Investment Perspectives

MARCH 2021 GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING

GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING | 1 We are delighted to share our aspects in the management of There are macro developments that perspective and insights on some of portfolio companies: workers’ give us reason to be optimistic. In the major industry trends influencing safety, cost control, and supply chain December 2020, within days of the our private equity business, and what maintenance. In particular, managers, transition period deadline, a new this means for 2021 and beyond. with the support of a banking Brexit deal was agreed between the system that showed more flexibility EU and the UK, removing significant As we reflect on 2020, it is clear that compared to the last recession along uncertainty and from the this was a year of two halves. Private with a greater role of private credit market. As the global vaccine rollout equity deal-making fell sharply as capital as a buffer, particularly in the gathers pace and life returns to the pandemic took hold. Sponsors middle market, ensured portfolio some form of normality, increased quickly turned their attention to their companies implemented important consumer spending will have a portfolios rather than commit to new measures aimed at safeguarding direct benefit on consumer-facing investment opportunities. Indeed, liquidity. In addition, managers businesses, albeit gradually, which there were winners, such as tech and have taken full advantage of simulates the performance of healthcare companies that benefitted programs made available by national companies coming out of a recession. from healthy capital markets and the governments, including tax breaks, History shows that this is an excellent IPO window, and losers, such as travel social security safety-nets and other time to invest. and leisure companies hurt by the economic support tools. lock-down restrictions. However, on A low interest rate environment balance, most portfolio companies The asset class as a whole, particularly coupled with sizeable levels of adapted well to the new conditions the buyout segment, has been able available capital paves the way for and mid-market firms actually fared to influence management decisions, continued high prices for attractive better than many larger companies. intervene with capital to support corporate assets, particularly for As a result, new deal activity picked portfolio companies’ liquidity crises businesses that have shown that up sharply in the second half of the and seize possible acquisition they can adapt to the impact of year. opportunities. Additionally, with the restrictions brought on by the managers taking a more hands-on pandemic. Historically low rates will The private equity industry saw the approach and appointing operating also mean that companies should be development of various trends over partners to look after the assets able to deleverage more quickly and the past 12 months that are expected day to day, private equity has therefore generate equity value. to accelerate in the coming years, developed a model providing for largely due to the repercussions closer collaboration with portfolio of the pandemic. These include companies’ management, allowing for increasing digitization and the so- a rapid intervention on organizational called “flight-to-quality” by . and operational changes, often The experience gained during the necessary in emergency situations. global financial crisis (GFC) and its aftermath has helped the industry react swiftly to the pandemic by paying immediate attention to key

