Dealmakers focus on recipe for fast-growing companies

25 August, 2021

Fast-growing companies and digital investment are capturing private equity interest according to Baker Tilly’s latest Dealmakers 2021 report.

The recipe for fast-growing companies has long relied on a mix of ingredients — geographic expansion, for example, coupled with operational improvements and new management.

But for investors and dealmakers looking to spur companies on to growth in the rocky recovery from COVID-19, there’s one ingredient that matters more than all others: digital transformation.

That’s the finding of Baker Tilly’s latest Dealmakers 2021 report, Scale and speed: Fast-growing companies defy their limits, which looks at the drivers for private equity investors in their choice of companies expected to grow.

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The report finds that after a year in which traditional markets and business models were tested like never before, the value of digital transformation has become clear.

The ability to automate some work, use distributed workplace models to accommodate remote operations, better capture and convert leads, and engage in online commerce or transactions, have all been differentiators for business performance in 2020 and 2021.

Overall, 92% of PE dealmakers say they will focus on digital transformations to drive growth in the next 2-3 years, making it by far the top tactic for growth.

Baker Tilly Spain Managing Director Xavier Mercadé says the gap was widening between those companies successfully delivering and operating at the digital edge and those just toying with new tools and platforms.

“Digital platforms should be workhorses not show-ponies,” he says.

“We are seeing more companies using their digital presence to test and introduce new business models and revenue streams, and allowing a seamless experience for a customer that is now more likely to be remote.

“There is little room for an analogue company in the new digital market.”

PE firms have used this crisis as an opportunity to examine assets top to bottom, interrogate the costs, and look at ways to streamline or reduce their cost base.

Michael Sonego
Corporate Finance Lead
Pitcher Partners

Baker Tilly USA partner William Chapman agrees.

“The past 18 months has underscored the importance of having a 360-degree view of customers and operations,” he says.

“The companies that have invested in technology that collates this information and makes it easy to understand and act on the findings are in a much better place than those who still have fragmented systems, with data scattered online and offline and held in different places.

“The characteristics of a fast-growth company are becoming clear: digitally led, able to introduce and develop new revenue streams to offset disruption, and with a strong staff and culture.

“What we are seeing in dealmakers is an understanding of how these levers can be used to accelerate returns and deliver value.”

Expectations managed

The Dealmakers report canvassed respondents at private equity firms focused on fast-growth companies — those with an average annual growth of 38%.

A quarter of dealmakers are more exacting in their demands, targeting growth of at least 50% in their investments.

While those parameters define their normal investment profile, this group of PE investors is remarkably bullish about the opportunities and growth potential created by COVID-19 chaos.

In fact, 68% of respondents expect to achieve at least 50% growth in their portfolio investments in the next year or two, and a further 30% expect growth of 26%-49%.

“For more than two-thirds of dealmakers to believe they can achieve a 50% or higher growth rate in the next two years is a sign that they are becoming more nimble and able to respond to uncertainty,” says Michael Sonego, Baker Tilly Corporate Finance Lead.

“Private equity has adapted to the volatile investment market exceptionally well, changing investment strategies to take advantage of new markets and digital transformation, while balancing risk by being flexible on investment timeframes and exit plans.”

Overall growth expectations are slightly down on pre-pandemic optimism, but there is a sense that the growth prospects of companies is now better founded, given assets have been tried and tested due to COVID and have shown resilience.

PE portfolios have also been strengthened by canny asset disposal and acquisition over the past 18 months, as dealmakers realised they needed to adapt to changing market conditions.

As one Indian PE partner puts it: “During the pandemic, we targeted many operational improvements, and our management teams took decisions to move along the growth. In the next 12 to 24 months, we will be targeting a 55-60% growth rate, and we know that the company has the potential to enhance performance.”

At the same time, the uncertainty of new strains and lockdowns continues to weigh on dealmakers.

Nearly all nominated economic volatility was the key threat to continued growth, followed by regulatory changes, disruption due to the pandemic, and political uncertainty.

