” compliance exercise: it should be integral to a firm’s investment decision process, incorporated into ESG and culturally valued.

Sean Epstein, Senior Vice President and Global Head of SAP Private Equity & Mergers and Acquisition Programs, and Marc Noë, a Managing Director in the EY Digital practice, join Winna Brown to discuss how customer experience is driving digital transformation in private equity. Visit ey.com to read our latest private equity perspectives. “Digital” drives enhanced experiences for customers. And while many people talk about digital in terms of technologies, the most important (and difficult) aspect of digital is adopting new ways of working in areas such as product orientation, design thinking and customer experience. Finding the right technology fit across the PE portfolio can be daunting, but the pandemic is inspiring PE firms to question the more fundamental processes of buying, making and selling: How can digital help us identify synergies in procurement across the portfolio so we can leverage our aggregate buying power to drive cost reductions? How can digital help us reimagine our sourcing and manufacturing so we can continue making products with fewer workers? How can digital better connect us with the experiences, desires and needs of our customers in a post-pandemic shopping environment? What are my peers doing that is driving superior performance and which digital technologies, investments and best practices will help me get there? Experience-led transformation impacts PE-backed companies from three key perspectives: Customer: customer experience and feedback changes business fundamentals and KPIs by informing how a company innovates, develops, markets and sells its products. Employee: employee experience and feedback surfaces valuable business learnings about what is working and not working “on the ground." Firm: scalable customer and employee feedback loops and the resulting KPIs serve as an ongoing barometer throughout the business lifecycle that is especially illuminative and relevant during due diligence. Top tips for PE-backed companies that want to enhance their customer experience include:   Rather than ask, “what do we need to do to digitalize our business?” ask, “what do we need to do to make us easier to do business with?” Launch and learn, speed is of the essence. You may fail but you will learn from the experience. CIOs need a seat at the table alongside all the other business leaders. It’s hard to attract and retain top talent, so don’t “sleep” on your talent.

Andres Saenz, EY Global Private Equity Leader, shares his observations regarding the evolution of private equity and the role it will play in a post-COVID world. Visit ey.com to read our latest private equity perspectives. The initial impact of COVID-19 on the private equity complex echoed what was seen in businesses across all sectors, with workplace safety, remote ways of working, investor and employee communication, liquidity and supply chain being top of mind to triage. In addition, deal markets (with the exception of credit funds) practically shut down overnight. PE firms are well-positioned for an economic downturn and have been preparing for this type of event in recent years. With over US$750b in dry powder in what is now a favorable buyer’s market, PE is looking to be as active as possible, as soon as possible. A few impediments to deals have included the inability to travel, a lack of available financing, and valuation disconnect between buyers and sellers in pricing assets. Despite these challenges, firms have become creative around investments in public equities as well as credit opportunities. Barring a resurgence of COVID-19, we anticipate buyers and sellers to converge sooner on valuations and in addition to pursuing opportunities in corporate carve-outs. PE-backed companies have a real advantage in this volatile environment: not only do funds have greater access to capital, they also have a mix of operating resources, expertise and advisor relationships ready to deploy across the portfolio. As PE navigates through COVID-19 and prepares for a momentous shift, a few trends will accelerate, including: Investing up and down the capital stack Defining digital transformation and enablement Refining their value proposition to attract incoming talent Hiring talent with the right skill sets Elevation of D&I and a broader focus on social responsibility Widening the aperture and representation of stakeholders Pivoting strategy towards long-term value

Tim Dutterer, EY-Parthenon Head of Private Equity, and Greg Schooley, EY US Value Creation Leader, discuss how COVID-19 is transforming operating models across the PE portfolio and beyond. Visit ey.com to read our latest private equity perspectives. After the economy recovered from the Great Financial Crisis of 2008, economic activity and growth were steady and predictable. As a result, private equity-owned companies optimized their operating models for efficiency, anticipating the next economic cycle would a more modest recession. No one, publicly traded corporates or PE-owned companies, was prepared for the sudden and complete secession of economic activity caused by COVID. However, PE investors reacted very quickly, understanding the severity of the crisis and mobilizing to increase liquidity across the portfolio. While a few sectors were spared from the sudden economic collapse, a wide spectrum of both impacts and actions can be observed across the vast majority of the US economy. We believe that the COVID-induced economic collapse will greatly accelerate several ongoing trends: Global supply chains will fragment as companies look for more resiliency Continued reconsideration of extent of reliance on China compared to lower-cost and lower-profile countries Automation will be more widely deployed in a range of activities and sub-functions Back-office functions will be increasingly outsourced The value of office real estate will diminish due to large-scale adoption of remote ways of working Assessing the impact “black swan” events will become the norm in scenario planning