What the PE industry’s famous dry powder means for multinationals and global subsidiary governance

Private equity is an industry whose star continues to rise. Driven by attractive returns and more than a decade of low interest rates, the asset class has experienced rapid growth in the last twenty years, continually attracting greater inflows, increasingly sourced from institutional investors. Total Assets Under Management (AUM) hit a record $4.74tn 2020, as investors committed more than half a trillion dollars, further boosting the substantial pile of dry powder available.[1]

The rising popularity of private equity, and size of available dry powder, has led to larger and more significant deals. Despite the 24% drop[2] in deal count during 2020, which came as no surprise as entire economies closed down for months on end, there were clear signs that pent-up demand will likely see deal flow rebound in a big way. But there was still considerable activity as managers continued to be on the hunt for more substantial deals, with many turning to multinationals.

This trend, which continues to gain momentum, is mirrored by multinational companies divesting large areas of their businesses. Notable divestments in 2020 included Unilever divesting the majority of its $3.5bn tea business (including brands such as PG Tips, Pukka Herbs and Tazo), whilst Phillips Electronics is set to divest its domestic appliances business worth $3.3bn. Whether to streamline operations or free up capital for other projects and R&D, unsurprisingly, they are finding that the buyers on the other end of the deal are increasingly from the private equity industry.

From a corporate governance perspective, the continued M&A activity raises a number of key elements that both PE and multinational firms need to understand with regards to equity financing and entity ownership. As the industry continues to grow, these matters become ever more pertinent.

THE IMPORTANCE OF CENTRALISED GOVERNANCE AND COMPLIANCE FUNCTIONS IN THE BUYOUT ENVIRONMENT

In comparison to multinationals, private equity firms tend to hold their entities for shorter periods of time as an investment, as well as having considerably lighter corporate infrastructure. This often means they have invested less in sophisticated governance and corporate secretarial functions which can cause issues, particularly when a firm looks to exit from its investments. 

In addition to the traditional penalties and fines that accompany compliance failures, for both the initial investment and the subsequent divestment, any delays in the Due Diligence process caused by a compliance failure slows the pace of which the deal can be executed and may even affect the valuation of the investment. This highlights the critical need for PE managers to centralise their governance and compliance functions and as the deals they are involved in continue to increase in size and complexity, so too does the risk of negative financial impacts from a failure in governance and compliance.

On the other side of the equation, it is also important that multinationals have simple, streamlined and centralised processes to manage their global portfolios of entities. If a large multinational is considering divesting a business line, it is a matter of critical importance to ensure that neither the value nor the successful execution of the potential deal is hindered or jeopardised by sub-standard governance practices.

ENHANCING TRANSPARENCY ACROSS THE BUSINESS, CREATING CLEAR WORKFLOWS AND RESPONSIBILITIES

The move towards establishing a set of best practices for managing worldwide entities and global responsibilities for the multinational industry, highlights the importance of transparency, which is something that the private equity industry continues to evolve with regards to corporate governance across their entity portfolios. Creating control through transparency supports managers in creating real business value. Confidently being able to rely on the compliance status across all entities, and assigning clear responsibility for tasks are key best practices which should be adopted.

INDUSTRY EVOLUTION THROUGH TECHNOLOGY

For those private equity managers or multinationals grappling with the highly complex task of delivering a successful global compliance strategy, the role of technology in ensuring best practice should not be underplayed. The entity portfolio management industry is now starting to see the incredible power that data and technology can have in our industry.

Leveraging technology, such as the proprietary task management system we introduced to our own clients last year, creates a whole new level of oversight and analytics enabling managers to gain full visibility on the status of all their entity management workflows, and be able to derive insights from the data, by region, entity and status.

Another innovation is the global compliance calendar, which proved particularly crucial during the COVID-19 pandemic, and helps ensure managers stay up to date with the ever-more complex regulatory landscape. Having a monitoring tool which provides a schedule of your obligations for the full year, specifying the work required and deadlines, increases efficiency and visibility across your portfolios and ensures annual obligations will not take you by surprise.

As they grow larger and more complex in their operations, having a set of best practices in combination with technological innovations is crucial in ensuring PE managers manage the transformation their industry now faces.

Kariem Abdellatif, Head of Citco Global Subsidiary Governance Services
Citco GSGS Focus – Summer 2021