It’s a situation that has placed pressure on PE investors to make educated — sometimes bold — guesses about the macro environment as well as M&A target fundamentals, and they are increasingly turning to advisors for support in this decision-making.

Half say they expect to use professional advisors more in the future, reflecting the complexity of making deals in this environment.

Tipping the scale

While digital transformations will drive the growth engine, it is not the only tactic dealmakers are seeking to employ. The need to operate at scale is also a key trend in the report, with 87% of PE firms looking to increase their use of alliances and joint ventures to expand and grow.

M&A is also an important part of the agenda for the next two years, with two-thirds looking to use acquisitions to fuel expansion.

But other tactics, less popular pre-pandemic, will also be employed.

Before COVID, just 15% saw having a competitive cost base as a factor for growth. Now, nearly 60% say this will be a focus in coming years.

“PE firms have used this crisis as an opportunity to examine assets top to bottom, interrogate the costs, and look at ways to streamline or reduce their cost base,” Mr Sonego says.

“It’s been an opportunity to look at measures inside and outside the business, and hone the operation so it is lean, productive and focused on growth.

“We have also seen similar attention on other internal differentiators, particularly the ability to train staff and implement operational improvements.”

Greater operational scrutiny has also exposed those assets that either don’t mean changing requirements or that no longer align with the PE strategy.

But there have been fewer opportunities for PE firms to dispose of assets — possibly fearing they will be undervalued by the market — so 43% have held on to investee businesses longer than planned.

For those looking at exit strategies, sale to other PEs is the preferred route, over trade parties, IPOs or SPACs.

Baker Tilly Singapore’s Adrian Cheow says the level of capital available from PE makes the sector an obvious first option for those looking to sell.

“The past year has seen a lot of excitement around IPOs and SPACs, but dealmakers are first turning to private equity, given the amount of capital available that has not yet been deployed.”

Adrian Cheow
Executive Director & Practice Leader, Deal Advisory
Baker Tilly Singapore

But he warns that might change.

“In the future, they may be more willing to explore other exit strategies if they can secure a faster, more lucrative exit that allows them to redeploy capital elsewhere.”

North America with a rocket

After a punishing year in 2020, North America has surged out of the worst of the pandemic as a key location for dealmakers looking to pick up fast-growth assets.

About one in three dealmakers report their most recent deal was in the territory, but 80% see it as a location for future opportunities.

Western Europe is another hotspot for growth, 75% eyeing it for the near future, with optimism there underpinned by a largely successful roll-out of vaccines and the opportunities offered by two trillion Euros in recovery funding.

“North America continues to capture the interest of dealmakers as a source of fast-growth investment options, but Western Europe, with its centralised plans for recovery post-pandemic is also an area with enormous potential,” says Baker Tilly Belgium’s Olivier Willems.   

Despite the interest in different markets, dealmakers were realistic about ongoing limits on free travel and the pace at which COVID continued to reshape economies.

Two-thirds say they are focused on domestic market expansion at the expense of cross-border opportunities for the time being.

Mr Willems says cross-border transactions may not restart in earnest until dealmakers feel greater security that their investment strategy won’t be undermined by economic, political and health factors.

But when they do resume, he expects competition to be fierce.

That view is backed by James Lawson, from MHA MacIntyre Hudson.

“There is clear pent-up demand for cross-border expansion but recent experience of new waves has continued to limit the option for companies to travel and explore new opportunities,” Mr Lawson says.

“That has left a gap: if companies are able continue their cross-border expansion plans while competitors are land locked, they can take first advantage of new markets.

“The message from this report is resounding confidence in the opportunities that lie ahead for growth. The key for dealmakers will be to be in the right place to take advantage of those opportunities when they arise.”

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Meet the experts
Michael Sonego
Corporate Finance Partner
Pitcher Partners, Australia
Adrian Cheow
Executive Director
Baker Tilly, Singapore
Xavier Mercadé Sanmartí
Baker Tilly, Spain
Olivier Willems
Corporate Finance Partner
Baker Tilly, Belgium
William A. Chapman
Baker Tilly, US
James Lawson

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