May 01, 2007
Private equity has become ubiquitous. But what exactly is it? It can most easily be defined by exclusion: it is whatever public markets are not. Capital flows between the private and the public markets, and is in a constant state of interactive flux. When capital begins to flow in new proportions, as private is currently doing, it forms a new continuum.
Private equity has recently achieved an integration in the capital markets that is not likely to abate, nor be marginalized. While the 1990s saw a boom in the public markets, the flow started going the other way a few years ago as private equity funds began to outperform the markets by significant margins on a regular basis. These funds—led by major US players like Blackstone, The Carlyle Group, Texas Pacific Group, Bain Capital, Kohlberg Kravis Roberts & Co. and Onex Corp.—are famous for intense due diligence, furious cost control, first-rate managers, and state-of-the-art management techniques in pursuit of a five- to 10-year exit strategy.
With the IPO market otherwise dormant and income trusts in disarray, Canadian law firms are competing madly for the private equity work. But there’s so much cash around that the competition for the good deals among the private equity firms themselves is equally competitive.
“This is an industry that hatches every cent,” says Stephen Donovan. “So if a deal doesn’t get done, you kind of have to take a partnership approach with the client and work out something that involves the next deal that gets done.”
Torys has used its New York office to establish a seamless beachhead for Canadian clients looking to expand in the United States. It has traditionally had a strong financial services practice, and the combination of the two suggests that it may have a jump on representing Canadian private equity investors as they expand into the United States.
To be sure, every major firm worth its salt has strong U.S. connections, or it wouldn’t be a major firm in Canada. Those U.S. connections come around in most areas of M&A, including in private equity megadeals.
But large firms are still benefiting most from mid-market deals—C$100 million to C$400 million—which can be stepping stones for exit strategies and larger acquisitions.
The mid-market is an economic necessity, says Stephen: “There just aren’t enough big deals to sustain the deal flow a large Canadian firm needs.”
Meanwhile, private equity headline-grabbing acquisitions overall have prompted a backlash. Unions characterize private equity funds as vultures; the United Kingdom's Financial Services Authority has questioned the viability of some private equity transactions; the U.S. Department of Justice is investigating the growing practice known as “clubbing,” where firms join together in a consortium bid; the Federal Trade Commission has ordered Carlyle and Riverstone to end their operating involvement in one of the two energy firms they own so as to protect competition; the House Finance Committee is scheduled to hold hearings on private equity; and shareholders are becoming suspicious of management that stays on with private equity buyers and reaps allegedly disproportionate benefits on execution of the exit strategy.
“Apart from high interest rates, the one thing that’s going to make people run away from the private equity market is an overdose of regulatory intervention,” says Stephen. “That has a lot to do with what drives capital from the public to the private market in the first place.”
But no one’s running away just yet.