Steward Quarterly Highlights 1st Quarter 2021

The Dawn of 2021 brought a resurgence of deal-making that began at the end of 2020. While commitments moderated during the pandemic, 2020 goes on the record as the third-largest year for private equity capital raising. The worrisome froth has been tempered by an overall net reduction in available dry powder. This contrasts with the swift ascent of the public equity markets and the volatility in rates, impacted by the unprecedented amount of stimulus flooding into the economy. Overall, price instability will continue to create consternation for asset allocators but a potential boon for agile Middle Market companies.

Henry McVey, KKR’s Head of Global Macro, increased his forecast for U.S. real GDP growth in 2021 to 6.5% (from 5.0%), and his 2022 forecast to 4.0% (from 3.0%), reflecting near-term recovery combined with an environment ripe for capital deployment.

Rebuilding Stronger — We began the new year with contentious events in our nation’s capital, further fueling the cultural conversations already underway, bringing renewed meaning to Martin Luther King Day, Black History Month, and Women’s History Month observances. Diversity and Inclusion, “D&I,” has been moved to the top of the boardroom agenda, in the same way that climate change and cybersecurity escalated in past decades. Employers, investors, and customers are uniquely aligned to achieve better inclusionary practices and measurable outcomes.

Growth and job creation are central to the success of this conversation as we strive to see new diverse leaders emerge. Dr. Dale Caldwell, Partner at WHATiF88, writing for the Group of Nations, noted that, “Most people are not aware that the official name of the march where he (Martin Luther King) delivered his famous “I Have a Dream” speech was the ‘March on Washington for Jobs and Freedom.’” Employment has become no less of a concern in these times of widespread COVID-related unemployment, which has especially impacted communities of color. 

Steward’s initiatives, focusing on pre-launch teams with a preference for diversity, are facilitating capital flows to innovative and growing companies in the U.S. middle market. This universe of more than 200,000 U.S. small and medium-sized private businesses benefit from partnership capital in the form of small buyout, special situations, and infrastructure equity investment. This part of the capital markets is at the heart of potential for advances in inclusive leadership, job growth, and durable business practices as the economy builds back stronger. For a deeper look at how we view ESG themes in this market, please view our ESG framework.

Unlocking New Talent, Fund I — Investors continue to view private equity as providing shelter from the COVID-19 storm, as reflected in Private Equity International’s December 2020 LP Perspectives, which reports that 40% of investors feel under-allocated to the asset class.

Fund I managers have had to be patient as fundraising timelines extended to a year or more over the last year. The limitations of remote relationship-building, LP’s time spent on triaging legacy investments, and the pivot to virtual diligence all delayed timelines. The Steward team has developed a pipeline of dozens of prospective teams poised to launch in 2021-2024, a deep emerging and diverse lineup of newly forming competitors to invigorate the landscape for decades to come.

Middle Market Innovation has continued in the face of the COVID-19 pandemic, with companies mobilizing research and development efforts into manufacturing and sales. Healthcare services have reacted to permanently changed delivery and protocols. Business services, especially those in data management and in the field of science, have found themselves at the core of supporting sustainable practices to understand the rapidly changing landscape. The tech-enabling skill sets, a common planning point for value-add with portfolio companies, has provided many companies with a competitive advantage. The emergence of new communications platforms provide day-to-day necessities to assist companies to lower their carbon footprint and increase employee productivity while working remotely. 

Bain & Company reported (below) the average MOICs for the last decade, broken down by sectors across the private equity landscape are as follows: Technology (2.9x) and Healthcare (2.4x) led the eight-segment universe, followed closely by a tie between Industrials (2.3x) and Business Services (2.3x).

The opportunity overlap at the intersection of Industrials and Business Services blends the old world economy with sustainable business practices — in effect, fueling efficient supply chains around better customer and product data science. Rounding out the list are Financials, Media, and Natural Resources (2.1-2.2x) and finally the Consumer segment (1.8x). All are representative of the liquidity premium expected.