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MARKET OVERVIEW

Investors have shown a willingness to continue COVID-19 cases, Capital Dynamics saw a drop in to investors and operating metrics in order to equity deals – the highest on record according to invest capital in private equity during the the number of deals as early as February, while facilitate investment decisions. More tech and to Preqin data. Managers have focused even most volatile time in the market with global in Europe and the U.S. a contraction of about growth-oriented managers have been investing more closely on companies that are industry fundraising reaching over USD 500 billion in 35% occurred from March and April onwards. in digital and artificial intelligence tools to leaders, particularly in countercyclical sectors, 2020. In this context, we have observed a However, Asia, led by China, saw the fastest effectively screen the investible universe and such as healthcare, technology and food & growing bifurcation between top-tier access- recovery in activity levels, ending the first half of refine their pipelines in real time. Furthermore, beverages. restricted managers who are able to meet their the year with a higher number of deals than the we have observed an increasing focus on fundraising targets despite the pandemic, and previous year. In Europe and the U.S., activity managers supporting their portfolio companies The expectation for the next few years is for the rest who are experiencing longer fundraising started to bounce back substantially from June in their digital transformation process. An an increase in sector-focused funds: in 2008, periods. and increased over the course of the year. increasing number of managers have engaged the amount of capital raised by technology- with digital operations specialists to support focused managers represented only 3% of Many investors that were historically willing to companies on a number of different projects, total fundraising globally, while in 2019 this commit capital only after conducting in-person INCREASING SHIFT TOWARDS DIGITIZATION ranging from IT and business integration proportion grew to more than 20%. Despite meetings, now feel more confident in finalizing tasks to digital marketing, data analytics and the ramifications of the pandemic, this “flight- diligence processes remotely, particularly with As highlighted in the introduction, a major e-commerce development. to-quality”, together with high valuations in the respect to re-ups. Similarly, across the primaries trend we have witnessed over much of the past public markets, kept entry prices at high levels strategy at Capital Dynamics, the team has not year is the industry’s increasing shift towards in the first half of 2020, with overall buyout made any fund investments since the onset of digitization, both at a manager and portfolio GREATER SECTOR SPECIALIZATION entry valuations in Europe reaching 11.7x. This the pandemic without having already previously company level, particularly since the onset of compares with 9.3x for the mid-market, which met the managers face-to-face pre-pandemic. the pandemic. Many private equity managers Another major trend that has become more suggests greater value in that segment of the Capital Dynamics believes in the importance have been able to adapt quickly to a new pronounced since the pandemic is greater market. of its primaries team’s ongoing engagement working environment. Virtual annual meetings sector specialization. In 2006, for instance, the with managers in between their fundraising and due diligence video calls with investors percentage of European buyout deals in the processes. and portfolio companies’ management teams technology sector was just 9%. This increased became routine fairly swiftly. to 24% in 2019. This trend has been accelerating Throughout 2020, deal making decreased during the pandemic, supported by the so-called following the spread of the pandemic. Starting Managers are progressively adopting new “flight-to-quality” by investors, with technology with Asia, the geographic area with the first technology platforms to deliver more insights sector deals accounting for 27% of all private

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MARKET OVERVIEW

The has seen rapid growth in Contrarily, fundraising in 2020 hit record to manage their private equity portfolios, for Below are some examples we are particularly recent years. Transaction volume has more than highs as investors expecting a perfect buying both allocation and administrative purposes. excited about: tripled over the last decade, while the public opportunity poured capital into multi-billion Furthermore, there is also a pent up supply of markets experienced the longest bull market dollar secondary funds such that there was GP-led deals as an increasing number of funds (i) Transactions facing limited to no run in history. Even though these volumes likely twice as much capital raised than are ageing and exits opportunities remain competition. For example, we see GP- have been driven mostly by large transactions, deployed last year. Looking ahead, we believe challenging. led deals with Asian managers as being there have been a number of trends that have that this large amount of available capital will attractive as they tend to be complex and hence require significant structuring significantly contributed to this growth. This drive a highly competitive secondaries market We also expect to find opportunities where expertise while the assets often have a lot includes: on larger deals and on large GP-led transactions. there are liquidity issues, given that the pain of growth potential; (i) An increase in active portfolio It is possible that this effect will be even more from the pandemic will be ongoing for a while. Firms with proprietary sourcing capabilities management by investors; pronounced in the future as secondary buyers (ii) Opportunities with sellers who are facing will be well positioned to take advantage of look to deploy aggressively. Conversely, Capital liquidity requirements or are facing (ii) Persistent strong pricing; such opportunities, as sellers in distressed Dynamics will continue to focus on the smaller operational pressures on their operating processes often wish to remain discreet and (iii) A growing supply of General Partner end of the market, which is characterized by an budgets due to COVID-19, such as (GP)-led deals (over a third of annual deal abundance of deal flow, a need for leadership prefer confidentiality – potentially bypassing university endowments; volume); and in structuring and underwriting more complex the auction channel altogether. transactions and less intermediation. By (iii) Portfolios with companies that have (iv) An increase in both the number and type of participants joining the market. focusing on the small-end of the market, buyers In the aftermath of this market dislocation, a resilient capital structures and overall are well positioned to avoid this heightened diverse set of market opportunities are likely lower amounts of leverage given the However, the secondaries market did competition. to materialize. It is difficult to predict the exact potential for rising default levels; experience significantly reduced activity from shape of those opportunities today. While we (iv) Preferred securities deals with downside the onset of the pandemic up until late summer expect large portfolio transactions to eventually protection that address the liquidity 2020, where buyers and sellers had misaligned OPPORTUNITIES make a comeback, these will likely encounter needs of investors or funds; pricing expectations. This major disconnect led strong demand due to the record amounts of to many GP-led processes and large portfolio Over the coming quarters, we expect to continue capital raised and hence be sold through very (v) Single asset deals that allow for deep and transactions being put on hold- until late Q3 to see numerous investment opportunities competitive processes. Capital Dynamics’ focus detailed due diligence. when the market regained stability. driven by a strong flow of motivated sellers, many will remain on the smaller end of the market of whom did not transact in 2020, as alluded to where market inefficiencies persist and supply- earlier. A number of these investors will need demand dynamics benefit experienced buyers.

GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING 6 | GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING | 7 DIRECT INVESTMENTS (CO-INVESTMENTS)

As with the private equity secondaries market, are better insulated from COVID-19. a relatively large number of attractive the market for direct investments has grown As we have illustrated in past research, direct investments in the second half significantly over the last decade. Although this intelligent portfolio construction (i.e., of 2020 and we are positioned to do may mean greater competition for attractive prudent diversification by sector, the same in the first half of 2021; and direct investment opportunities, the COVID-19 country, manager and vintage) pandemic has provided a number of positive mitigates risk of loss materially. We outcomes for investors with proven experience, are particularly rigorous about how (v) In addition to this supply-demand including: we do that at Capital Dynamics; imbalance, multi-manager direct investors like us have been able to negotiate preferred terms (i) Many of the management teams of (iii) Transient players – who use co- with sponsors, improving pricing private equity portfolio companies investment when times are good and and structure. These enhanced have been able successfully to re- leave the market when times are bad transaction structures being deployed engineer their businesses during the – are disappearing from the market, (e.g., use of convertible or preference pandemic, entering new markets or with all-weather sponsors of multi- share/warrant instruments) provide setting up new sales channels, and manager direct investment funds downside protection, mitigate hiring great talent from larger, less remaining firmly committed; volatility and bridge nimble competitors. This has provided valuation gaps. plenty of attractive investment opportunities and increased the value (iv) A consequence of fewer market of many existing mid-market holdings; participants is a supply-demand The pandemic has provided direct investment imbalance (i.e., less capital to meet teams with more deal flow as well as the ability the demands from managers looking to pick-and-choose companies in industries that (ii) Sponsors of multi-manager direct to preserve liquidity to protect their have benefitted from the pandemic or where investment funds remain agile vis-à- existing portfolios). We are seeing this management teams have reacted well to the vis sectors and countries, specifically dynamic play out, where many good changed environment and have improved the in sectors that are likely to be sponsors in our network are turning value of their underlying businesses. beneficiaries, and in the countries that to us for capital. As a result, we made

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As supported by ever-increasing data, Capital analytics, we can monitor our suppliers and Dynamics strongly believes that sound, investments making sure that they adhere to fundamental ESG underwriting will translate our responsible investment tenets. We believe into meaningful value creation through that we can do well by doing good. closer alignment between the objectives of institutional investors, business stakeholders, We have a longstanding commitment to and society-at-large. Through our rigorous responsible investment and we are dedicated approach to ESG investment diligence and to maintaining the utmost transparency with disciplined screening processes, the Firm has our investors and business partners when established a high standard across the private it comes to these topics. As the ongoing markets industry globally. initiative to improve RI reporting and the associated drive to collect meaningful and Our proprietary ESG scoring system, the accurate metrics continues, we are proud R-Eye™, developed in 2018, and implemented to have issued our first annual Task Force on across our investment strategies in 2019, helps Climate-related Financial Disclosures (TCFD) ensure that the Principles for Responsible Report in 2020, an initiative set up to develop Investment (PRI), the United Nations a set of recommendations for voluntary Sustainable Development Goals (SDGs) and and consistent climate-related financial risk other ESG factors are included throughout the disclosures in mainstream filings. full investment cycle starting from investment appraisal to post-investment monitoring. Capital Dynamics is committed to reinforcing its The unique R-Eye® scoring system scores investment in the middle market, an area where each investment from 0 to 5 based on a set we have deep capabilities. Small and mid-sized of criteria developed in conjunction with the companies are among the most affected by the UN Sustainable Development Goals and helps COVID-19 pandemic and would benefit greatly ensure a consistent and transparent approach from the capital and operational expertise to RI due diligence. of experienced private equity investors. Importantly, these investment opportunities While incorporating ESG principles across are not only socially responsible, but due to all investment decisions is vital, it is equally the market dislocation, they have the potential important to ensure all existing investments, to deliver differentiated risk-adjusted returns. Firm partners and vendors continue to abide This return profile is consistent with our core by these principles as well. By engaging message that good ESG practices translate into RepRisk, a leading business intelligence -term outperformance for investors. provider that specializes in dynamic ESG risk

