“Private equity is a lot like buying a flat and renovating it. All the repairs add value” says Nadiia Kaznacheieva, Investment Director at UMG Investments, a leading Ukrainian investment firm. “Ukrainian companies could really benefit from this approach.”
Private equity has been on the rise globally yet it remains misunderstood by Ukrainian managers. Many believe it’s all about buying assets on the cheap only to sell them later at a profit.
Rather, Kaznacheieva says, private equity is about doing your homework as a business manager – understanding a business in depth, developing a solid business plan, installing the best managers, cleaning up finances and implementing best practices (especially in terms of transparency and corporate governance). “There is a specific private equity culture and approach,” Kaznacheieva explains.
UMGI recently entered the private equity sector with its acquisition of a stake in Feednova*, a producer of high-protein feed additives and animal fats. Together with Ukrainian and Dutch partners, they plan to start production soon, targeting not just the Ukrainian but also international markets with high-quality animal feed.
Private equity – how does it work
Despite becoming a common term in business media, private equity remains a mystery for many on the market, UMGI’s investment director says. According to her, one of the most important misconceptions concerns the approach and mindset of private equity. “People think this is like speculation,” Kaznacheieva says with a hint of disappointment. “It’s actually the opposite – private equity takes a strategic investor perspective.”
While there are thousands of firms, each with its own culture and way of working, there are a few things in common.
In brief, private equity funds find interesting but undervalued companies whose operations and finances can be improved, acquire a share of ownership in a private deal (as opposed to buying on public markets), and spend several years investing and transforming the company. After that, they sell it (a term known as “exiting”), either on the private market or via a public offering.
“In a way, it’s like buying and renovating a flat,” Kaznacheieva sums it up. The more, and better, repairs and tuning you do, the better the final exit price.
The time horizon between entry and exit is critical – during this period, the private equity fund has the opportunity to transform the company, but also bears all the risks involved. Earlier this time horizon would be less than 5 years, Kaznacheieva says, but recent studies by global consultancies Bain and McKinsey show it is extending, often to 6 or 7 years.
Kaznacheieva adds that UMGI is well positioned in this regard as it only has one limited partner (what investors providing capital are called in the private equity world). The firm maintains the flexibility to exit at the best possible moment, rather than having to hurry to meet someone’s timetable and agree to a sub-optimal deal.
A global boom for the industry
Private equity is enjoying a good run. A recent article in the Financial Times noted the number of private equity-backed companies in the United States rose from less than 2,000 to nearly 8,000 between 2000 and 2018. Meanwhile, publicly listed companies declined from 7,000 to around 4,000.
Similarly, the private markets have added a whooping $4 trillion to assets under management over the past decade – from $2.4 to $6.5 – according to a study by McKinsey.
There is a long list of factors supporting the industry. Interest rates on financing of deals are at record lows – something that has also improved in Ukraine, Kaznacheieva says. The list of companies ripe for transformation has grown.
Despite the global growth, the private equity industry is still heavily United States-focused, says Kaznacheieva, adding that around 80% of the top 25 private equity firms are from the U.S. “It’s a mature market, not just in terms of the market, but also the culture,” she explained.
A unique culture of transparency, diligence and hard work
This private equity culture is indeed a unique driver of the industry. Contrary to some misconceptions, the industry is not all about buying companies and slashing jobs, or just waiting for the market to turn around.
“People think that we just sit and wait,” Kaznacheieva says. “The believe that private equity will not add value.”
In fact, the opposite is true. While there are many different strategies, most funds are about hands-on investment, overhauling old models via reorganization and operational improvements. That means installing good managers, cleaning up finances and running an efficient and transparent business.
This transparency is important for the sector. By having more reliable and open books, Kaznacheieva notes, private equity funds can attract bank financing on better terms. It also helps secure a better valuation on exit, because buyers understand the company better and have lower risk.
“The more transparent you are, the better the deal you can get,” Kaznacheieva sums it up.
This doesn’t always sit well with company managers in Ukraine. Kaznacheieva recalls one manager telling her it’s “cheaper to not pay taxes, than to pay taxes and attract a private equity partner.”
Short-term thinking leaves a lot of value on the table. It is also a reason why having good managers you can turn to – that can join a company and clean things up – is a real competitive advantage for private equity firms, the expert says.
This is one of the advantages of UMGI, which has deep operational expertise understands production. “Our transparency and expertise are why partners choose us,” the UMGI investment director explains.
Large private equity players have another advantage. By working with many companies, big funds build relationships with top-tier managers who can come and help them steer acquired firms towards profitability.
“When you grow businesses, you typically need more people,” Stephen Schwarzman, the CEO of the world’s biggest private equity fund with assets under management (the value of companies managed) of over $600 billion, told a global industry forum last year.
The private equity opportunity for Ukraine
Private equity is a great opportunity for Ukrainian companies, says Kaznacheieva. There are a large number of sectors that offer interesting investment opportunities, including recycling, mining and agro-processing. “Healthcare is a blue ocean,” the investment expert adds.
The industry is not exactly new to the country. Horizon Capital was one of the first players on the market after it was spun out of the Western NIS Entreprise Fund in 2006. Since then, others have come in, like Abris Capital or Advent International, a major Boston-based firm. But the crisis of 2008-9 led to many firms leaving the market.
Since then, some new names have appeared – Dragon PE, Diligent Capital Partners and others.
But there is still an opportunity to seize, Kaznacheieva notes. Global private equity firms are sitting on record levels of “dry power,” an industry term for capital that has been raised but not yet invested, exceeding an astounding $2 trillion as of end of 2019. Part of that capital could come to Ukraine.
The benefit for the market is not just additional investment, Kaznacheieva explains. “Every private equity firm works a bit differently,” she notes. “This experience is very valuable.”
Private equity has a wide range of benefits – healthier and better performing companies, stronger and more transparent governance practices, increased tax revenues and more innovation. So what is holding back its wider adoption?
According to Kaznacheieva, companies not only need to understand the benefits and how the industry works, but also find the right partner with the right management capabilities and sector expertise. You also need to have a strong culture and know how to work with people.
“Private equity, it’s a bit like marriage. You need the right ‘chemistry’ with people. When you have it, everything else is working well,” she says.
*FEEDNOVA – modern enterprise for production of high protein feed additives for agricultural and domestic animals. It is an investment project of «Effective Investments» group of companies, Mada Participations B.V. (the Netherlands) and UMG Investments. The total project investments are more than USD 20 million.
