Garrett Black December 30, 2014
CohnReznick’s Jeremy Swan recently contributed to a Friday Morning Dealmakers column discussing private equity and the construction industry, positing that the space is ripe for PE investment. Mr. Swan, who is a partner with CohnReznick and a principal with CohnReznick Advisory Group, was kind enough to speak with us concerning PE trends in 2015.
Is the gradual recovery of the housing market worldwide driving the increased interest in the construction industry, or what other drivers do you see?
The gradual recovery of the housing market is one factor driving increased interest in certain components of the construction industry.This is especially true when combined with the potential impact of immigration reform on the entry-level housing market. More broadly, the construction spending expected to increase in the U.S. by double digits on a percentage basis in 2015 combined with the growth of new billion-dollar infrastructure projects will provide significant opportunities for construction and related services.
You’ve spoken before on the recent LP push for single-investor funds. What are some reasons for this shift? Furthermore, do you think this will lead to a marked decline in co-investments?
The primary driver behind LPs pushing for single-investor funds is improved and customized LPA terms. The funds that we are seeing drawing interest from LPs to structure a new fund as a single investor fund are smaller and primarily either geographically or industry-specific vehicles being raised by large, multifund managers. We do not expect to see a reduction in co-investments, especially when countered by the increase in co-investment rights that we are seeing in new funds recently closed and currently in the market.
The rate of closing times has varied considerably as of late; you’ve indicated that pre-sale due diligence is speeding up the deal process, so do you anticipate a decrease in average closing times?
While sell-side diligence can shorten the due diligence process, this typically only impacts the period post signing of a letter of intent when the full diligence process starts with the heavy use of third parties. Over the past year we have seen buyers doing significantly more work on the front end. This includes more internal business, strategic and market due diligence ensuring that the deal is one that they want to move forward with before spending significant dollars on third-party due diligence. This is being exacerbated by the increased competitiveness and valuations required for each quality asset in the market.
Which segments of the middle market do you think will attract the most PE interest? Some have pondered a return to activity in the upper middle market, for example, especially if public market valuations decline and some PE firms increase take-privates.
We believe we will continue to see strong levels of activity across the middle market, particularly in the lower middle market. Based on the number of companies comprising the lower middle market and the growth opportunities for these businesses, they present a substantial pool of investment opportunities for the PE market. A real resurgence in activity in the upper end of the middle market will likely require a decrease in both public market valuations as well as a return to normalcy of private market valuations.
Regarding an earlier statement you’ve made on the SEC’s increased scrutiny, what are some of the most common steps you see fund managers taking to minimize risk?
In order to minimize risk due to increased SEC scrutiny, fund managers are focusing their efforts on three key areas: establishing or strengthening the internal compliance function—no longer just the fund CFO also playing the role of the CCO; increased clarity regarding fees and expenses, especially where the dollars come from to pay these fees and expenses (fund, portfolio company, etc.); and consistent adherence to stated valuation policies and practices. Overall, the common steps are focused on those that are driving increased consistency and transparency of practices and policies between funds and their LPs.
Featured image courtesy of Wikimedia Commons user Sten Porse.