The Overton window (generally defined in political circles as the willingness a population has to change towards new policies) now has a new reference – consumers’ willingness to change behavior. Businesses are facing a vast opening of their Overton window, as loyalties are fragile post-COVID disruptions. Changing opinions and behaviors will cause additional volatility in market share, creating what we view as an opportunity for smaller competitors to pounce.

One example of this is found among the recent healthcare delivery protocol adaptations, disrupting product needs and uses. This new openness to changing protocols will continue to disrupt industries and underscores the premium LPs will place on sector expertise.

Reflation Reduces the Moat of Large Incumbents — The massive stimulus package airdropped into the U.S. economy this quarter brings with it the threat of destabilized operating margins. Price instability is the potential “unintended consequence” of reflation. This compounds the outlook for business risk when viewed through the widened Overton window.

In short, a laser-focused competitive analysis will help to drive returns over the next decade, as the landscape is more easily altered. New competitors may have a unique opportunity to challenge incumbents. Expect dramatic shifts in supply chains, pricing policies, and relationship drivers with key clients. Input and product pricing will be less predictable, and inflexible pricing may prove to be the enemy.

Deep-sector expertise found within the strategic capital partnerships of small buyout, growth equity, and special situation strategies have never been more important to the health of U.S. private businesses. Firms will need intelligence across their sector as the value chain shifts. Nimble and agile middle-market companies will likely be the beneficiaries giving way to their ability to pivot, gain new contracts through dynamic pricing, and ensure high-touch service delivery. Naturally, as they grow, these companies are candidates for multiple expansions, providing them an additional lift to drive shareholder returns.

Fund I Diligence: Who, How and Why — Investigative due diligence seeks to uncover teams with talent and process, but also provides the “why” within a repeatable and durable process. The bridge from a prior large employer to launching a Fund I is a path which the Steward team understands well. This often involves veteran talent launching a new enterprise unburdened from legacy distractions. Their high alignment is demonstrated, not just by capital deployment at the new firm, but from standing up as leaders at this moment of high conviction, with an eye to the opportunities in their universe.

Steward’s approach to a “Foundational Assessment” digs deep into the unique aspects of pre-Fund I launch conditions. The best characteristics are a common history, shared vision, and broad ownership that endear loyalty amongst the team, service providers, and early LPs.

There is a bridge which LPs create connecting the old and new, understanding that there are gaps in the analysis until Fund III. Strategic anchor partnerships, like Steward’s, help fill those gaps, reducing leap-of-faith allocations, and instead creating a bond within a strategic relationship with milestones. By providing capital that unlocks the first close and by participating in GP economics, anchor investors reduce inertia in the capital markets and advance the talent pool. The net result for LPs is an offset of expenses alongside GP economics, an additional source of alpha.

In February, David Toll of Private Equity Career News led a lively virtual discussion entitled “Raising a Debut Fund”. Sheryl Mejia, the Managing Partner of Steward, was joined by Nik Shah, Co-Founder of Cohere Capital, Sanjiv Shah, Managing Director of HarbourVest Partners, and Patrick Dunleavy, Managing Director of Moelis & Company.

SEO USA is in the midst of planning their Twelfth Annual Alternative Investments Conference, which will take place this year on April 6th–8th. Sheryl Mejia will be contributing to the conversation around fund formation. Keynote speakers include Henry Kravis of KKR & Company, Marcelo Claure of SoftBank, Mellody Hobson of Ariel Investments, and Orlando Bravo of Thoma Bravo.

Kudos to Beth Falk and her team’s work in extending the Falk Marques Virtual PE Women’s Summit to the virtual and very engaging platform.

Thank you to Kerry Kennedy’s team led by Sancia Dalley for sharing their inspiring work at the RFK Compass Investor event this month. RFK Human Rights helps to set the agenda for the next decade around inequities, pension management, and sustainable investing themes.

