Riding the Private Equity Resurgence
With experts predicting Australia moving to a lower interest rate environment over the coming two years, is there finally reason for optimism for private equity fund-raising activity? Katie Higgins, Corporate Lawyer, shares why sentiment is rising for private equity capital market investment volumes in the back half of 2024 and what business leaders can do now to prepare for investment demand in 2024 - 2025.
A case for optimism?
Following the pandemic-fuelled ‘fundraising frenzy’ that saw the Australian private equity market boom 2022, there emerged a sharply declining trend in private equity markets, both domestically and globally. This persisted over 2023 and into early 2024, however early signs of improving market conditions, along with positive investor sentiment, are offering Australian business leaders' new glimmers of hope. But those who are best prepared, are looking likely to ride the resurgence to success.
There is no denying that last year’s domestic private equity numbers displayed some blunt downward trends in both value, volume and investor commitment. What we saw was:
valuations fall by 41% on average from 2022 to 2023 for companies raising Series B rounds and above;
just 10% of local deals being greater than $20M, reflecting smaller round sizes across the spectrum; and
local investors failing to achieve meaningful investment cadence in 2023.[1]
The stubbornly high interest rates and persistent volatility shifted deal terms in the favour of investors with complexity in deal structure, terms and interest rate hedging strategies. This left some business leaders wary about their chances of turning their current equity capitalisation table into cash in the bank; at a time where cash is critical for business survival and growth.
However, the Australian private equity market could be on the verge of a welcomed level of heightened activity with credible speculation about rate cuts later in the 2024 and the economy finally showing promising signs of gaining control over inflation. What this likely means for the private equity market is increased access to funds and lower borrowing costs.
Katie Higgins, who specialises in private equity expects an uptick for the local funding landscape: “Following a period of stagnation, it's logical to anticipate a substantial reserve of capital in the market, awaiting suitable investment opportunities. This observation, combined with the projection that approximately three-quarters of Australian VC funds intend to raise capital within the next two years, holds promise for the market”. This positive assessment was also recently conveyed in the State of Australian Startup Funding 2023’ Report [2], highlighting the same optimistic perspectives and noting stabilised valuations and increased interest from international investors.
Katie believes that business leaders who invest time and effort in strategic preparation will be well-positioned to spearhead the anticipated resurgence. She emphasises that focusing on developing sound growth strategies, enhancing financial reporting, and ensuring robust governance structures will give these businesses a competitive edge.
As the market recovers, those who have laid a solid foundation will be the first to capitalise on the new opportunities, attracting investment and driving significant growth. “If businesses that can demonstrate defensible growth narratives and provide investors with confidence in business finances, operations and governance, they should feel increasingly confident in their ability to attract capital during the anticipated market resurgence” says Katie.
How to ride the private equity resurgence
To capitalise on the resurgence, Katie believes first movers will be at an advantage - if they can follow these four key steps:
Step 1: Start preparing now
Katie recommends business leaders start with a strong focus on pre-investment alignment, structural adjustments and internal due diligence: “Getting your ducks in a row is critical before you venture into the capital markets,” she says.
Even in a favourable climate, capital raising always takes longer than expected – and time equals money in the world of deals: “Anything that slows down the process will add costs,” says Katie, “It’s about frontend loading the process and getting organised for the best chance of success.”
Where multiple and often differently motivated decision makers are involved, it’s crucial to establish a mutual understanding of the drivers for the capital raise: “If the business leaders are not aligned at this stage on the baseline terms, it’s a sure-fire recipe for misunderstandings and even conflicts down the line,” says Katie.
Katie advises business leaders reach clarity on issues such as:
How much capital do you need to raise?
What do you intend to do with the new funds?
What equity are you prepared to give away?
Who are you looking for as an investor? Are you prepared to offer special terms to secure ‘right fit’ investors?
Step 2: Prepare for due diligence and ghost reporting
Poor or insufficient preparation for due diligence is one of the most common reasons potential investors lose confidence and pull out of negotiations. “Think of due diligence as the investor playing detective; every aspect of the business or transaction will be scrutinised to expose hidden risks or potential problems,” says Katie.
“Before you open your financial records, legal documents, operational procedures, and anything else relevant to the transaction to scrutiny, be sure you’ve undertaken a forensic investigation of your own business to identify anything that may raise questions for investors in the reliability, accuracy or completeness of the information provided.”
Katie recommends working closely with the business’ accounting and legal partners to run “ghost” due diligence reports to identify any red flags – before the embarrassment of prospective investors doing this. “Anything from late publication of financial records, material swings in financial data or even issues raised in letters to management by auditors, can raise red flags for investors. Make sure you find them first and have the chance to rectify or explain them in your narrative.”
Step 3: Educate yourself on the process and funding options
Business leaders should not necessarily resort to the same model of funding for each subsequent round. The most appropriate source of funding for each round will be determined by a range of factors including: urgency for funds, cash flow status, tax considerations, desire to maintain equity/ownership in business, deal complexity, securities (including personal guarantees if required) or need for skills and experience that may come to the business, in addition to cash.
“Look for investment partners who bring more than just cash to the deal,” says Katie. “Think about whether your investor can open doors to new markets, bring new management, operational or marketing skills to the relationship, or provide access to resources.”
Step 4: Plan for logistics with the experts
Trusted legal and accounting partners are invaluable for businesses preparing for a raise. Before the first approach is made to investors, ensure these partners are fully briefed and time and budget is reserved to work through a host of logistical tasks, including:
Advise on and undertake any structural adjustments, for example, introduction of an Employee Share Options Program;
Set up and populate a data room, ensuring legal, accounting and prospective investors will have access to all the information necessary to make an informed investment decision;
Draw up and ensure prospective investors sign an NDA prior to granting access to data room;
Ensure all employee/ contractor/ advisor equity is recorded in your cap table.
Systematically working through these tasks will help ensure a smooth and transparent process and convey greater certainty to prospective investors – and importantly assist in the early elimination of any roadblocks.
If you’re considering a capital raise, our Corporate + Commercial lawyers have experience with crowd-source funding, Series A to D venture capital, private equity investment and can deliver legal support throughout the pre and post investment phase. Reach out via [email protected]
1 The State of Australian Startup Funding 2023’ report, Cut Through Venture and Folklore Ventures via https://www.australianstartupfunding.com/?utm_medium=email&_hsenc=p2ANqtz-9VBCzIv8TppwEAkXfmIekHlYocx2HREQo5njkbCyFq4S3UszUF_zy7GPbeUCHUAiGGl3E-rSU-XmHlU0BYauiZ8pTWSA&_hsmi=2&utm_content=2&utm_source=hs_email
2 As above