A private equity deal solves business succession issues
Anthony Pitcher, director, LGL Trustees Limited, also says there is a real concern that we are seeing a bubble, aand that asset prices may lower.
We understand there is a substantial amount of cash available for private equity investment. Will this change the trust industry?
There is a huge amount of cash available with deals now stretching into the hundreds of millions of pounds. This has already changed the trust industry substantially and is likely to continue to do so. Management are driving fee revenue with cut price fee deals to clients which are affordable to the business by slashing costs. Staff are having to do more with less. Service levels in PE backed businesses are falling. The client proposition is becoming industrialised. Fit the model or go elsewhere. Management effort is about profit and loss accounts and not the client experience. Clients have proven to be resilient to the falling service levels and higher fees as they perceive that the risk of change of provider may be too great so they tolerate the change in service levels.
What impact does it have on the industry?
The industry is polarising. Boutique businesses offering personal or high value added service are flourishing and the big businesses offering an industrialised service are also growing. I don’t think there is any room in the middle.
If there are very few potential targets, how do PE firms compete for what is available and where next?
Private equity firms compete on several levels. Price is an obvious tool, but there are others. Advice from the PE house is important and so is cultural fit. Prior experience in understanding the industry can make a difference.
If valuations are on the high side, what does this mean for the trust industry?
There are differing views about whether prices are high or not. By historical standards prices are astronomic, but investment opportunities are few and returns are low. Bond yields are low and even negative. Prime real estate yields are tiny. There is a wall of money looking for a return. Trust company income is largely annuity income which is the Holy Grail and carries with it a premium price.
Tell us about secondary deals?
PE is about doing deals. PE houses need to see their investments being realised in a maximum five-year time frame for them to be deemed a success. Trust businesses often have further growth opportunity beyond that three or five year horizon and a secondary deal allows an introduction of new capital and ideas to take the business to the next level. PE houses have optimum deal sizes. Businesses grow beyond those deal sizes and a different PE house with a different optimum deal size needs to come in. Management co-invest alongside the PE house and need the opportunity to realise at least part of their investment in a realistic time frame. The pressures on management are huge and they need line of sight to a financial reward for their efforts. In the absence of a deal, there is a risk of management becoming demotivated. Staff in PE owned businesses are often dissatisfied. The opportunity of a retention bonus at deal time is at least in part some kind of compensation for the stress of working for a private equity owned business.
How would a bubble hurt the market? Is it simply inability to sell?
There is a real concern that we are seeing a bubble, and that asset prices might collapse. There are real risks to this for many parties. The least of these is to the PE houses themselves. They will survive. They may not flourish but they will continue.
So who will lose out?
The main losers are likely to be two groups. First of all and most significantly management. They will most likely have borrowed to fund their co-invested deal, and may not be able to realise money to pay back their loans. A large number of management who are insolvent cannot be a good thing for them or their businesses. It may also impact their status as fit and proper persons in extreme cases.
Secondly owners of businesses that are looking for their first sale to a PE backed business. A PE sale is often seen as a solution to a succession issue in a business. If PE is not there to buy they will need to look for alternative succession plans.
The industry as a whole will most likely suffer from a shortage of capital. Banks will be less willing to lend. Owners may be less willing to invest. Fees to clients may well go up as PE owned businesses are currently offering cut price fees to attract additional revenues. Without the pressure to deliver the next deal, these cut price fees may dry up. Investors seem oblivious to the long tail risk of trust relationships.
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