INSTITUTIONAL ASSET MANAGEMENT AWARDS WINNER Top rating (A+) for Private Private Equity Manager of the year Equity strategy Capital Dynamics Capital Dynamics Private Equity

GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING 10 | GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING || 1111 CONCLUSION AUTHORS

The latest crisis – the COVID-19 pandemic across more flexible capital structures, helped – has once again tested the resilience of PE-backed companies better navigate through the private assets industry. Further, major the COVID-19 pandemic. Private equity recent macro developments – a Brexit deal, managers were also busy on the investment a new U.S. Administration, acceleration of a side as the pandemic created several unique global vaccine rollout – give us reason to be investment opportunities. optimistic. While still early, 2021 is shaping up to be the Private equity managers with robust operating year of a new recovery cycle that we believe models and the experience of past crises have will present many attractive investment Andrew Bernstein Andrea Mazzaferro Senior Managing Director Managing Director largely been able to benefit from the “new opportunities for private equity investors. In Head of Private Equity Primaries, Europe normal”, working in close collaboration with particular, private equity investors can benefit their investors and portfolio companies. As from emerging demand trends captured by an experienced manager dedicated to global innovative companies in the middle market private equity for over three decades, we as well as by identifying targets that may remain focused on investing in middle-market have experienced temporary disruption in companies that help drive local and global demand due to the nature of their services economic growth and job creation. but nevertheless have fundamentally sound business models. Lastly, and also importantly, Private equity as an asset class proved to be the global pandemic demonstrated that resilient during the global pandemic, with the private assets industry has embraced a managers benefiting from the investments more sustainable business model, with the they have made in operating capabilities, a integration of comprehensive and formalized Jospeh B. Marks Andrew Beaton lesson learned during the GFC. These skills, ESG standards supporting value preservation Managing Director Senior Managing Director combined with the expansion of private equity and creation during challenging times. Head of Secondaries Co-Investments

ABOUT CAPITAL DYNAMICS

Capital Dynamics is an independent global asset Capital Dynamics roots go back to 1988, the management firm focusing on private assets year our predecessor (Westport Private Equity) including private equity, private credit, and was founded in the UK. Our headquarters were clean energy infrastructure. Capital Dynamics established in Zug, Switzerland in 1999. The offers a diversified range of tailored offerings firm employs approximately 160 professionals and customized solutions for a broad, global globally and maintains offices in New York, client base, including corporations, family London, Paris, Tokyo, Hong Kong, San Francisco, offices, foundations and endowments, high net Munich, Milan, Florida, Birmingham, Dubai and worth individuals, pension funds and others. Seoul. The firm oversees more than USD 15 billion in assets under management and advisement1. In 2020, Capital Dynamics was awarded the Capital Dynamics is distinguished by its deep and highest rating (A+) from the Principles for sustained partnerships with clients, a culture Responsible Investment for (i) Strategy & that attracts entrepreneurial thought leaders Corporate Governance, (ii) private equity and a commitment to providing innovative strategy and (iii) clean energy infrastructure ideas and solutions for its clients. strategy. For more information, please visit: www.capdyn.com

1 As of December 31, 2020. GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING | 13 12 | GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING Copyright © 2021 by Capital Dynamics Holding A G. All rights reserved. | 13 DISCLAIMER “Capital Dynamics” comprises Capital Dynamics Holding AG and its affiliates.

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