Bain. 2021 Global Private Equity Report. “Firms need in-depth intelligence on how the recovery will unfold in a given sector and where the ground has shifted.”

Discourse. The Overton Window is Now Wide Open for Much Needed Reforms. “The reforms that have been critical in the COVID-19 pandemic are also the right medicine during good times.”

RSM. Private Equity Deal Making Surges, with Gains in the Middle Market. “But in 2020, Middle Market transactions of $250 million or less have grown to 16% of all M&A.”

Middle Market Growth. 25 Years in Private Equity - Three Key Evolutions. One of the reasons middle-market private equity investments have performed so well is that there is a greater ability to impact results and add value than large-cap companies, which typically already have the scale and resources they need.

Private Equity International. Four Key Trends in the MidMarket. Despite the pandemic, limited partner appetite for emerging managers does not appear to have dissipated; 89 percent of institutional investors surveyed said they would back a debut private equity or venture capital fund.

Grant Thornton. Private Equity in the Middle Market Reshaping Strategies for 2021. Unsurprisingly, private equity houses are drawn to tech-enabled businesses that can sustain growth through the current–and any future–regional or global disruption. 

Dale Caldwell, WhatIF 88. Fighting Poverty with Entrepreneurship. “One of the most successful ways to reduce poverty in the Group of Twenty (G20) countries is to implement a place based program called ‘Entrepreneur Zones’ or ‘EZones.’”

McKinsey & Company. Racial equity in financial services. McKinsey takes the gloves off and gets to the figures. “In our research, 75 percent of Black employees above entry-level are onlys, compared with 40 percent of Latinx, 31 percent of Asian, and 4 percent of white employees.”

Emerging Manager Monthly. Graduation Day. Meketa Investment Group’s LaRoy Brantley, Judy Chambers, and Alli Wallace Stone capture the essence of a mature emerging and diverse manager program. “Those who have been successful in cultivating their emerging and diverse manager programs know it requires far more than just capital.”

NY Times. The Hottest Amenity From (Real Estate) Developers? A Power Plant Made of Batteries. “We are at a turning point,” said Mark Dyson, a clean-energy expert at RMI, a Colorado organization focused on sustainability. “Since price points have come down so much, especially for batteries, I’d expect a growing fraction of new homes will incorporate these technologies…“

Connected RE. The Rudin Family launches one of the first multi-tenant CBRS networks at 345 Park Avenue. Infrastructure is making innovative leaps to meet data needs. “CBRS (Citizens Broadband Radio Service) spectrum, also known as the ‘innovation band,’ 345 Park tenants will be able to create and access their own dedicated, private broadband wireless network…Tenants, employees, and visitors can use this higher capacity private network, while building owners can accommodate a lot more devices.”

Visual Capitalist. 25 Largest PE Firms. “In fact, of the largest 25 private equity firms in the last five years, just four are headquartered in Europe (CVC, EQT, Cinven, and Permira) and one in Asia (Hillhouse).”

SS&C Intralinks. 2020 LP Survey. Allocation trends.

Ted Talks. The counterintuitive way to be more persuasive | Niro Sivanathan What’s the best way to make a good point? Organizational psychologist Niro Sivanathan offers a fascinating lesson on the “dilution effect,” a cognitive quirk that weakens our strongest cases–and reveals why brevity is the true soul of persuasion.

Based in New York, Steward builds portfolios of small buyout, growth equity, and opportunistic strategies to invest in the Middle Market. Through strategic partnerships with emerging and diverse managers, we seek to share in their success on the path to launching fund I while lowering the cost of private markets investing for our Limited Partners.

A value orientation focuses our lens on innovation and disruption in the healthcare, consumer, industrial, fintech, and technology sectors. Additionally, on a limited basis, we expand our scope to complementary special situations and infrastructure strategies.  

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